Date 20 September 1934
Author Malcolm H. Bryan
Title The Federal Revenue System: The Excess Profits Tax
Description A report to the Secretary of the Treasury
Location Box 62; Tax Reform Programs and Studies; Records of the Office of Tax Analysis/Division of Tax Research; General Records of the Department of the Treasury, Record Group 56; National Archives, College Park, MD.

September 20, 1934

Malcolm H. Bryan




I.   Historical Note and Preliminary Statement
II.  General Considerations: Favorable
III. General Considerations: Unfavorable
IV.  Recapitulation and Evaluation
V.   Provisions of the Present Law
VI.  Comment on the Present Law


The excess profits tax is not a major pillar in the Federal revenue structure. It had a place of outstanding importance during the war; it was afterward abandoned; and now an excess profits tax of a sort has again been levied. The widespread adoption of excess profits taxation during the war has been the principal recent point of departure from the more usual practices of public finance; and the present American law, in addition, appears to represent a point of departure from the ordinary procedure in getting an excess profits tax under way. Moreover, there are various hints in the scanty literature of the subject, perhaps simply because of the title of the tax, that advocacy of excess profits taxation is in some vague way to be connected with a "liberal" social philosophy, and opposition to it is to be identified with a "conservative" point of view. For such reasons, among others, the tax merits more extended examination than its current proportionate place in the revenue system would indicate.

This memorandum, then, is an attempt to outline broadly the various points that may be urged for and against revenue assessments on excess profits, to offer something in the way of evaluation, to point out as many details as possible, and to make certain comments on the existing statute. The outline character of the work done must be insisted upon. The theory of the tax is exceedingly complex. Its operation in practice is in many respects even more baffling. There is a scarcity of material in regard to it, especially material of a factual variety, and most of what can be said must rest, perforce, on judgment rather than on objective demonstration. From the writer's personal standpoint, further, the time available for devotion to the several problems raised by excess profits taxation in general, and the present enactment in particular, has been much less than he would have wished. Other tasks have pressed for attention.

It is just as well to warn the reader specifically, therefore, that this paper has certain notable and regrettable failings:

1. Under nearly every heading there is undoubtedly a great deal of detail, particularly of practical minutiae, that the writer has been unable to uncover; much that he has been unable to think through; some that he has not had time to include.

2. More effort should certainly be devoted to a point by point examination of the United States' preceding experience with excess profits taxation. In some ways the present law seems to be an improvement, but it has no doubt forgotten many things that it should have remembered.

On this score, however, the Treasury's notice should be called to the fact that it has at hand two careful and extensive memoranda on our war-time excess profits and war profits acts. One is entitled MEMORANDUM ON ADMINISTRATIVE EXPERIENCE WITH WAR PROFITS TAXES and is by Mr. Joseph Weare and collaborators; the other is called LEGAL PROBLEMS ARISING OUT OF WAR PROFITS AND EXCESS PROFITS TAXATION and, though unsigned on the copy at hand, was written (according to informal advices) by Mr. P. J. Mitchell. Both of these reports were prepared in the Bureau of Internal Revenue.

3. The writer has been able to do very little with foreign excess profits laws, either with those existent during the war or with those at present in force. These should be inquired into most carefully. Latvia, Spain, Roumania, Sweden, Yugoslavia, Paraguay, and Peru have revenues that are, or appear to be, of an excess profits nature.

4. No investigation of the capital stock tax, as such, has been made. This limitation is the more to be regretted because the present capital stock and excess profits tax is currently a capital stock tax first and an excess profits tax incidentally. If excuse is to be offered, it can be said that the form of the capital stock tax under the NIRA, and for the first year under the Revenue Act of 1934, is scarcely more than a slight addition to the rate on corporation incomes.

5. No examination of normal-period revenue possibilities from the present excess profits law, or any other, has been made. In regard to the statute now in effect, moreover, it may be remarked that its adoption of free-will capital declarations as the groundwork for beginning the tax would make long-term forecasts of productivity at the moment even more dubious than tax estimates usually are.




