An excess profits tax, also sometimes referred to as a windfall profits tax, is a corporate income tax that is levied on profits above a specified level. It is assessed in addition to any corporate income tax already in place. It typically takes effect when corporate profits reach a certain level above what is considered normal. Historically in the United States, an excess profits tax has been put into effect by the federal government during periods of war. In addition, an excess profits tax was assessed on oil producers during the 1980s when the price of a barrel of crude oil went above a certain specified level.
The federal government of the United States put an excess profits tax into effect around the time of World War 1 (1917-21), World War 11 (1940-45), and the Korean War (1950-53). The purpose of the tax was to return to the government the profits private businesses realized as a result of high government spending caused by the wartime situation. The World War II excess profits tax, for example, was set at 95 percent of all corporate income in excess of what was considered normal.
Historically the excess profits tax has been difficult as well as expensive to administer and collect. Disputes arose between private corporations and the government over a variety of accounting practices and treatments that affected corporate profits. Among the accounting practices that were argued over were the treatment of borrowed capital, accumulated deficits, new business, and invested capital. Since the tax was relatively expensive to administer, its net yield was often less than anticipated.
The excess profits tax enacted during the Korean War, effective July 1, 1950, was intended to raise $4 billion annually. The target of the tax was corporate profits that were inflated by government expenditures related to the Korean War. As originally enacted, the law imposed a 30 percent tax on all corporate profits that exceeded 85 percent of the average three highest years since 1946. Subsequent legislation modified the terms of the tax, which expired on December 31, 1953.
The only non-wartime excess profits tax in the United States was enacted in 1980 under President Jimmy Carter. Commonly referred to as the windfall profits tax, it was assessed against the excess profits of oil producers that resulted from an energy crisis. Internal upheaval in Iran had caused the price of oil to soar, and Americans were waiting in lines to fill their cars with gasoline. It was perceived that oil producers were enjoying excess profits as a result of the situation, so the federal government enacted an excess profits tax.
The excess profits tax on oil producers was levied when the price of a barrel of crude oil hit a certain level, ranging from $19 to $29 depending on the oil's classification. The tax rate varied from 30 to 70 percent of the oil producer's revenue above the trigger price. The oil industry had many disputes with the government over the tax, and in fact the industry regarded it as an excise tax on revenues rather than as an excess profits tax. In 1994, Amoco Corporation was awarded a $440 million refund from the Internal Revenue Service for overpayment of the tax. Amoco's dispute was based on a variety of accounting treatments, including what types of expenses could be allocated to an oil well.
The excess profits tax on oil producers was repealed in 1988 under President Ronald Reagan as part of a wide-ranging trade bill. At that time the price of crude oil was approximately $15 per barrel, well below the trigger price. The government had not collected any significant revenues from the tax since 1986, when the price of crude settled below the tax's trigger price. According to the oil industry, it was costing oil producers approximately $100 million annually to comply with the recordkeeping requirements of the law. During the eight years it was in effect, the excess profits tax on oil producers generated about $77 billion in tax revenue for the federal government.
In England, a windfall profits tax was levied on banks in 1980 by the Conservative government then in power. The one-time tax was levied on the excess profits banks were making as a result of a sharp increase in interest rates caused by new monetary policies. When England's Labour Party submitted its budget for fiscal 1998, it included a provision for a windfall profits tax on recently privatized utilities such as British Telecom, British Gas, and Railtrack. Concerns raised in discussing the tax included whether or not it would be a one time tax, how far back the retrospective tax would be applied, and how to define a "privatized utility." If the tax were an ongoing one, rather than a one-time tax, it was argued that such a tax would blunt the taxed companies' incentive to keep costs under control and that customers would end up paying higher prices for services. If the tax was truly a one-time tax, then it was argued that the costs would be borne by the taxed companies' shareholders in the form of lower dividends and share prices.
[ David P. Bianco ]
"Chasing Windfalls." Economist, 14 June 1997, 61-62.
"A Tempting Target." Economist, 9 December 1995, 67.