The Uneasy Case for Windfall and Excess Profits Taxation – Part I

Economists support taxes on windfall profits, which are considered equivalent to economic rent and therefore an ideal object for taxation, capable of generating substantial revenue without economic distortions. However, the design of windfall and excess profits taxes is fraught with problems, due to the difficulty of identifying the windfall portion of profit and the inherent risk of imposing additional burdens on specific groups of taxpayers without a valid reason. The purpose of this (two-part) article is to review the economic and legal arguments underlying the taxation of windfalls and, secondly, to distinguish windfalls from excess profits, challenging the belief that they are the same thing; thirdly, to pinpoint the shortcomings of the attempts to separate “supernormal” from “normal” profits. The key finding of the article is that this is hardly feasible. This weakens, on practical grounds, the normative validity and usefulness of the theories supporting the implementation of special taxes on economic rents. What appears to be a supernormal profit often depends on the time frame taken into account, while considering the undertaking’s life cycle could tell a different story. Based on these reasons, this article questions the initial statement made by scholars and legislators, i.e. the case for skimming away surplus income through taxation, on both equity and efficiency grounds. Since windfall levies hit only specific groups of taxpayers, their failure in targeting supernormal profits jeopardizes the principle of equality in taxation and, at the same time, weakens the assumption that these kinds of taxes can be applied without economic distortions.