1. Money

    Annabel Denham

    A windfall tax on energy firms is a mistake

    A windfall tax on energy firms is a mistake
    North Sea oil giants would be targeted under Labour's plans, but ordinary Brits would pay the price (Getty images)
    Text settings

    Is it time for a windfall tax on energy companies? Judging by a poll during the first lockdown – which found more than half of the UK public would welcome an additional tax on businesses that had thrived because of the extraordinary circumstances of the pandemic – it would be a popular measure. A windfall is typically something you get for free, after all.

    Advocates often reference Chancellor Gordon Brown’s windfall tax on privatised utilities in 1997, which raised £5.2bn over a number of years and was justified on the grounds that corporate profits had risen due to failed government policy. But even in such circumstances, windfalls are a bad idea. Companies don’t pay taxes, people do. A windfall would reduce the dividends paid out to company shareholders. These companies are not owned by 'fat cats,' but by us all through pension funds and insurance firms.

    They also hurt consumers by stifling competition: while incumbents must put up with the tax regime, new entrants can divert their efforts elsewhere. And they risk a decline in investment, given few investors will put funds towards an industry that is subject to an unstable tax policy.

    But just like wealth taxes, windfall taxes are a bad idea that never seems to die. Over the weekend, Labour joined the Liberal Democrats in calling for one on North Sea oil and gas producers, to fund a £200-average cut to household energy bills plus £600 of targeted support for those most in need. Even within the oil and gas industry, this is nothing new: these companies already pay an elevated rate of corporation tax at 30 per cent on their upstream profits, compared with 19 per cent for most other companies. They also pay a 'supplementary charge' of ten per cent – a measure introduced by Brown two decades ago. At one point during the coalition government, when the oil price was at its peak, there was a staggering 62 per cent tax rate on North Sea fields. When the oil price started coming down in the mid-2010s, there was a noticeable collapse in investment.

    It’s unclear why shadow chancellor Rachel Reeves, who set out her plan for a £1.2bn tax on producers, expects her opportunistic proposal to lead to different results. Tackling rising energy costs by disincentivising investment in energy risks a reduction in output, and increasing prices for customers. To hammer the only group who can invest in more supply domestically would be perverse. Already, as one Oil & Gas UK spokesperson pointed out, the industry’s fortunes mean a multi-billion pound tax uplift: the Treasury will get an additional £3.5bn in taxes in the two years from last April – making a total of more than £5bn.

    It comes as some relief that the government is standing firm in its rejection of a windfall tax. But the praise stops there. Policymakers have meddled so incessantly in the energy market over the last two decades – with subsidies, regulations, taxes, targets – that it now scarcely resembles a market at all.

    Energy policy has become increasingly muddled in recent years. Last month, Boris Johnson's supposedly pro-oil and gas government proposed that new North Sea projects only be approved if ministers judge them to be compatible with the drive to net-zero carbon emissions by 2050. The government wants to decarbonise, but rather than devising a technology-neutral system with simple carbon pricing that would allow different schemes to compete fairly, it introduces policies designed to keep carbon prices low. Boris talks a good talk on the role of market capitalism in reducing emissions, while setting arbitrary targets that will shut down the discovery process.

    The solution to the current crisis is not more intervention and taxation in the energy sector. Ministers should let the market react to rising costs and use those price signals to drive investment to where it’s needed. Lower, stabler taxes would deliver more investment, and signal a welcome commitment to the 2019 Conservative manifesto, which clearly states that the path to a net-zero economy will include a 'key role' for the North Sea oil and gas industry. It would do a world of good for hard-pressed consumers, too.