Update 29/05/2022: The UK government announced that it would impose a 25% windfall tax on oil and gas giants to raise £5 billion. See Reuters for more details.
The war in Ukraine coupled with global supply shortages have led to rising food and energy prices at rates not seen in a generation. In April, the energy price cap in the UK was raised, by meaning household bills doubled overnight. The Bank of England predicts that inflation will soar to over 10% in the UK and that rising food costs and shortages will have devastating consequences for most households, particularly for the poorest. One group in society however, are profiting from this crisis, the energy companies. Energy giants are enjoying a bumper period with many seeing their best ever quarterly profits. The largest 28 oil and gas producers made a staggering $100 billion in profits in the first quarter of 2022 alone. Shell tripled its quarterly profits from Q1 last year, posting a huge $9.1 billion. With one sector of business making such enormous profits due to and amidst a generational crisis, surely some rebalancing is due?
This is what the UK Labour Party and other opposition parties have called for. They propose that a windfall tax is imposed on the oil and gas giants to raise billions in income that can be spent to help the poorest in society. A windfall tax is a one-off tax levied on a company or sector. It is used to generate government revenue where companies have generated substantial profits from circumstances out of their control. So far, the UK government has rejected these calls and claims they will do more harm than good. But what are the merits of a windfall tax? We explore the pros and cons of a windfall tax and see whether it would be effective in practice.
The most obvious benefit of the windfall tax is that the money raised can be hypothecated to support those worst affected by the cost of living crisis. Labour predicts that a windfall tax could raise up to £2 billion. They propose these funds could be used to provide targeted discounts on energy bills to soften the impact of inflation. With the Office for Budget Responsibility (OBR) predicting one of the steepest declines in living standards since records began, it seems incumbent on the government to take significant action. Energy bills are spiking to nearly £2000 a year while rising interest rates are seeing many households pay more for their mortgages. Meanwhile, earlier this year, Big Oil firms began record breaking share buyback programmes due to their huge profits. By April, the biggest five oil and gas firms had returned $44 billion to shareholders. Evidently, there is substantial cash available to energy firms so the government could impose a windfall tax without hitting their reserves too significantly.
A key justification for the windfall tax is that it brings no change to the long-term tax burden of those targeted. A windfall tax applies a one-off basis to “windfall” profits. Windfall profits means the relevant companies have not generated these profits due to their strategy or ingenuity. Rather, in the case of oil and gas firms, these huge profits derived exclusively by chance due to global crises that caused wholesale prices to skyrocket. Penalising businesses for ingenuity or innovation would undoubtedly harm confidence and investment but this simply isn’t the case in the current situation. Given there are no proposed long term changes to the companies’ tax burden, a reasonable windfall tax is unlikely to harm business confidence.
In the UK, a windfall tax has been proven to be effective. The most recent windfall tax was imposed in 1997 by Tony Blair and Gordon Brown and this was the largest in UK history. This was applied to water, telecoms and energy companies. These companies were recently privatised and were undervalued. £5.2 billion was raised from the windfall tax and this funded Labour’s welfare-to-work program and provided capital investment for schools. The tax did not harm investment or consumer prices in any substantial way. In 1980, Margaret Thatcher’s chancellor, Sir Geoffrey Howe, levied what was considered a windfall tax on North Sea oil and gas producers as well as a levy on banks. These examples show that a windfall tax is not unprecedented and that it works. Recently, Italy introduced a windfall tax, raising rates for windfall profits from 10% to 25%. The previous successful implementations of a windfall tax support its use in the present day.
The main argument against a windfall tax is that levying the tax on oil and gas giants will further raise energy prices and discourage investment. Firstly, when taxes increase, companies often pass these costs onto consumers. There is no indication that energy firms wouldn’t do this at the petrol forecourts, so adding more tax could be counterproductive. Secondly, even though a windfall tax is a one-off, it signifies that the government is willing to pull this lever. If businesses deem the UK tax regime as unstable, this could discourage long term investment. Furthermore, higher taxes reduce capital and makes it more expensive to borrow, ultimately harming investments. The Head of Offshore Energies UK (OEUK) trade association has warned the government of this. BP and Shell have pledged around £40 billion in UK investment over this decade, creating a huge number of jobs. With North Sea oil and gas investment already in decline, the government understandably wants to avoid discouraging further investment.
Opponents of a windfall tax also note that oil and gas firms already pay more than most companies, so a windfall tax would be excessive. For companies active in the UK North Sea, their total tax burden paid on profits is 40%. This is significantly higher than the standard 19% rate of corporation tax. In 2022, OEUK predicts the sector will pay £7.8 billion in UK tax. Oil and gas giants have also taken huge financial losses from pulling out of Russia due to the war in Ukraine. BP alone had to write off $25 billion due to its exit from Russia. It is worth noting however, that due to tax breaks for decommissioning old oil fields, many oil and gas giants have paid no or very little tax in the past few years. BP and Shell paid no tax on its profits from its UK North Sea operations between 2018 and 2020 after receiving around £400 million in tax breaks. This undermines the argument that their actual tax burden is too high already.
One of the reasons the UK government is currently opposed to a windfall tax is due to their ideology. Raising taxes is typically an anathema to the UK Conservative Party. The Conservative Party prides itself on being the party of low taxation. Having already raised national insurance by 1.25% and freezing higher rate income tax thresholds, Johnson’s government has, in practice, raised taxes more than any government in almost 30 years. Adding a windfall tax to the list would receive opposition from Conservatives MPs who hold firmly to their core free market low taxation principles.
The case for a windfall tax grows stronger each day. It is understandable however, why the government is tentative about imposing a windfall tax so swiftly. The government must be careful not to dissuade long term investment and a swift implementation could send the wrong message out to businesses about the UK’s tax stability. Notwithstanding, the government has a duty of care to support households in society. The severity of the cost of living crisis is too stark to be ignored and requires significant action. While a £22 billion support package was announced earlier this year, it simply doesn’t go far enough and households are in desperate need of more support. Although raising taxes can dissuade companies from investing, a modest one-off tax is unlikely to have this effect. Labour’s proposals plan to raise around £2 billion after the one-off tax is applied to the whole sector. By comparison, in February Shell unveiled a $8.5 billion share buyback programme. Just three weeks ago, BP expanded its own buyback programme by $2.5 billion. Clearly the firms have sufficient capital and they are in a financial position to bear a greater (and temporary) tax burden. A windfall tax, like the one proposed, is reasonable and would account only for a small amount of their record profits. Crucially, such a small amount is unlikely to deter future investment. There is a strong case to impose a windfall tax but it must be a reasonable rate and should come with some assurances of tax stability to prevent an investment exodus.