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Windfall Taxes Are All the Rage. They Shouldn’t Be.

Punishing energy companies has become an easy way to supplement revenue, but such taxes carry significant risks. 

Easy target.

Easy target.

Photographer: Peter Boer/Bloomberg

With energy prices soaring, thanks partly to Russia’s invasion of Ukraine, countries around the world have been experimenting with a hodgepodge of interventions to ease the pain, including consumer subsidies, price regulation and ad hoc nationalizations. Because all of these measures come with significant potential downsides, one other supposed solution has been getting increased attention: windfall taxes.

The idea of such taxes is to demand a surcharge from companies that have benefited from high energy prices, then use the proceeds to aid ailing consumers or businesses. The European Union recently proposed a “solidarity contribution” of at least 33% of the “surplus taxable profits” of oil and gas companies. It would also cap the revenue of renewable-energy and nuclear-power companies whose profits are linked to the price of gas. So far, more than a dozen EU countries have either enacted a windfall tax or said they’re planning to. In the UK, Prime Minister Rishi Sunak is being urged to increase a limited windfall tax imposed earlier this year.

On Monday, US President Joe Biden joined the chorus, accusing oil companies of “war profiteering” and threatening them with big new levies if they fail to bring down consumer prices. 

For policymakers, such measures have an obvious appeal. Russia’s invasion created a boon for the energy industry. Surging quarterly profits for companies such as BP Plc, Shell Plc and ExxonMobil Corp. have resulted in billions distributed in dividends or spent on share buybacks. Why shouldn’t some of this bonanza be used to support the vulnerable?

Moreover, windfall taxes are (in theory) economically efficient, as they’re easy to collect and hard to avoid. They also have the benefit of simplicity and tend to poll well with the public. Politically, they’re a no-brainer.

Yet in politics, as in life, there’s no such thing as a free lunch. The benefits of windfall taxes are very likely less than advertised — and the unintended consequences are likely to be substantial.  

For one thing, they often fail to raise the anticipated revenue. In one notorious experiment, a windfall profit tax that the US imposed on oil companies in the 1980s raised just $80 billion in gross revenue out of a projected $393 billion. Today’s levies are designed somewhat differently, but the effect is likely to be the same: Italy’s windfall tax has (as of September) yielded only about one-fifth the income the government had hoped for. 

Another problem is determining what constitutes a “windfall.” Energy is a volatile industry. Today’s windfall can easily turn into tomorrow’s wipeout, meaning that occasional years of high profits are essential to meeting future demand. Yet the temptation to define “normal” profits at a confiscatory rate will be strong, and all too likely to persist beyond the current crisis. Especially in Europe, new taxes have often proved habit-forming.

Such measures also tend to discourage needed investment. Although Europe is right to move toward net-zero carbon emissions over the long term, the fact is that fossil-fuel producers will be needed to bridge the gap for many years, and much investment will be required by renewables firms subject to the new tax. If these companies think their profits can be seized whenever a bureaucrat deems them “excessive,” they’ll have less incentive to add capacity, and Europe’s goal of energy independence will be all the harder to meet. 

Finally, there’s a principle at stake. Imposing an arbitrary tax on a small subset of companies deemed to have been too successful sets a dreadful precedent. It penalizes blameless shareholders and punishes prudent investment. Worse, it simply evades all the difficult questions the Western world must confront — on taxes, spending and more — as it belatedly tries to wean itself from Russian energy.

Right now, energy companies rolling in dough make a convenient target. But a persistent truth of policy making is that there are no easy solutions to hard problems. In this case, a windfall tax is no solution at all.

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