Excess Profits Tax: A Howling Mess

The Congressmen who are urging an excess-profits tax on the oil industry are making a proposal that is more innovative than they may realize. Major excess-profits taxes have been clamped on U.S. business three times since 1917, but in every case the tax was levied on almost all corporations in order to help pay for a war. Never before has the nation debated imposing an excess-profits tax on a single industry in peacetime.

Previous excess-profits taxes have been justified partly as a way to raise vast amounts of money quickly. Now, practically nobody bothers to talk much about how many dollars an excess-profits tax might collect. Instead, the controversy turns on issues of fairness and effectiveness.

By its very nature, an excess-profits tax is highly complicated. Many economists contend that there is no such thing as "excess" profit because in a free economy a corporation is supposed to earn the highest profit it can. Alan Greenspan, a member of TIME'S Board of Economists and adviser to the Nixon Administration, contends that people who favor the tax are unconsciously adopting a Marxist view that profit is basically exploitation.

The answering philosophical argument has been that profits can be considered "excess" if they result not from a corporation's efficiency or inventiveness but from outside circumstances that remove the normal checks of the market and allow profit at the expense of the public. Historically, that argument has been given a moralistic cast by war: it seemed wrong for a company to earn outsized profits out of a situation that imposed suffering on many citizens.

Advocates of an excess-profits tax on oil now make exactly that pitch. Senator George McGovern, introducing a bill to tax "excess" oil earnings, declared: "Simple justice demands that no company or individual profits unconscionably from a national crisis." A more economic argument is that the artificial shortages created by war or an Arab oil embargo give companies a chance to post higher prices than normal markets would justify. In such cases those prices may have to be tolerated to encourage needed production. But, the argument goes, Government should make sure that at least some of the "abnormal" profits generated by those prices work for the public good--by capturing them through taxation.

But just how much of the profits should be considered "excess"? A cynical definition is that excess profits are whatever a legislature chooses to call by that name. Joseph Pechman, a tax expert and member of TIME'S Board of Economists, notes: "There is no scientific way to measure it. What you do is designate a time period for 'normal' profits and tax the excess over that."

During both world wars and the Korean conflict, companies had a choice of paying the tax either on profits exceeding a specified percentage of those earned during a prewar base period or on earnings that topped what was legally defined as a reasonable return on invested capital--8% during World War I and the Korean War, 10% during World War II. The rates were stiff: a maximum of 65% on "excess" profits during World War I, 90% during World War II, 82% during the Korean War. McGovern's proposal would levy an 85% tax on oil-company profits that exceed the average. Congressman Wilbur Mills has said that his House Ways and Means Committee will soon draft a bill imposing an excess-profits tax of more than 50% on the oil companies.

The writers of all such bills are forced to make arbitrary definitions of what should be considered "normal." The oil industry contends, for example, that its 1969-1972 earnings were subnormal. If so, what base period should be set for figuring "normal" earnings? Historically, difficulties of defining precisely "normal" and "excess" profits have led writers of excess-profits-tax laws to riddle them with loopholes and exemptions that have made administration of the tax, in Greenspan's words, "a howling mess."

The current moves are no exception. McGovern, for example, recognizes that taxing away the great bulk of profits that oil companies earn in excess of the 1969-1972 base period might deprive them of money that they need to drill wells, build refineries or develop nuclear power plants. So he would exempt profits that companies reinvest for these purposes. That loophole, however, could be widened to cover almost any investments that an oil company makes--so McGovern would apply the exemption only to "net" reinvestment, which he defines as investments over and above those that an oil company would make normally. But how could the Government determine what investments a company would have made if there were no Arab embargo and oil shortage?

A final and clinching argument against excess-profits taxes is that a company can dodge them all too easily by indulging in wasteful spending. Says Pechman: "An excess-profits tax is an invitation to corporations to spend money like water to get out from under it --by paying huge salaries or bonuses or even making misguided investments." All those activities would reduce the profits subject to tax, while contributing little to the community welfare.

The drive to enact an excess-profits tax is primarily a political response to a deep public conviction that the oil industry is taxed far too lightly. Perhaps it has been. But it makes little sense for Congress to grant the oil industry special tax benefits, and then take away the high profits that result by subjecting that one industry, in peacetime, to a tax that historically has been framed to meet the financial needs of war. Congressional critics of oil company profits would do well to attack depletion allowances, special benefits for intangible drilling costs and foreign tax writeoffs rather than plunging into the philosophical and administrative surrealisms of a one-industry excess-profits tax.

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