Corporate profits

It’s time to tax excessive corporate profits

Senator Bernie Sanders recently introduced the Ending Corporate Greed Act. the law would impose a 95% tax rate on the excess profits of large corporations that earn more than $500 million a year. Excess earnings are defined as earnings that exceed the company’s average earnings level from 2015 to 2019, adjusted for inflation. This excess profits tax will be imposed in addition to the normal corporation tax of 21%, but the two rates will be coordinated so that the maximum combined tax rate does not exceed 75% of income for a year. The tax will be a temporary emergency measure, applicable only in 2022, 2023 and 2024.

Like many of Senator Sanders’ ideas, this sounds radical (95% taxation!), but in fact it is not. Sanders’ proposal is entirely consistent with both the tradition of corporate taxation in the United States and its underlying economic and regulatory rationales.

More Reuven Avi-Yonah

First, the story: During World Wars I and II and the Korean War, the United States introduced a broad-based windfall tax. During World War II, the tax rate reached 95%, which prevented companies from profiting from the war. In addition, the United States adopted a tax on windfall profits of oil and gas companies as recently as the mid-1980s. The idea behind these earlier efforts was that companies should not make “windfall” profits, i.e. profits resulting from external circumstances such as wars or extraordinary increases in the price of certain raw materials, and not from their own efforts.

The current combination of the COVID-19 pandemic, which has driven the profits of companies like Amazon to record highs, and the war in Ukraine, which has done the same for oil and gas companies, fully justifies the relaunch of windfall tax. Sanders’ proposal is essentially identical to the World War II version of the tax, including reliance on a prewar average, the 95% rate, and limiting the overall effective tax rate.

Second, economics: economists distinguish between normal returns to capital, which are subject to competition and therefore relatively constrained, and rents or excess returns, which are not. Normal returns are a legitimate objective of taxation, but the tax rate should not be too high because a high rate would deter companies from making socially useful investments. Excess returns, on the other hand, are those that are not subject to competition. These are the benefits that a company that enjoys quasi-monopoly status like Amazon or Google, or quasi-oligopoly status like ExxonMobil or Chevron, derives from its access to a single resource and its dominance of the market. Since excess returns are not subject to competition, taxing them at even very high rates will not deter investment as the remaining after-tax profit will remain a bargain. The Sanders proposal correctly distinguishes between normal profits taxed at the normal rate of 21% and extraordinary profits taxed at 95%.

Finally, the regulatory objective: corporate taxation is not primarily about revenue (it accounts for less than 10% of total federal tax revenue) or redistribution (it is unclear who bears the burden normal corporate tax under competitive conditions, as part of it can be passed on to employees or consumers, while a tax on excess profits falls entirely on shareholders). Corporate tax is primarily aimed at regulating large corporations by granting them tax incentives (eg green energy credits) and disincentives (such as tax penalties offered for investing in Russia).

The Sanders proposal is designed to regulate companies that take advantage of the current inflationary wave, the pandemic and the war in Ukraine to increase their profits well above their previous average profit. Ideally, this would generate little revenue but induce lower prices, which would benefit everyone except the shareholders of the companies. But if such a price drop does not occur, the tax would generate significant revenue (according to Senator Sanders, about $400 billion in one year for 30 of the biggest profiteering companies alone). These revenues could be used to subsidize working families who are suffering the effects of rising prices and to accelerate the transition to renewable energy so that the economy is less at the mercy of oil companies, national and foreign.