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August 16, 1940 THE WAYS AMD MEANS SUBCOMMITTEE * S EXCESS PROFITS TAX The excess profits tax drafted by the Ways and Means Subcommittee on Taxation differs from the proposal submitted by the Treasury principally in its method of measuring excess profits, and in the rates of tax to be applied. In earlier excess profits tax legislation in this and other countries, one finds two distinct concepts of excess profits. According to one concept, excess profits are determined by comparison with past earnings and are defined as the excess of profits in the taxable year over average profits in a specified base period. According to the other definition, excess profits are determined by reference to invested capital, and profits in excess of a specified rate of return are regarded as excess. The Treasury proposal rested upon a skillful combination of these two concepts. Although base period earnings were to be used in the first instance in arriving at excess profits, a "floor" based upon invested capital was provided as a measure of relief to corporations whose rate of return was abnormally low in the base period, and a "ceiling* based upon invested capital was substituted for standard earnings wherever rates of return in the base period were abnormally high. Thus, corporations whose average earnings in the period 1936-39 were below 4 per cent of invested capital (6 per cent on the first $500,000 of invested capital) might elect to be taxed on the excess over this rate of return instead of on the excess over their actual earnings, while corporations whose rate of return in the base period was over 10 per cent were obliged to treat as excess all earnings above this rate. The Ways and Means Subcommittee has abolished this "ceiling* provision, enabling corporations earning 20 per cent, 50 per cent or more to be exempted from excess profits taxation if the corporations concerned have been accustomed to these rates of return in the past few years. The Subcommittee proposes tax rates of 25, 30, and 40 per cent, as compared with the Treasury rates of 25, 40, and 50 per cent. This description of the two proposals omits many detailed provisions, including favorable treatment of personal service corporations and small corporations generally, and special allowances for corporations, particularly small corporations, having outstanding debt. It is difficult to escape the feeling that the Ways and Means Subcommittee has set itself the task of devising the mildest tax formula which would have any chance of getting by under present conditions. The political wisdom of a half-hearted approach to excess profits taxation is surely questionable in a period of emergency so grave that it may require conscription of manpower. The following specific points should be noted: 1. The abolition of the "ceiling" provision means that corporations will be taxed, at most, only on the increase in their earnings. Since virtually all of the increase in corporate profits over the next few years will be attributable, directly or indirectly, to defense outlays, it is scarcely enough to tax away only a modest fraction of that increase. If we are to create the morale which is the most basic requirement for national security, we must take advantage of the emergency to make much swifter progress in reducing inequalities -3- than would be possible in less critical times. At the very least, the excess profits tax should be levied against all excessive corporate profits, not merely against the increment of profits. This implies the restoration of a "ceiling" provision in the bill. 2. The proposed rates of excess profits taxation are exceedingly low. In Great Britain the rate was placed initially at 60 per cent. (It has since been raised to 100 per cent.) In the last war, we had rates of 65 and 80 per cent. A rate schedule reaching at least 60 per cent at the highest bracket should be imposed if we are going to have an excess profits tax at all.
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