Taxes in the Time of Coronavirus: Is it Time to Revive the Excess Profits Tax?

Courtesy of Reuven S. Avi-Yonah

A recent New York Times headline summarizes one of the most significant economic impacts of the current pandemic: “Big Tech Could Emerge From Coronavirus Crisis Stronger Than Ever.” At a time when most American citizens and businesses are suffering catastrophic economic damage from the Coronavirus recession, some corporations—such as Amazon, 3M, Gilead, and Zoom—are seeing their profits rise dramatically because of the pandemic.

Given that most corporations are losing money, but some are now earning enormous profits due to the crisis, it is time to revive the wartime excess profits taxes that the US deployed in World War I and World War II to prevent corporate winners from achieving this form of opportunistic unjust enrichment.

The most recent US excess profits tax was enacted shortly before the US entered World War II. It was first adopted in 1940, amended in 1941, 1942, 1943, and 1945, and repealed in 1950.

Excess profits taxes are designed to tax the proportion of profits that derives from some external event, not of the taxpayer’s making. Congress adopted the excess profits tax to “syphon off war profits.” The tax addressed both direct and indirect profits resulting from the war, and the tax rate was set at 95%. This made the definition of average profits crucial since those profits would only be taxed at the regular corporate rate (currently 21%). Any profit above average profit was deemed to be excess profits.

The calculation of the excess profits tax base began not with gross income but with net income as shown on the corporate tax return. This number was then reduced to create “excess profits tax net income.” The reduction removed certain items like long-term capital gains and losses, income from the discharge of indebtedness, and income from recovering bad debts incurred before the war.

“Excess profits tax net income” was then used to calculate the “excess profits tax credit,” which was designed to remove average profits from the tax base. There were two methods used to calculate the credit: The “average earnings” method and the “invested capital” method.

The average earnings method of calculating the excess profits tax credit began by looking back at the years 1936, 1937, 1938, and 1939 (before the war) and determining a monthly base-period average income. The amount of the credit was 95 percent of the “average base period net income,” plus eight percent of the corporation’s net capital addition (or minus six percent of net capital reduction). The result created a deduction from excess profits tax net income. The average base period net income was deemed to be average peacetime profit and, therefore, not subject to the excess profits tax.

Alternatively, the invested capital method assumed that a fair return on invested capital is eight percent on the first $5 million, six percent on the next $5 million, and five percent on invested capital beyond $10 million. Calculating invested capital involved summing all of the cash and property investment in the corporation and all profits prior to the taxable year, then reducing that figure by“ all the distributions that have been made to stockholders out of other than earnings and profits,” plus 50 percent of current debt. This figure was then multiplied by a ratio of “inadmissible assets” to total current assets, which removes credit allowance for partially or wholly tax-exempt assets (such as tax-exempt bonds and stock in corporations producing exempt dividends). The idea was that a taxpayer should be entitled “to a fair return on its invested capital before being subjected to [the] excess profits tax.”

Finally, the sum of the excess profits tax credit, any carry-back or carry-forward of unused credits, and a de minimis exemption was deducted from excess profits tax net income. The result was “adjusted excess profits tax net income,” which was taxed at 95%.

If Congress wanted to impose a modern excess profits tax, how should it go about it?

Given the diversity of the corporations that are likely to profit from the pandemic and the fact that most of them are not engaged in capital intensive activities, the tax should use the average earnings method based on 2016, 2017, 2018, and 2019. The rest of the World War II methodology can be applied unchanged. Thus, to use Amazon as an example, one would start with Amazon’s 2020 net income, subtract a credit for average 2016-2019 earnings plus 8% of R&D (the principal capital investment), and apply a 95% tax rate to the excess profits. The resulting tax can be reduced by credits for wages of additional employees hired in 2020 to encourage the winners to hire and pay well during the recession.

It is unconscionable that some corporations would profit from the current crisis while everyone else suffers. Moreover, the federal government will be spending trillions to save the economy, and much of this spending will benefit the winners since it will be spent on their services. There is no reason not to use this opportunity to revive the excess profit tax and apply it to profits that derive entirely from the pandemic.

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