Labour Party voices, especially on the left and in the unions, are increasingly demanding a windfall tax on energy companies (and on banks and anyone else they can think of). When criticising the government for failing to get its act together, they beg the question “OK, so what would you do?”. And the easy, stock answer is, “Let’s have a windfall tax. Let’s confiscate these obscene profits that the energy companies (and the banks — except that they’re mostly not doing so well). are making. Then we can reduce prices at the pumps, address fuel poverty, and so on”. It’s amusing that a Labour politician can readily propose to take one sum of money and spend it three times over.
Windfall taxes may be tempting to those on the left, but they should stay their hand, for two sets of reasons. Windfall taxes are wrong in principle, and perverse in practice.
A windfall tax is, in effect, retrospective legislation. We are saying to business that no matter how carefully companies plan, no matter how successful they are, we will come along afterwards and confiscate any profits which we deem excessive. On that basis, do we also have to pay subventions to companies that make an unexpected loss? Government should not be in the business of telling companies what is an appropriate level of profit, not should they be in the business of moving the goalposts in the middle of the game. By all means let them change the rules on taxation in an orderly way, in a budget, with due notice. But they have no business to undermine, in an arbitrary way, work that has already been done and profits already earned.
In fact the so-called “obscene” profits are usually nothing of the kind. An energy company may well make tens of billions of pounds. But “A million pounds a minute” is a tabloid headline, not economic analysis. The first question should be “What is their return on capital employed?”. After that we can enquire about investment in R&D, exploration of new reserves, investment in recovery and refining capacity and so on. A headline profit figure is meaningless.
A particularly amusing European angle is Brussels’ Emissions Trading Scheme (ETS), which has had the unintended effect of awarding quite substantial funds to energy companies. But we have no right to offer a novel system, invite companies to plan on that basis, then ask for our money back because we got our sums wrong. Again, let them reform the system (in this case they’d do better to abandon it), and proceed on a rational basis. Not confiscate the money they solemnly guaranteed a couple of years ago.
But a windfall tax also has perverse and unintended consequences. First, an energy company will look to strengthen its margins to respond to any attack on its profit. In other words, we will create a new incentive for market players to increase prices — hardly what we wanted. Second, they will try to cut costs. This may mean less investment in exploration, just when we need new reserves. Less investment in new technology, just when we need alternative energy technologies. Less investment in extraction and refining capacity, just when demand and prices are going up.
A windfall tax may make leftist politicians feel good, but it will result in less energy and higher energy prices. Not a very good day’s work.
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