1. That the present excess profits tax, in conjunction with a capital stock tax, should be maintained for the time being.

a. The current enactment's method of initiating an excess profits tax by means of taxpayers' declarations, as restrained by the flat-rate capital stock tax, is an interesting departure in excess profits taxation, and, while open to many objections, has a great deal to be said in its favor from an administrative standpoint and, from the standpoint of equity, does not suffer in comparison with alternative procedures as much as might on first view be supposed.

b. The arguments for excess profits taxation as a continuing feature of the revenue system are sufficiently strong to merit its trial under favorable conditions.

c. The general agreement that excess profits taxation should be used in time of war strongly indicates the advisability of building up administrative experience, court decisions, principles, and data before actual conflict and necessity arise.

2. That the Administration should regard the present law in particular, and the principle of excess profits taxation in general, as experimental and exploratory of future possibilities, not as an immediate source of a substantial fraction of the Government's revenue requirements.

a. The existing Act is not a true excess profits tax or a true capital stock tax and can only approach such a status after the passage of a good many years in which the original capital declaration retire into the background, being largely superseded by subsequent capital additions and subtractions.

b. The arguments against excess profits taxation, on grounds of both equity and administration, have been believed to outweigh the arguments for it, and, even in the light of reexamination, they cannot easily be brushed aside.


1. That rates should be kept low until the development of knowledge as to the actual working of the tax in practice indicates the possibility of its equitable retention or the necessity of its abandonment.

a. There is reason, however, for considering the advisability of introducing a slight progression in rates.

2. THAT THE ACCOUNTING PERIOD ON WHICH THE EXCESSIVITY OF PROFITS IS MEASURED BY ALL MEANS BE LENGTHENED. THE WRITER PROPOSES A FOUR-YEAR AVERAGE, AND CERTAINLY NOT LESS THAN THREE YEARS. He also suggests the advisability of seriously considering permission to forward actual net losses indefinitely, or at least for an even longer time period. (See pp. 53 et seq.; p. 88 -- E)

3. That when business assets or businesses are sold either (a) their capital value to the purchaser for tax purposes should be the same as the capital value to the seller, or (b) a special capital increment tax should be devised as a levy on the seller to take care of good will and other intangibles that will be capitalized through the sale process and that are excluded from capital when they remain unsold in the hands of their original developer. (See pp. 63, 95 -- G)

a. Under legislation in accord with (a) and (b) above, social policy probably indicates certain distinctions in the treatment of various types of intangibles. (See pp. 61 et seq.)

4. That both the capital stock and excess profits taxes should be extended beyond the corporate form of enterprise. (See p. 81)

5. That the investments should in general be excluded from capital for purposes of the excess profits tax, and the return yielded from the investments should be excluded from income assessed under the excess profits tax. (See pp. 29, 68 et seq.)

6. That the assessment period for the capital stock and the excess profits tax should be made the same and the taxes applied to the average capital for the year. (See p. 91 -- H)

I. Historical Note and Preliminary Statement.

During the Civil War there arose in the State of Georgia a popular outcry against profiteering. It was chiefly directed toward manufactories of uniforms and other materials of war located in Athens, Augusta, and Atlanta; but it also had a broader basis in the apparent profits resulting from the currency inflation incident to Confederate and Georgia war finance. The General Assembly of the State took cognizance of the situation by enacting a special profits tax on the ratio of profits to capital. A normal earning of 8 per cent was exempted, and graduated rates from 5 to 25 per cent on profits above that exemption were applied. /1/

With the lapse of Georgia's levy the excess profits tax dropped almost completely from view until the Great War. Then, beginning with Denmark, which wished to secure for the Government a portion of the profits arising from a lucrative war-stimulated trade with belligerents, the idea of taxing excessive profits spread until it was encompassed in the revenue acts not only of combatants on both sides but of many neutrals as well.

