Excess-Profits Tax

Having heard that U. S. Steel, Boeing Aircraft, other leading Defense producers were delaying construction of urgently needed new plants, the U. S. waited last week for two acts of Congress: 1) a 20%-a-year depreciation allowance for tax purposes on new Defense plans; 2) repeal of that part of the Vinson-Trammell Act which sets an 8% ceiling on aircraft and shipbuilding contract profits. The Administration had spoken for both measures. The Defense Advisory Commission was for them. So was business. So was the President.

But this unanimity did not produce results because the President figured that once he let business have what it wanted, his Congressional opponents would hold up a third matter he wanted just as much --an Excess-Profits Tax. He therefore decided to attach the excess-profits tax like a price tag to the package business wanted. Last week, Congress' tax-originating body--the House Subcommittee on Internal Revenue Taxation--sent package and tag to the House Ways & Means Committee. In the package were the 20% depreciation allowance, the repeal of the Vinson-Trammell restrictions, as expected. Business' eyes fastened fearfully on the price tag. It was surprisingly low.

As a Treasury revenue producer, the excess-profits tax plan was too low. The Treasury had planned a bill to raise $500,000,000 the first year. But as revised by the House Subcommittee, it could not be counted on for more than $225,000,000.

The bill was as complicated as all excess profits tax bills. But outside the lunatic fringe of club-going anarchists, most businessmen agreed that if they had to have an excess-profits tax this was a mild one.

They had feared being caught between two classic tax millstones--a tax on profits above a certain return (in 1917, 8%) on their invested capital (unfair to smaller, growing companies), and a tax on earnings above the average of recent years, unfair to railroads, others who have almost forgotten the taste of profits. The new tax plan employed both millstones. But instead of crushing all corporations between them, it offered them a choice.

Choice No. 1 calculates excess-profits as those in excess of a corporation's average yearly earnings (after normal income taxes) from 1936-39. Thus, if a company averaged $100,000 a year in those years, and makes $150,000 in 1940, $50,000 is ascribed to the Defense boom, called "excess." From this is deducted a "specific exemption" (for the benefit of small business) of $5,000, leaving $45,000 subject to the tax. And if the company invests any new capital, it may deduct 8% of its new investment from the $45,000 (regardless of how much it makes or loses on its new investment).

Choice No. 2 calculates excess profits as those in excess of the corporation's average rate of return in 1936-39, so long as they are not more than 10% on the invested capital. Hence all companies normally making more than 10% will probably prefer Choice No. 1. But Choice No. 2 also affords a floor of 4% below which no profit, however much improved over 1936-39, is counted as excess. Thus railroads, shipbuilders, other defense beneficiaries who have been close to or in the red, are given leeway before they feel the tax. If a company has a profit of $150,000 (after normal taxes) and had previously earned the 10% maximum allowable rate on a capital of $1,000,000, its credit would be $100,000, leaving $50,000 taxable less the $5,000 "specific exemption." In cases under Choice 2 in which new capital is invested, the credit is 10% of this amount up to a total capital of $500,000, 8% after that.

Tax Rates. Once the excess profit has been calculated, the application of the tax rate is still more complicated. There are three brackets--and the first two are figured not in terms of the excess, but in terms of the 1936-39 profit credit itself. Bracket No. 1 calls for a 25% tax on 10% of this credit. Thus, the company which averaged $100,000 from 1936-39, and made $150,000 in 1940, pays 25% on 10% of its $100,000 normal profit. This is 25% of $10,000, or $2,500. Bracket No. 2 takes another clip out of the next 10% of the normal years' profit--this time 30%, or a $3,000 tax. Finally, Bracket No. j takes 40%--the top rate--of anything left of the excess profit after Brackets 1 & 2. In this case, Brackets 2 & 2 would have absorbed $10,000 apiece of the $100,000 normal-income credit. This is subtracted from the $45,000 excess profit, leaving $25,000 for Bracket 3. Forty per cent of this is $10,000. Adding it all up, a company with $45,000 of excess profits would pay a total of $15,500. This works out to just about a third of the total excess profits.

Objections to the bill were soon heard. Loudest came from Congress' left wing -- Jerry Voorhis of California, Wisconsin's Bob La Follette. They thought it coddled profits instead of taxing them; they talked of boosting the top bracket rate from 40% to 82%. They also disliked Choice i, on the grounds that it would let slip the most profitable corporations. But their biggest objection was to the 20% depreciation allowance and the Vinson-Trammell repeal. Calling the latter "bribes" to induce manufacturers to do their duty under the Defense program, they would have preferred to hand business a bigger price tag with no package at all. Objection 2 came from the conservative wing, some of whose members also objected -- for a different reason -- to tying the tax bill to the depreciation and Vinson-Trammell "bribes." Their case: uncertain ty about depreciation and a profit ceiling is delaying the Defense program. Those provisions should therefore be passed immediately, so that Congress can take its time discussing the excess-profits tax. The tax will not be collected until 1941 in any case. But this opposition did not follow strict party lines. Some Republicans, felt that the proposed plan was too mild, played with the idea of confounding the New Deal by helping up the rates in the Senate. Objection 3 was less political, more general. It came from those businessmen who did not object to paying more taxes to help finance the emergency, but who wanted to see the whole Federal tax structure's many contradictions, inadequacies and inequities (TIME, July 15) ironed out first. Those people wanted to see the regular income tax overhauled before an excess-profits tax is added to it. They also felt that no administration should ever turn on the heat to pass anything as important as a tax bill in a hurry.

But the prospect this week was that hearings on Mr. Roosevelt's priced package would be over in a fortnight or so. Unless the profits tax rates are upped, the three proposals should then go through intact under the leadership of Congressional Tax Boss Pat Harrison, who is working for Mr. Big again. The advantage to Defense was made clear by Secretary of War Henry Stimson, who appeared before the House Ways & Means Committee to plead for the whole bill. "Uncertainty," said Lawyer Stimson, "in respect to the industry's right quickly to amortize its investments in expanded construction, and also the uncertainty as to the amount and character of taxation which will be levied . . . have chiefly prevented the execution of these [Defense] contracts. . . . Definite tax legislation . . . will benefit every factory that may be called upon." Whether the excess-profits tax was premature or not, it served one good purpose. Business was finding out what the score was before stepping to bat.

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