The Concept of Excess Profits under the Revenue Acts of 1940-42

Abstract

Congress has developed a concept of excess profits during the past three years, vague on some points but fairly definite on others. It is not expressed in summary form anywhere in the four revenue laws that have initiated and revised the excess profits tax; the present paper is an attempt to distill it out and compare it with concepts designed for peacetime taxation.1 Implicit Distinction Between War Profits and Other Profits.-Although the tax law makes no formal distinction between profits due to the war and all other profits, it is evidently intended to reach only the former. The taxpayer .is given the option to use either the base-period method or the invested-capital method, whichever results in the smaller tax.2 As a consequence, the tax is not imposed on profits on the grounds that they are larger than they need to be to induce the firm to carry on at its existing level of output. If excessive profits in this sense were being received in the base period, they can be received in wartime free of the excess profits tax. Further evidence of the desire to tax only profits that are due to the war lies in the refinement of the base-period concept, discussed below, to approximate the peacetime earning power inherent in the corporation as it stood just before the defense effort of the United States got well under way. Moreover, even an increase in profits over the level of the base period is exempt if that level was very low in terms of per cent of invested capital. Specifically, the taxpayer's option referred to above means that the law exempts any increase in profits over those of the base period up to the point where the wartime earnings are 5? (ranging up to 8% for smaller firms) of invested capital. This provision might reflect