The United States itself began such taxation while still a neutral. To the Revenue Act of 1916 is perhaps to be ascribed the first move toward assessing the fruits of conflict, since it contained a special provision for taxing munitions. The Act of March, 1917, however, applied the first excess profits tax. It apparently derived its inspiration from a feeling that the United States might be drawn into the war, and, in any event, the impact of a compelling movement for military preparedness indicated the advisability of substantially increased revenues. After the declaration of war, two further enactments of excess profits taxes were adopted: that of October, 1917, the "war excess profits tax," and that of February, 1919. /2/

These taxes were immensely productive. /3/ And, while the war lasted, there seems to have been so unusual opposition. In the provisions of the Acts, however, in the Hearings, and in the Congressional debates accompanying their passage, there was more than a hint that excess profits taxation might become a permanent feature of the Federal revenue system. Congress wavered between the "war profits" principle for basing the tax, which was assumed suitable only for temporary use, and the "excess profits" principle, which was believed capable of continuing imposition. The former method involved the determination of pre-war profits for each business as a standard from which the excessivity of its war profits should be judged. The judgment of excessivity under the latter method rested upon the percentage of profit to invested capital. /4/ Because of conflicting views as to the proper course to purpose, the United States used both principles in part and produced a pretty thoroughly confusing result. /5/

                           CALENDAR YEARS

                                         Munitions manufacturers or
                                        excess profits or war excess
Year                                           profits tax /a/

1917                                                $1,638,747,740
1918                                                 2,505,565,939
1919                                                 1,431,805,690
1920                                                   988,726,351
1921                                                   335,131,811
1922                                                 8,466,114 /b/
1934 /c/      Capital Stock Tax:                        80,168,344
              Excess Profits Tax:                        2,630,616


                         FOOTNOTES TO TABLE

     /a/ Separate figures for war profits and excess profits taxes
are not available.

     /b/ On net income earned from July 1 to December 31, 1921,
reported on fiscal year returns where accounting period terminated
prior to July 1, 1922.

     /c/ Fiscal year. Figures from Division of Accounts and
Collections, Bureau of internal Revenue.

                          END OF FOOTNOTES

When the Great War was only a few months ended, there arose in the United States an active and determined campaign for the repeal of the then current excess profits tax. Business men charged on every hand that the legislation was unfair in principle, capricious and thoroughly exasperating in practice. It restricted business development, the statement was, by discouraging business initiative, and fell with unwarranted severity upon the earnings of business in a period of peace; and at the same time it was charged that the tax increased the cost of living through shifting to consumers.

To practically all of these contentions for repeal, the Treasury under Mr. Carter Glass /6/ and Mr. D. F. Houston, lent the support of argument and vigorous recommendation. /7/ The Bureau of Internal Revenue added that the tax constituted an impossible administrative load, that it threatened, indeed, a complete breakdown of administrative operation. The Bureau, it will be remembered, was struggling at the time with an income tax only six years old.

The whole movement for excess profits tax abandonment was accorded by economists what seems to have been fairly general approbation. Notable among those who wrote extensively, Mr. Thomas S. Adams had possessed ample opportunity for examining such taxation in its manifold details. He had previously been almost entirely sympathetic with the principles involved in excess profits levies but, after considerable and intimate experience as tax adviser to the Treasury, was forced to conclude -- rather reluctantly, one gathers -- that the excess profits tax should certainly be allowed to lapse. /8/ He suggested at least a decade for re-examination and re-consideration. Mr. Haig, a second American authority in the field, had undertaken a conscientious and scholarly examination of the British excess profits duties in comparison with our own. While apparently friendly on the whole with the general ideas that prompted the tax in both countries and not advocating its repeal in the United States, he was forced to indicate at almost every point certain serious errors in the drafting of our enactment and quite grave administrative problems. /9/

The testimony of these two men was all the more effective, not merely because of their experience with the tax, but because they appear as somewhat reluctant witnesses against a form of revenue that they would normally, one suspects, have been disposed to favor. Other economists voiced similar sentiments after less investigation and with a less friendly original predisposition. Mr. Carl C. Plehn denounced the tax and tax gatherers in language that at places has the ring of exhortation. /10/ Mr. Fred R. Fairchild, while observing that the movement away from excess profits taxation had an appearance of stampede, none the less counseled discontinuance. /11/ The Committee on War Finance of the American Economic Association could find nothing good to say for the excess profits acts except that the revenue that they had provided had been substantial. /12/

