As we saw in Chapter 7 , there are two different measures of a
firm’s profit—accounting profit and economic profit.
Accounting profit is the difference between the firm’s revenues
and its explicit costs, such as labour, materials, overhead, and
depreciation. The same firm’s economic profit would also take
into account the opportunity costs of the owner’s time and
financial capital. Since there are additional costs included,
economic profits are less than accounting profits. As it turns
out, the burden of the corporate income tax depends crucially
on which measure of profit is used as the basis for the tax.
Let’s examine two alternative taxes: one that applies to
economic profits and another that applies to accounting
profits. To illustrate the two taxes, we consider an imaginary
firm that produces hockey equipment—Canada Hockey Inc.
(CHI), located in Brampton, Ontario. Suppose in 2019 CHI earns
accounting profits of $1.5 million. Also suppose the opportunity
cost of the owner’s capital and time is $1.1 million. Once these
opportunity costs are considered, CHI’s economic profits are
equal to $400 000.
A Tax on Economic Profits
Recall that economic profits are the return to the owner’s
capital over and above what could be earned elsewhere.
Specifically, CHI’s $400 000 of economic profits represents the
firm’s return to its capital in excess of what that capital could
earn in the (equally risky) next-best alternative investment. If