March 25, 2022
March 25, 2022
Several recent proposals introduced in Congress would tax excess corporate profits, meaning profits that have landed in the laps of companies and their shareholders because of market power or luck rather than new investment or innovation. These proposals are a reasonable response to huge profits flowing to corporations that may have done little to earn them while consumers pay higher prices than ever for goods and services.
But most corporate profits are, in some sense, excess profits, as explained further on. These proposals address the current situation, but ultimately leaders in Washington must fix federal law to tax all corporate profits and stop the corporate tax dodging that is rampant today. Congress could accomplish this right now by enacting the corporate tax reforms in the Build Back Better Act that was approved by the House of Representatives last year.
The New Excess Profits Tax Proposals
Last week, Rep. Peter DeFazio, D-Ore., introduced a bill imposing a one-time tax of 50 percent on excess profits of the biggest oil companies for 2022. And this week, Sen. Bernie Sanders of Vermont introduced a 95 percent tax that would apply to excess profits of all large corporations (defined as corporations with more than $500 million of revenue) in 2022 through 2024.
Both define excess profits as the difference between a corporation’s 2022 profits and its average profits during the five years before the pandemic, 2015 through 2019. Both allow an adjustment for the usual expected growth in profits. The DeFazio bill defines excess profits as more than 110 percent of the average profits from the five pre-pandemic years while the Sanders bill takes inflation into account. Both define corporate income broadly to prevent companies from getting around the tax.
The DeFazio bill would use the revenue raised to send rebates to taxpayers, with income limits borrowed from the stimulus payments provided under the American Rescue Plan Act. The Sanders bill does not spell out any particular use for the revenue.
Two weeks ago, Sen. Sheldon Whitehouse of Rhode Island and several other Democrats introduced the “Big Oil Windfall Profits Tax Act” which technically would impose a tax not on windfall profits themselves but on the excess of the price of oil sold by the largest oil producers compared to the average pre-pandemic price from 2015 through 2019.
The tax would be imposed on domestically produced oil and imported oil, and the revenue raised would go toward rebates sent to consumers. Only the largest oil companies, accounting for 30 percent of the market, would be subject to the tax, which would make it more difficult for them to pass the tax onto consumers via higher prices.
While the mechanism differs from the other proposals, Sen. Whitehouse’s bill is motivated by the same understanding that Americans are paying higher prices to a group of corporations that did little to earn their surging profits.
Long-Term Solutions Required to Address Untaxed Corporate Profits
These proposals are helpful responses to the current situation. But the long-term solution must recognize that most corporate profits are in a sense “excess profits” and ultimately Congress must fix the federal tax code to tax all corporate profits rather than attempt to disentangle which profits are more “deserved” than others.
A 2021 ITEP study found 55 large, profitable corporations avoided paying federal income taxes in 2020 while the pandemic economically battered most of America. A later ITEP study found that 39 large corporations reported profits in each of the first three years that the Trump tax law was in effect yet paid no federal income taxes over that period. Another 73 consistently profitable corporations paid less than half the statutory rate of 21 percent on their profits.
Most corporate profits going untaxed today likely are what economists call supernormal returns or excess profits. These are profits exceeding the normal profit needed to attract shareholders or pay lenders and justify the investments, work and innovation that go into the business. In theory, even if excess profits are taxed away completely, corporations would still have an incentive to invest and innovate to generate what economists consider normal profits.
In a competitive market, a corporation cannot generate supernormal returns/excess profits for a very long time because another company would come along and replicate whatever it is doing to make money. But markets are not always competitive. Corporations can often generate these profits year after year, even when they are no longer investing or innovating very much.
This might be because a company has a monopoly or near monopoly after acquiring its competitors (like Facebook acquiring Instagram, WhatsApp and other companies), or because the barriers to entering the market are very high (such as oil refineries that are hugely expensive to build), or because of government-granted patents and copyrights barring other companies from selling the same products (important for pharma and tech companies). Or these profits might result from luck – like a surge in global oil prices caused by war in Ukraine.
This is consistent with how the business world has behaved for the last several years. In 2013, Paul Krugman noted that corporate profits are increasingly disconnected from investing and producing anything. Whereas General Motors once employed 1 percent of the workforce, a modern-day colossus like Apple “seems barely tethered to the material world.” According to Krugman, Apple, which employs just 0.05 percent of the U.S. workforce, “simply charges what the traffic will bear, and given the strength of its market position, the traffic will bear a lot.”
If most corporate profits are supernormal returns and excess profits, this means that any proposal to prevent companies from avoiding the corporate income tax would mainly increase taxes on these types of profits and have little effect on incentives to invest and build our economy.
Fortunately, a whole package of such corporate tax proposals is before Congress right now. It was included in the Build Back Better Act that was passed out of the House of Representatives in November. The revenue-raising provisions seem to have the support of all the Senate Democrats, although the bill has stalled in their chamber because of disputes over how to use the revenue that would be raised. The list of corporate revenue-raising provisions that were recently debated but did not make it into the House bill is even longer.
Temporary tax increases to address the current situation are a fine start, but lawmakers have in front of them all the pieces to build a comprehensive reform that fundamentally fixes our tax code and ensures that corporate profits are taxed fairly.