A hundred years of history on windfall profits: more legal disputes than tax revenue

Luigi Einaudi described the tax on so-called ‘extra profits’ as ‘sentimental’. ‘Sentimental’, meaning that it cannot be challenged on the basis of rational arguments (of which there would be plenty). But if reason is of no use, perhaps history can help.

1915: the tax on ‘war-related profits’ was levied on companies’ net profits exceeding the average profit recorded in the peacetime years prior to 1914, with progressive rates ranging from 5 per cent to 20 per cent. In 1919, a tax was introduced on increases in assets resulting from the war, deemed equivalent to the sum of the ‘war-related profits’ realised between 1914 and 1919. In 1920, ‘war-related profits’ were finally subject to a rate of 100 per cent (and thus confiscated). Revenue? In Einaudi’s words, a ‘meagre yield’. This was a consequence of the difficulties in defining and assessing the tax. In the aftermath of the war, the liquidity problems caused by the tax – and above all by its subsequent tightening – led to widespread litigation and corporate crises. The outstanding cases were settled through lump-sum agreements.

1940: the extraordinary tax on ‘excess profits relating to the state of war’ was levied on the surplus of a company’s net income generated during the war period compared with its ordinary reference income (calculated on the basis of the average net income achieved by the company in the years prior to the war, or as a percentage of a return deemed normal on invested capital). As had been the case in the immediate post-war period, it was replaced in 1947 by the extraordinary progressive wealth tax. Here too, the results were unsatisfactory (even less so than in the immediate post-war period) due to persistent difficulties in definition and assessment, as well as the inadequacy of the administrative apparatus. Once again, the legislation gave rise to widespread disputes, which were resolved through out-of-court settlements regarding the tax.

2022: the tax on ‘additional profits made by energy companies’ applies to the increase in the balance between input and output VAT transactions observed between October 2021 and April 2022 and the same period in the previous year, provided it is 10 per cent or more and exceeds 5 million euros, with a rate initially set at 10 per cent and subsequently raised to 25 per cent. As before, the tax gives rise to legal disputes. Difficulties in definition and assessment result in revenue amounting to 0.2 per cent of GDP (compared with initial estimates four times higher).

2023: the special tax on ‘bank windfall profits’ applies to that part of the net interest margin which significantly exceeds (by more than 10 per cent) the figure recorded in the previous financial year, at a rate of 40 per cent and with an upper limit of 0.26 per cent of the intermediary’s net assets. Following discussions with the parties involved, financial institutions are permitted to replace the tax with a specific form of capital strengthening. The release of the reserves thus constituted results in additional revenue of 0.1 per cent of GDP.

The lessons of history are simple. Firstly, the concept of ‘extra profit’ does not correspond (and in all likelihood cannot correspond) to a single, concrete accounting term and, consequently, the concept of ‘extra profit’ does not give rise to a clearly identified tax base. Secondly, this gives rise to difficulties in definition and application which significantly limit the relevance – in terms of revenue and therefore for the purposes of public finance – of forms of taxation on ‘extra-profits’, and which usually lay the groundwork for extensive litigation. Thirdly, the limitations – from the perspective of tax revenue – of taxes on extra-profits result in calls for further increases in the tax, which may culminate in demands for confiscatory rates, or in demands to tax not only cash flows but also the capital stock that is presumed to have accumulated (as in 1920 and 1947). It is worth emphasising that the coincidence between the debate on the taxation of ‘extra profits’ and the discussion on the taxation of large fortunes is by no means coincidental: these are, in fact, proposals that follow the same logic and are closely linked (a point that often escapes some advocates of ‘extra profit’ taxation). Fourthly, difficulties in terms of revenue and the prospect of widespread litigation often force the legislator to backtrack (as in 2023), or to provide for settlement procedures to resolve disputes (as in 1924, 1947 and 2022).

In short, in all the cases examined, there is only one outcome: disappointing tax revenue accompanied by a significant twofold divergence: that of the tax system from its standards of certainty, predictability and transparency, and that of the economic system from its growth prospects.