Unfair, Unsound & Popular

As Congress adjourned after passing the $4.5 billion emergency tax bill, it made a solemn promise to itself: as soon as it comes back after the November elections, it would slap a retroactive excess profits tax on U.S. business to "take the profits out of war."

Nobody, least of all any responsible U.S. businessman, quarrels with anti-profiteering objectives. But is an excess profits tax the best way to accomplish it? The argument, unfortunately, has been obscured by such foggy conceits as New York's Fair Dealing Senator Herbert H. Lehman's plea for a tax because, "The mobilization of the profits dollar is just as essential as the mobilizing of human lives."

The experience of two World Wars has proved that an excess profits tax is not an efficient way of "mobilizing the profits dollar" or, for that matter, of capturing unreasonable war profits. Even Harry Truman's own tax experts privately confess that in both wars the tax proved inherently unfair, vastly difficult to administer, and an unsatisfactory revenue producer. Last week Tax Expert Beardsley Ruml told the American Bar Association in Washington that the clamor for an excess profits tax is "a hysterical manifestation of schizophrenic masochism." Nobody, he added, had ever yet been able to devise a good one.

What Is Normal? The best argument for an excess profits tax is the vague one that it helps morale in wartime. By imposing a heavy burden on business, the Government supposedly makes such burdens on the general public as rationing and price & wage controls easier to bear. To some extent, the tax also tends to cut down non-military production since there is no incentive to boost it as long as any additional profit is to be siphoned off. But the few arguments for the tax are far outweighed by those against it.

The worst feature of an excess profits tax is that it penalizes new and expanding companies. And no tax can be drafted that does not favor one industry over another or give unfair advantages to individual companies within an industry.

In World War II, companies could compute their excess profits taxes by either of two methods: 1) choose a "normal" average profit during the base period years of 1936-39 and pay up to 95% tax, minus a 10% rebate, on all profits in excess of the average, or 2) take a "fair return" on their total capital investment. But use of the 1936-39 base discriminated against industries which were on the downswing of their particular business cycle in the base period, or had poured money into expansion and so had less than normal profits. Use of the investment base bogged down on the proper valuation of good will, know-how and other intangibles. In all such calculations, as the University of Chicago's Professor Roy Blough, now a member of the President's Council of Economic Advisers, pointed out two years ago, "Any two persons or groups of persons ... might differ by perhaps as much as 20 to 50% with neither provably more right than the other . . . Gross discrimination [is] inevitable."

Down the Rathole. In practice, an excess profits tax spurs wasteful spending. In World War II, when 85-c- of every "excess" profit dollar "went to the Treasury anyway," no one paid much attention to padded expense accounts, high costs and wild spending on all kinds of hare-brained projects. "In effect," recalled U.S. Plywood's President Lawrence Ottinger, "the Government promised to throw $6 down any rathole where you threw $1."

With its other faults, the excess profits tax is also inefficient as a revenue raiser. Though it is five years since World War II's tax ended, a 25-man board is still considering thousands of claims for rebates. As a result, the apparent $40 billion yield of World War II's tax may ultimately dwindle to half--without counting other hidden billions "thrown away" in padded costs. The proposed new tax of Wyoming's Senator Joe O'Mahoney (an 85% levy on all profits above a 1946-49 base) is touted to yield $2.7 billion on 1950 profits. But even O'Mahoney admits that subsequent claims might easily whittle that figure in half. Thus, an 85% excess profits tax, which has the political virtue of sounding huge, actually would not yield as much additional revenue as would a boost of the present corporate income tax from 45% to 50%.

Needed: Statesmanship. Since higher corporate taxes tend to build themselves into the permanent tax structure, many businessmen probably prefer an excess profits tax which would end with the emergency. But the emergency which the U.S. now faces, as Harvard's Sumner H. Slichter pointed out, may last for a decade or more. During that time the U.S. must expand all of its resources in a production race with Russia. "We must see that our productive capacity grows rapidly," says Slichter. "An excess profits tax which discourages the growth of productive capacity ... could help us lose the contest. An excess profits tax could be devised that could do more harm than good--it is a tricky sort of business."

Most economists feel that the U.S. may need higher taxes, both corporate and personal, to help pay for the full-scale rearmament that faces the U.S. (see BACKGROUND FOR WAR). But they think that it would be far better for the Government to shelve an excess profits tax in favor of a boost in the regular corporate tax, and a system of tax incentives (e.g., a more favorable rate on profits put into new capacity) to encourage plant expansion.

On top of that, a tightening up of renegotiation of war contracts would capture any excess profits made on arms. But in the emotional, vote-catching air of Congress, the prospects for a sensible solution of the argument on an excess profits tax seem slim.

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