Excess Profits Tax: Meaning, History, and Recent Proposals

What Is an Excess Profits Tax?

An excess profits tax is a special tax assessed on individual or corporate income beyond a specified amount of return on invested capital, usually exceeding what is deemed to be normal income. An excess profits tax can be implemented to reduce income inequality, redistribute windfall gains that may result from special circumstances or government policies, or generate emergency revenue for the government in times of crisis. Excess profits taxes may be temporary measures or a permanent feature of a tax system.

Understanding Excess Profits Tax

An excess profits tax is an extra tax levied on business profits or income above a specified rate of profit. Companies or self-employed individuals who earn above the specified level have to pay an additional tax on that income.

An excess profits tax is assessed in addition to any individual or corporate income tax already in place. In effect, an excess profits tax represents an increase in marginal tax rates on profits in higher tax brackets. Because of this, an excess profits tax represents an increase in the progressivity of the tax system, by taxing individuals and businesses with higher income at an even higher rate than normally imposed.

Some economists and policymakers who are critical of income inequality in society advocate for excess profits taxes as a way to reduce or slow the wealth gap. Understandably, excess profits taxes are not popular with free-enterprise thinkers who feel that it discourages productivity by reducing the profit motive for businesses.

Excess Profits Taxes in Extreme Circumstances

Excess profit taxes can also be imposed to directly redistribute windfall profits that result from random, extreme events:

• For example, if construction supply companies can earn higher than normal profits by charging higher prices in the wake of a hurricane, the government may consider implementing an excess profits tax on them. That's because their higher profits are due to the random occurrence of the hurricane rather than to good business sense or management practices. The tax could apply to any increase in the rate of profit these businesses receive relative to normal times. 

Alternatively, an excess profits tax may be imposed if the windfall profits are due to a deliberate government policy:

• For example, if a war breaks out and the government suddenly boosts demand for munitions, an excess profits tax could also be levied on ammunition manufacturers and suppliers of related raw materials like copper to compensate for the increased rate of profit these businesses will enjoy as a result of increased government demand. In this case, the tax itself may be imposed on the difference between the amount of profit that a company generally earns during peacetime and the profits earned during times of war.

History of Excess Profits Taxes

Congress enacted the first American excess profits tax in 1917 with rates ranging from 20% to 60% on the profits of all businesses in excess of peacetime earnings. In 1918, a law limited the tax to corporations and increased the rates. In 1921 the excess profits tax was repealed despite powerful attempts to make it permanent. In 1933 and 1935 Congress enacted two mild excess profits taxes as supplements to a capital stock tax.

During World War II, Congress passed four excess profits statutes between 1940 and 1943 with rates ranging from 25% to 50%. During the Korean War, Congress also imposed an excess profits tax, effective from July 1950 through December 1953. The tax rate at this time was 30% of excess profits with top corporate tax rates rising to 47% from 45%.

In 1991, some members of Congress attempted to pass an excess profits tax of 40% upon larger oil companies as part of energy policy, but that effort was unsuccessful. Some activists have advocated for a peacetime use of the excess profits tax, but such proposals face strong opposition from businesses as well as some politicians and economists who argue it would create a disincentive to capital investment.

New Excess Profit Tax Proposals

Economists Emmanuel Saez and Gabriel Zucman proposed an excess profits tax on businesses that benefited from the effects of COVID-19 and the government enforcement of related public health restrictions.

Fears of the disease as well as imposed quarantines, business closures, shelter-in-place orders, and social distancing measures harmed many businesses but also benefited some, especially web-based and remote services. E-commerce, cloud computing, remote business applications, media streaming services, and social media all saw higher traffic and business volume as more people work, shop, and socialize online from home. 

The U.S. government ramped up spending by passing a stimulus package to offset the economic damage caused by the virus. Saez and Zucman proposed the excess profits tax to help pay for emergency spending and to help make sure the windfall profits of those who benefited from COVID-19 are shared with those who suffered. In 2022, two significant legislative proposals were introduced to address corporate profiteering during crises like the pandemic and the Ukraine conflict. 

Sen. Bernie Sanders (I-Vt.) introduced legislation to tax excess profits of corporations during the COVID-19 pandemic and the Ukraine conflict. The Ending Corporate Greed Act would apply a 95% tax on profits that exceed levels defined as normal, targeting only the biggest companies. The plan, which drew inspiration from similar taxes used during the World Wars and the Korean War, was designed to raise upwards of $400 billion over three years. 

The Bottom Line

An excess profits tax, which is charged on profits that exceed a certain amount, has been part of U.S. fiscal policy throughout history, especially during times of war. Its goals include redistributing windfall gains from large corporations, reducing income inequality, and raising emergency funds for the government. 

But, this is a controversial tax, as opponents argue that it discourages investment and may slow economic growth. Proponents argue that excess profits taxes are a fair way to redistribute windfall profits from big corporations, while also addressing inequality. A proposal from Bernie Sanders to implement such a tax during the pandemic and Ukraine conflict highlights the ongoing debate about the role of windfall taxes in the economy.