Finally, the whole agitation for repeal drew on to its climax when both Governor Cox and Senator Harding entered into the general denunciation in the Presidential campaign of 1920. President Harding, the successful contender, brought the subject into one of his Congressional messages; /13/ and, thereafter, President Coolidge, with the somewhat cryptic remark that he was "opposed to war taxes in time of peace," /14/ flatly threatened in 1923 to apply his veto power to any revenue act in which the excess profits feature should reappear. Only the Farm Bloc in Congress remained faithful to the notion that such revenues should be maintained, and even that support became gradually quiescent; /15/ for President Coolidge, in 1924, seemed to secure a consensus of agreement when he declared the developing forces of economic prosperity to be in large part ascribable to the relief of business from the hardships of taxation. /16/ America had come a long way from the time when President Wilson could "take it for granted" that henceforth one of the mainstays of Federal taxation would be the excess profits assessment. Discussion of the tax almost completely disappeared from the increasing volume of American literature on public finance. The usual attitude of economists specializing in the field is apparently inferentially expressed by a recent textbook on the subject. The author contents himself with a simple statement that "an excess profits tax has no place in a peace-time revenue system." /17/

Now, surprisingly, such a tax is again in force. Congress, having once abandoned the excess profits and capital stock levies, has been sufficiently attracted to return to their use, and, having indicated the return to be a temporary expedient by making provision for their automatic lapse, has finally lifted them from the National Industrial Recovery Act and incorporated them in the Revenue Act of 1934, where they remain in effect until specifically repealed. /18/

For such reasons, if for no others, the examination of these sources of revenue must be something more than cavalier. The present existence of the capital stock and excess profits taxes is evidence of renewed Congressional interest in them: this alone would appear to justify a careful consideration of their theoretic and practical basis and an endeavor to direct their development along lines that shall be either most beneficent or in any event least harmful. /19/

The task, then is to find an answer to certain questions: (1) Do these taxes meet in themselves the ordinarily acceptable canons of economic and social desirability? and do they make a useful addition to the Federal revenue system as a whole? (2) Are they administratively feasible? (3) Are their revenue possibilities substantial? (4) Are they politically and socially expedient in the broad sense that they appeal fundamentally to conceptions of justice among thoughtful citizens? (5) Is there any more satisfactory method of arriving at the same result? With a view to the resolution of the questions, arguments pro and con are set forth for subsequent evaluation.

II. General Considerations: Favorable. /20/

A. The excess profits tax is at the present juncture a politically expedient form of Federal revenue. Action of the Congress is in itself mute testimony. Other items are obvious.

The title of the tax alone possesses a subtle allure, these days, for multitudes of Americans. Vast groups are smarting under the liveliest sense of social and economic injustice. On the one side, many business proprietors themselves, for whom the existing economic attrition has meant largely curtailed returns or actual losses, feel that a greater relative tax load could be shouldered by those who have been permitted, through happier circumstances, to maintain higher rates of earning. This is closely akin to the opinion now gaining prevalence that the activities of the Government itself are hampering some businesses and some sections of the nation as against others that are being materially assisted in the procurement of expanded profits. Here the Federal program for price-level expansion and NRA codes are decidedly pertinent; for their effects, regardless of intentions and efforts at even-handed administration, are by no means uniform. On the other side, to the agricultural interests and to people not directly engaged as business proprietors -- many of them bankrupted, unemployed, or reduced in earning --, the thought that some business undertakings are still yielding large rates of return must be especially galling.

