Excess Profits Tax Definition

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Excess Profits Tax Definition

What is an Excess Profits Tax?

An excess profits tax is a special tax levied on individual or business income that exceeds a certain level of return on invested capital, generally in excess of what is considered regular income. An excess profits tax may be adopted with the goal of lowering income inequality, dispersing windfall gains caused by specific circumstances or government policies, or producing emergency money for the government in times of crisis. Excess profits taxes may be either temporary or permanent features of a tax system.

Key Takeaways

  • An excess profits tax is an additional tax levied on corporate earnings or income that exceed a specific threshold.
  • Excess profits taxes, which might be temporary or permanent, are often meant to counteract income disparity, particularly those caused by windfall gains.
  • Excess profits taxes have been levied by the federal government in the United States on several occasions during times of war and other emergencies.
  • During the coronavirus epidemic in 2020, Berkeley economists Emmanuel Saez and Gabriel Zucman recommended a federal excess profits tax once again.

Understanding Excess Profits Tax

An excess profits tax is a tax paid on company earnings or revenue that exceed a certain level of profit. Companies and self-employed persons that earn more than the stated amount must pay an extra tax on that income. An excess profits tax is levied in addition to any existing individual or company income tax. An excess gains tax, in effect, indicates a rise in marginal tax rates on earnings in higher tax bands.

As a result, an excess profits tax increases the progressivity of the tax system by taxing higher-income people and enterprises at a greater rate than is ordinarily charged. Some economists and politicians who are concerned about societal income inequality propose for excess profits taxes as a means of closing or slowing the wealth gap. Excess profits taxes are understandably unpopular among free-market advocates, who believe they inhibit productivity by lowering the profit motivation for enterprises.

  Proportional Tax Defined

Excess Profits Taxes in Extreme Circumstances

Excess profit taxes may also be levied to directly disperse windfall earnings resulting from unforeseeable, exceptional occurrences. For example, if construction supply companies are able to make higher-than-normal profits by charging higher prices in the aftermath of a hurricane, the government may consider imposing an excess profits tax on them on the grounds that their higher profits are the result of the hurricane’s random occurrence rather than good business sense or management practices. The tax might be applied to any increase in the rate of profit received by these enterprises in comparison to regular periods.

Alternatively, if the windfall gains are the result of a purposeful government policy, an excess profits tax may be applied. For example, if a war breaks out and the government suddenly increases demand for munitions, an excess profits tax could be imposed on ammunition manufacturers and suppliers of related raw materials such as copper or lead to compensate for the increased profit margins these businesses will enjoy as a result of increased government demand. In this situation, the tax might be levied on the difference between the amount of profit produced by a corporation during normal times and profits gained during times of conflict.

History of Excess Profits Taxes

In 1917, Congress passed the first American excess profits tax, with rates ranging from 20% to 60% on all firm profits in excess of peacetime earnings. A statute was passed in 1918 that confined the tax to companies and raised the rates. Despite strong efforts to make it permanent, the excess profits tax was abolished in 1921. As supplements to a capital stock tax, Congress established two moderate excess profits taxes in 1933 and 1935.

  Tax Schedule

Between 1940 and 1943, Congress approved four excess profits legislation, with rates ranging from 25% to 50%. During the Korean War, Congress established an excess profits tax, which was in place from July 1950 until December 1953. At the time, the tax rate on surplus earnings was 30%, with top corporation tax rates climbing to 47 percent from 45 percent.

As part of energy policy, certain members of Congress proposed, but failed, to impose a 40% excess profits tax on the largest oil firms in 1991. Certain activists have called for the adoption of the excess profits tax during peacetime, but such suggestions have been met with considerable resistance from corporations as well as some politicians and economists who claim it would create a disincentive to capital investment.

Recent Excess Profit Tax Proposals

During the 2020 coronavirus pandemic, economists Emmanuel Saez and Gabriel Zucman recommended an excess profits tax on enterprises that benefitted from the epidemic’s consequences, as well as government enforcement of relevant public health regulations. Fear of the illness, as well as mandated quarantines, company closures, shelter-in-place orders, and social distancing measures, hurt many enterprises while benefiting others, particularly web-based and distant services. As more individuals work, buy, and socialize from home over the internet, online shopping, cloud computing, remote business applications, media streaming services, and social media have all witnessed significant increases in traffic and business volume.

Simultaneously, the federal government increased spending considerably by approving a stimulus package to counteract the economic harm caused by the virus and the public health response to it. Saez and Zucman recommended the excess profits tax to assist pay for emergency expenditures and to ensure that windfall earnings from the coronavirus are shared with those who have suffered.

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