Introduction
Energy companies sometimes report large profits while millions of households struggle with the cost of living generally and energy costs in particular. These companies are able to charge high prices, due partly to the fact that demand has increased but partly because of supply constraints, for example, those resulting from sanctions imposed on Russia after its invasion of Ukraine.
These profits have prompted calls for governments to introduce a ‘windfall tax.’ A windfall tax is a one-off tax imposed by a government on a company or group of companies. In this case the suggestion is to raise taxes on oil and gas producers’ profits and to use the funds to subsidise those households who are struggling with high energy bills. Some governments have introduced a windfall tax, others have not. Here we assess the arguments for and against such a tax although we make little reference to the various alternative ways that consumers might be helped by the money raised by such a tax.
Here are five of the key issues to consider.
Key Issue One: Excess Profits
Russia’s invasion of Ukraine caused oil and natural-gas prices to rise rapidly and then to gyrate wildly, so that firms are making record profits as a result of something for which they were not responsible. They have not earned them by taking risks or improving efficiency. Indeed they are profiting from bloodshed. In the meantime governments, having run up enormous debts during the pandemic, must now find more money to protect poor consumers from soaring energy bills and to boost defence spending. Under these circumstances a windfall tax sounds reasonable.
However, there are those who have pointed out that energy markets go through periods of boom and bust. In some years they even make a loss. For example, the big UK company, BP lost £4.2bn in 2020 when there was a collapse in global demand for oil, a result similar to most fossil fuel producers. They only regained part of this loss in 2021-22 when economic activity restarted. If they cannot enjoy boom profits in the good years to offset the bad years, it threatens their long term viability.
Key Issue Two: The Effect on Investment
Will lower net profits as a result of a windfall tax lead to less investment? One can argue that oil companies look for new oil and gas fields but will invest in infrastructure to develop such opportunities only if they are profitable when markets settle down rather than at existing prices.
During 1922, when asked if any of BP’s planned investments would not go ahead if a windfall tax were introduced, chief executive Bernard Looney said: “There are none that we wouldn’t do.”
In other words, taxing some of that windfall profit will not change future investment plans.
But the kind of investments made by oil companies are often considerably risky. Is it believable that they would continue to make these investments if they felt that their profits would be seized when their investments pay off?
Key Issue Three: A Redistribution of Income to towards those in Greatest Need
Remember that you cannot tax companies, only people. A windfall tax, like all company taxes, is a transfer of income between people. However, it can be argued that income in the form of dividends to shareholders is paid, largely to higher income groups so that a windfall tax is a means of redistributing income to those in greatest need and is therefore appropriate.
Critics of a windfall tax have said that older people could suffer disproportionately, as many pension funds benefit from the profits of big oil companies. How big an issue is this in the case of the energy firms? As an illustration, about 8% of BP and Shell’s shares are owned by UK pension funds.
Key Issue Four: Climate Change
It can be argued that the risk of windfall taxes deterring investment in fossil energy is less powerful now that most of the world is trying to phase out the burning of fossil fuels because of the concern about climate change.
Against this two things should be considered. One is that investment in fossil fuels will continue to be needed in the short term. Alternative sources of energy such as wind power, solar energy and nuclear power are only realistic alternatives in the longer term.
Second, these companies are themselves investing funds in other forms of energy such as off shore wind power so that a windfall tax might discourage a movement away from fossil fuels. In 2021 the Spanish government announced an ‘excess profit’ levy on Spanish electricity companies, but then watered down the proposal for fear that it would harm investment in wind farms.
Key Issue Five
The purpose of the windfall tax is to help households who will then spend virtually all of the additional income they receive. However, had the income been left with the energy companies , some of it would have been saved. It would have gone into pension funds and other financial instruments where it would boost people’s savings. Thus the overall effect of the tax is to boost total demand. Since the source of current inflation levels can be argued to be created by excessive demand, the effect of a windfall tax would be to add to inflationary pressures.