It is reasonable, therefore, to predicate an appreciable change of public sentiment from the early years of the last decade, when the New Era was burgeoning, to the days when the New Deal arises out of disenchantment. There has been a drift of mental and emotional processes. Such things lie outside the domain of economic analysis, to be sure, and no doubt these notes stray apace. But to put the matter strongly, none the less: the enforcement of an excess profits tax, which would in some measure allay the feeling of injustice on the part of large and numerous groups of citizens, which would in a degree mitigate the current hostility to business, and which would for business itself act as a sort of insurance premium against more drastic alterations of the economic system, might indeed be a stroke of policy well worth the Administration's most serious consideration.

B. Such comment foreshadows the line of further remarks. The mention of conditions created by the Government, is an instance.

1. War has received almost exclusive attention. It is pointed out that the economic environment created by War, with large Government orders and the usual accompaniment of currency or credit inflation, produces super-normal demand in many lines of enterprise and super-normal profits as a consequence. From the direct result of Government activity in prosecuting a war, therefore, a "profiteering" element, whether conscious or unconscious, is likely to arise in most businesses. These fortuitous gains are, practically by universal agreement, within the proper scope of special taxation. /21/

2. What is more commonly overlooked is that Governmental activity that takes effect on profit margins is by no means confined to war periods. Tariffs, of course, are a classic example; but there should be monetary and price level legislation designed for price level expansion or contraction, shipping and transport subsidies of all kinds, sectional subsidies under one guise or another, rate regulation and price fixing, franchises, licenses, patents, copyrights, Government research, sales assistance, and codes.

The fact is, the whole sphere of economic activity is sometimes deliberately and often unavoidably permeated by the effects of Government, even in peace; and where deliberate or unintentional Government action encourages, say, a more favorable price situation for a given industry or establishment on the one hand, its activity is likely at the same time to create an equal accompanying strain on the economic structure elsewhere, either by increasing the costs of other producers or by diminishing the relative share of funds on which they can draw for sales.

Another fact is perhaps even more pertinent. It is plain that the solicitude of Government in the field of business regulation must customarily be directed if not to the least then to the less favorably situated producer. This is a procedure that at once produces enlarged rates of profit for those firms whose differential advantage for some reason or other places them in the upper range of productive effectiveness. /22/

All this tends, of course, to a justification of an excess profits assessment in peace as well as in war. The argument would run, presumably, to the effect that what the Government gives the Government has a right to take away, at least in part. Perhaps better stated, it has the right to take away a portion of what it does not intend to give -- the gift being in the nature of an unintended and unearned increment. The case is strengthened a little at this point by the probable future expansion of Governmental regulation, encouragement, and admonition, and the corresponding diminution of the role of private enterprise pure and simple.

C. In connection with differentials in business profits it must be emphasized that the differential factor is by no means confined to the effects of Government interference. It normally runs through most economic endeavor.

1. For example, there are frequent differential profits of a temporary nature. These partake of the general characteristic of windfalls, attributable to various incalculable fortuities.

2. In addition, however, there are the regular differentials emphasized in economic theory in connection with land rent, but likewise important with respect to managerial ability, capital, patent and copyright monopolies, and the general complex of cost elements. In regard to these differentials, it has been contended that they represent a very real of element of ability to pay, and that, though the Government cannot in any sense equalize either ability or opportunity, it can fairly appropriate a share of the differential products. /23/

D. Some showing can be made for the excess profits tax as a useful adjunct to Government policy in a period of increasing price levels.

1. Where prices are moving upward and profits increasing, the yield of the tax is likely to expand, since profit margins will be enlarged. If appreciation of the capital base, upon which profit rates were calculated for tax purposes, was not allowed in correspondence with the expansion of the price level, it is even probable that the revenues would increase in proportion greater than the price-level rise. While this advantage is seriously diminished by the gap between the income-earning period and the payment date of the tax -- a lag which will average just a year, if quarterly installment payment is permitted --, the tax could still be counted on to increase its yield substantially over the course of an extended business upswing, and might be very useful in helping to attain, say, the more rapid liquidation of Federal indebtedness.

