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The Pitfalls of Windfall Taxes

There have been increasing calls by politicians throughout the world for windfall taxes. A windfall tax is a one-off tax imposed by a government on a company or group of companies. The idea is to target firms that were lucky enough to benefit from something they were not responsible for — this is a windfall. A prime contemporary example of such a windfall is the massive increase in oil and gas prices throughout the world. Since energy prices began to surge last year, Bulgaria, Italy, Romania and Spain have introduced new taxes on the industry. On March 8th, the European Commission recommended that countries should “capture a part of the returns” made by energy companies. In the US, 12 Democratic senators have proposed a tax on every barrel of oil big firms produce or import, with that tax set at half the difference between the current oil price and the 2015-19 average.

Such calls have become even louder since Russia’s invasion of Ukraine have driven energy prices even higher. This has led to the widespread perception that energy firms are profiting not only from the pandemic, but also from the war. And because governments have run up enormous debts during the pandemic, they have been forced to look for more revenue streams with which they can protect beleaguered consumers who are already battling massive inflation.

Practicality: the bane of sound climate policy

The traditional argument against windfall taxes is that they risk deterring future investment. After all, who wants to invest more into an industry that will have its profits clawed back? But this argument is not as strong as it once was, since most of the world is attempting to wean itself off of fossil fuels. The stronger argument is that energy markets go through cycles of boom and bust. In 2015 and 2016, prices were so low that the net operating margin of the energy industry was negative (companies did not make money). But companies endure these bad times in hopes that they will be able to recoup their losses when macroeconomic winds shift, as they have recently. Being forced to weather the storms, and then have chunks of profit clawed back when the weather is good, makes these businesses far less viable. Climate activists may see this as a win, but that thinking is considered myopic by many.

Harrowing UN research findings and scientific consensus about climate change tipping points have done little to move countries to phase out carbon emissions. But the Russian invasion of Ukraine, and the determination for Europe to be less dependent on Russian oil and gas, have provided a short-term motivation that align with the planet’s long-term interests. But that said, it does not mean we are in the position to tax energy companies to death, at least not yet. For now, we have to accept them as necessary evils, because we need a carefully managed phase-out of carbon emissions. Renewable energy sources and infrastructure are not quite where we need them to be to make this great shift. The good news is that we are moving in the right direction, and even if the motivation for this move is geopolitical rather than ecological, the ends certainly justify the means.