Windfall taxes have mixed results in recent history


In a recent speech before the United Nations General Assembly, Secretary-General António Guterres demanded that advanced countries take a stand against the climate crisis by taxing “windfall profits of fossil fuel companies”.

US lawmakers have pushed for similar action. This summer, Senate Finance Committee Chairman Ron Wyden (D-Ore.) introduced a bill, the Taxing Big Oil Profiteers Act, that would impose a 21% tax on oil companies’ “excess profits.” and gas companies making over $1 billion a year. . “Our tax code should benefit the American people, not oil executives and their wealthy shareholders,” Wyden said.

Whether qualified as “exceptional” or “excess” income taxes, these levies have had a mixed historical record. While some have raised significant and much-needed government revenue during national crises, others have focused more on political symbolism than economic efficiency. In short, they are not a panacea for economic and social ills. Understanding their promises and limitations can help mitigate potential challenges.

An excess profits tax was first enacted in the United States during World War I. Even before the United States entered the Great War, large industrial corporations benefited enormously from war-related manufacturing. Between 1914 and 1916, US Steel and Du Pont saw their annual profits increase by more than 1,000% each. In response to these “war profiteers”, social commentators have supported sharply progressive taxes of all kinds to make “war brides” pay.

Once the United States officially entered the conflict in 1917 and began sending troops overseas, the demand for the taxation of profits intensified. People on both sides of the political aisle called for a “conscription of wealth and income” to match the “conscription of men”.

Tax experts at the Treasury Department have begun to study several types of income taxes already in force in Canada and Europe. These existing rights generally fell into two categories: “excess or high profits” taxes and “war profits” taxes. An excess profits tax was levied on profits that exceeded a certain benchmark level considered a “reasonable” or “normal” rate of return on “invested capital”. In contrast, a ‘war profits’ tax was levied on profits that exceeded a certain average level of ‘pre-war’ profits.

In October 1917, the idea of ​​taxing excess profits won. The “War Excess Profits Tax” exempted up to 9% of returns on invested capital and taxed all profits above that level at progressive rates ranging from 20% to 60%. Treasury economist Thomas Adams hailed the tax as “the most revolutionary development in public finance since the introduction of the income tax”.

This first excess profits tax in the United States accomplished a great deal. It generated nearly $7 billion in revenue, accounting for about 40% of all federal tax revenue collected for the war and making it the single largest source of wartime taxation.

But it didn’t take long for the biggest corporations to figure out how to avoid the excess profits tax head-on. Working with their high-priced lawyers and accountants, these corporations were able to inflate their invested capital measure and thereby reduce their excess profits tax.

As a result, one of the unintended consequences of the World War I excess profits tax was that it hit small businesses harder than the large ones it was meant to attack. This proved to be the death knell for the first excess profit tax. With the war over, Congress quickly abolished the tax in 1921 as part of the Republican rollback of the wartime fiscal state.

The idea of ​​taxing excess profits persisted, however. During World War II, President Franklin D. Roosevelt was adamant about enacting an excess profits tax to curb war profiteers. “Our current state of emergency and a common sense of decency make it imperative that no new group of war millionaires emerge in this country as a result of the struggles on board,” he said. “The American people will resent the idea of ​​an American citizen becoming rich and fat in an emergency of bloodshed and slaughter and human suffering.”

After the World War II draft was instituted in 1940, Congress quickly passed a new version of the levy, but this time the political compromise allowed companies to choose the method they would use to measure their “excess” profits. Not surprisingly, the World War II excess profits tax was not as effective as its predecessor. It generated only around 25% of total wartime tax revenue, and it was also abolished soon after the war, with little discussion of its permanence.

It is not only in times of war that Congress levied such taxes. In 1980, under President Jimmy Carter, the federal government enacted a “windfall” profits tax on the US oil industry in response to soaring gas prices and recent deregulation of the industry. The Crude Oil Windfall Profit Tax Act was perhaps the most ill-conceived measure of its kind. In fact, it did not tax profits. Instead, it was an excise duty imposed on the difference between the prevailing market price of oil and an adjusted base price set by law. Essentially, he taxed the rise in the price of oil.

As the price of oil quickly stabilized, the revenue generated remained well below projections. The complexity of calculating the tax has made it an enormous administrative burden for the IRS and potential taxpayers. And because the tax was imposed primarily on domestic oil production, the law helped increase dependence on foreign oil. Most economists called it a colossal failure.

The historical US experience with excess and windfall taxes should therefore be taken as a cautionary tale. When these taxes are well designed and carefully implemented to capture rent-seeking activity, they can be effective, as they were in World War I, at least initially.

Certainly, there are many parallels between today and the experience of the First World War. Fossil fuel companies today have largely profited from current geopolitical conditions, particularly the war in Ukraine, just as munitions manufacturers did during both world wars. In July, Exxon announced record quarterly profit of nearly $18 billion, while Chevron unveiled its own record quarterly profit of more than $11 billion.

Even those who think that taxing the windfall profits generated by current crisis conditions is a laudable goal should realize that historically such levies seem to work mostly during moments of short-term crisis, such as the one we may be witnessing. -to be today. Their long-term durability is hardly guaranteed. Such taxes might provide some political and moral solace now, but they rarely deliver on their promise of greater lasting tax fairness, which ultimately dooms their permanence.

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