2. Here may be mentioned, at the risk of some repetition, the effect of price level alterations on the rate of profits. Ordinarily, profit rates will be greatly increased by a price level rise. This is especially worthy of consideration when such a rise follows hard on the heels of a preceding deflation. Then costs have been squeezed to the uttermost, and wages and salaries reduced; and, in the ensuing turn of the cycle, profit margins are substantially widened. So far as losses are merely recovered, of course, no argument on this score is merited; but, to the degree that net gains are actually enlarged through the process, a special tax is justified; and in the considerable number of instances in which properties and evidences of ownership have changed hands at bankrupt prices, a large fraction of the profits in a business upturn is in a real sense an "unearned increment". Force is lent to this point when the Government steps in -- as, for example, in the present program -- to boost prices. There is a real argument, in other words, from the standpoint of social justice.

3. As a sort of corollary to the foregoing consideration is the fact that an excess profits tax, by applying a disproportionate impost to the most profitable industries and businesses, will similarly apply at least a modicum of restraint upon the inevitable temptation of these firms and industries to over-expand during a wave of prosperity and easy profits. By the same token, in a period of contracting business the tax is automatically lightened, and most profits will fall under the normal deduction and go tax free so far as the excess profits tax is concerned, thus releasing needed funds for the business community. /24/

E. Excess profits taxation has been advocated for special cases where a single direct action of Government brings a single direct and measurable profit to an industry or undertaking. An example of this would be the recent silver legislation. Another example is the Vinson Act, in which the Treasury is directed to acquire all profits in excess of 10 per cent on the construction of naval vessels and aircraft. /25/ Again, excess profits taxation has been urged for cases where social considerations favor repression of what is believed to be an anti-social activity, to prevent, that is, the flow of capital and effort in particular directions. An instance of this is the liquor industry -- a case where, incidentally, not merely the social consideration just outlined is important, but where, in addition, it has been assumed that certain difficulties of low gallonage taxes designed to cure the illicit liquor traffic could, so far as revenue is concerned, be met through the excess profits route. /26/

III. General Considerations: Unfavorable.

In spite of a good many arguments that may be listed in favor of excess profits taxation, the objections have generally been believed to overbalance the advantages.

A. On the one hand, the complexity of the tax in practice, even conceding the possibility of devising a law satisfactorily equitable as between taxpayers, is too great, the claim is, to make it administratively practical. It involves, obviously, not merely the evolution of a satisfactory definition of profits, capital, excess, and so on, but their determination in actual practice, a determination that must be carried on through a myriad variations and changes, and a host of obstructions from reluctant businesses. It was frequently pointed out that the complexity of the former excess profits law was so bewildering that the Bureau of Internal Revenue found continuous difficulty in maintaining an adequate staff; for there was a rapid turnover of persons in the Bureau who, becoming relatively expert in the accounting procedure involved, would leave for the more remunerative field of private tax practice after a few months of training.

B. On the other hand, quite aside from administrative difficulties, it is frequently said of excess profits taxation that it in fact, even in the broadest sense, ignores the canon of equity. It is a tax resting essentially on business as an organization, whereas the true basis, the argument is, should be the individual distributive share. /27/ In short, it is contended that the distributional aspects of the tax are entirely unsatisfactory, and that, in any event, the desirability of an excess profits tax at the present time is obviated by the level of surtax rates on individual income.

C. Allied with the general equity problem is another phase of the same question of justice. Here the idea is that it is impossible to secure equity between taxpayers, even regarding them as organizational units rather than as an assembly of individuals as was done in the paragraph above.

1. First of all, there is the element of risk. Evidently the normal rate of return for successful concerns is necessarily high in certain lines of business and probably low in other branches, not because one is monopolistic or in fact justifiably subject to heavier taxation, but because, simply, the risk element is higher or lower in one in contrast with the other, or with the generality of business taken as a whole. A rate of return, therefore, that might be excessive in one case would have no necessary general validity as a true test of "excessiveness."

2. Along the same line, it is plain that differential rewards accruing to particular business establishments arise from altogether different sources. Government favor has already been mentioned, of course; but there is also a distinction between profits that arise because of some element of monopoly or quasi monopolistic advantage, and differential profits that arise, on the contrary, because of competitive efficiency.

The notion is usually that monopoly should surely be taxes, but fiscal repression should not be applied to the gains from differential efficiency. Since it is ordinarily impossible to make an administrative distinction between elements of monopoly and elements of business effectiveness, it would be preferable for the Government to control monopoly and monopolistic practices directly, rather than to attempt the acquisition of a share in monopoly profits by virtue of revenue impositions.

3. Price level fluctuations, again, tend to make excess profits taxation unjust in still another fashion. Clearly, the relative capital value of assets will be materially affected by the price level situation at the time of acquisition. Thus, a company that purchased properties or equipment in the late war years, or in 1929, say, would be in a very different position from a company that began in 1932. Closely bound up with that feature of the matter is the problem of whether it should be permissible to revalue assets in accordance with a general increase in the price level.

4. It has been strongly urged that the amount of capital has little to do with the appropriate earnings of a company and, therefore, cannot serve as a justifiable tax base. The reasoning is that companies vary all the way from organizations in which the actual material assets are almost an exclusive element in their earning power to complete personal service businesses in which the capital assets, speaking in terms of land, physical plant, equipment, and so forth, will amount to hardly more than a desk and a few chairs. Obviously, in almost all kinds of undertaking a variable and undifferentiated but nonetheless vital determinant of the apparent return on the enterprisers' capital is of a "personal service" nature. That is, the rate of earning will be largely affected by the degree of plant utilization and the rapidity of working-capital turnover that management is able to secure. /28/ Intangible factors, commonly denominated "good will", play a large part in the success of any concern; yet, if good will is allowed in the capitalization from which excess profits are calculated, the door is open wide to fraud, and, the fact is, there will be no "excess" profits. Capitalization will logically be expanded with earning pari passu.

Pure personal service organizations are usually considered outside the bounds of appropriate assessment under an excess profits levy because their capital is only remotely connected with earning. If personal service businesses are exempted, however, disparity of treatment is established; for, existing in connection with personal service gains, are differential elements in most instances, which sometimes possess monopolistic features. These personal-ability differentials are just as truly a legitimate source of differential taxation as is the exercise of ability, which, instead of working through personal services directly, expresses itself through the auxiliary use of capital. /29/ And if personal service enterprises are an extreme case, they are at least illustrative. The claim is, the economic structure is so shot through with variations in the proportionate influence of capital in a given rate of return that a tax based essentially on a ratio of earnings to capital is entirely invalidated.

5. Within the broad problem of equity it is often pointed out that there develop various types of unusual and unanticipated cases in an excess profits tax. Frequently an abnormal situation will result in exceptional hardship to individual companies if the tax is applied in full rigor. To avoid manifest injustices, therefore, it seems necessary to permit administrative authority to temper the application of law whenever its letter appears to work contrary to its spirit. Yet a "special assessment" provision designed to care for unusual situations is itself an invitation to trouble. Businesses cannot resist the temptation to believe their position out of the ordinary, and requests for special assessment multiply tremendously, so that the effort to gain something of equity is counterbalanced by increasing the trials of an otherwise sufficiently harassed administration. /30/

6. From the point of view of organizational units, again, it has been urged that an excess profits tax is regressive. Small businesses, the contention is, are likely to have a higher rate of earning on their capital than larger organizations; /31/ and in support of this reasoning, the Treasury in 1918 presented figures to show that the bulk of collections under the United States' previous excess profits tax came from other than the largest companies. /32/

a. In line with this circumstance is the further fact that either horizontally or vertically integrated concerns are likely to be at an advantage in relation to the tax as compared to independent units doing -- as an aggregate -- the same kind and volume of business. By means of inter-company sales, charges, commissions, allowances, and so forth, it is possible to shift profits around among affiliates and subsidiaries in order to secure the minimum tax load. That is, large profits in one unit of the organization can be reduced and the lesser earnings of another increased. The upshot is, possibly, that neither will be subjected to an excess profits assessment, or that the amount of the liability will at least be reduced. Even if consolidated returns are required, much the same result occurs; for the larger organization gets the advantage of averaging its earnings -- low returns or losses at one point offsetting excessive gains at another place --, whereas a number of independent units, having the same rate of return on total capital, will not possess the advantage of averaging: some of the units will not be taxed because their returns are below the statutory exemption, but the units showing an excess will not have their tax liability pulled down.

7. It is often claimed, furthermore, that the difference in the SOURCE of capital used by various undertakings makes evenhanded justice extremely difficult to secure in a tax resting on a ratio between investment and earnings. Differences in the composition of capital assets -- as between tangibles and intangibles, for illustration -- also give rise problems of equity and administration, as will be noticed in succeeding paragraphs; but the reference here is to two points: (a) the distinction between borrowed and other capital, and (b) the distinction between sources of owned capital -- manager ownership and non-manager, or, possibly, "absentee" ownership.

Thus, it may be said that borrowed funds are not "owners" capital at stake in the business, and that they should, therefore, be excluded from investment for the calculation of an excess profit. It is open to critics to reply, however, that the equities involved are not nearly so clear as a program of absolute exclusion would indicate. It is frequently true that borrowed resources have no other security in fact than the profits of the business as a going concern, and, though the lender may not realize it, his capital is oftentimes just as much at stake as are the contributions of the so-called owners. In many small businesses especially, friends and relatives put in money that is legally and theoretically in the borrowed category, but in regard to which, indeed, their chances of recovery are considerably less than those of the owner who is presumably taking the risks, for friendly solidarity will in many cases prevent the lender from recouping at the expense, say, of the livelihood of the owner and manager, or salary juggling on the part of the latter will preclude recovery by the lender, even of stipulated interest.

As to closely-held enterprises, whether corporate in form or otherwise, it is difficult in many instances to distinguish between income that is in reality managerial salary and income that is ownership profit. In many small companies the salaries are contingent and depend, in fact, on earnings. On the other hand, wherever the salaries and bonuses of officers are not determined through arm's-length bargaining, an excess profits tax is open to defeat because such items can be inflated by the owner-officers, and ownership income -- otherwise subject to the tax -- may be hidden in exaggerated salary payments.

D. Probably worthy of a separate heading are a series of difficulties of more or less miscellaneous character. In part they involve points of equity, in part concern themselves with problems of administrative determination, and in part result from the nature of accounting procedures and records.

1. One company may have followed what are usually called conservative methods of accounting. It may have followed the policy, that is, of rapidly writing off its capital investment, frequently much faster than actual disappearance through depreciation or obsolescence. Another company may have pursued an exactly opposite policy. Should the books of the two concerns be taken as a basis for laying the tax, therefore, serious inequities are probable, since two identical capital investments might easily show up as greatly differing totals. On the other hand, a real administrative problem is presented if an attempt is made in each case to go behind the accounting and arrive at the facts.

a. Differences in accounting practice and in equities are especially noteworthy in the cases of intangibles. From the standpoint of social policy and fiscal theory there are likely to be good reasons for differentiating between classes of intangibles. It may be desirable for example, to make a distinction in the treatment of earnings from patents as contrasted with the good will profits of a clever advertising slogan, between a copyright and a franchise or mineral leasehold. If these distinction are made, however, there arise the problems of drafting them with sufficient precision in law and effecting them in administration, and in addition the particularly troublesome task of valuing the intangible properties of an enterprise not merely as a whole, but by classes of intangibles.

From the standpoint of accounting, again, companies differ markedly in their handling of intangible assets. Some carry intangible values at nominal sums, others carry them at inflated valuations; some charge the costs of their development to current expense, others to capital account; some acquire them in the course of their own business history through the exercise of their own ingenuity or inventiveness, others secure them by purchase for cash or money's worth. In consequence, the Government is at best faced with an elaborate problem of accounting adjustment and at worst must also meet the difficulties of appraisal, and depreciation and obsolescence allowances in a field in which the facts are infinitely more elusive than they are, even in the case of tangible assets.