Explained: What is windfall profit tax
The 2022 price increase for fossil fuels has resulted in significant windfall profits for the energy sector. Many countries are considering policies to tax a portion of these profits.
A wave of countries, including the U.K., Italy, and Germany, have either already imposed or are considering imposing a windfall profit tax on supernormal profits made by energy companies.
Windfall taxes are intended to tax profits derived from an external, sometimes unprecedented event, such as an increase in energy prices as a result of the Russia-Ukraine conflict.
These profits cannot be attributed to something the firm actively did, like an investment strategy or an expansion of business. Governments typically levy a one-time tax retrospectively over and above the normal rates of tax on such profits, called windfall tax.
The chief of the U.N. (United Nations) urged all governments to tax these excessive profits “and use the money to support the most vulnerable people through these difficult times.”
How are energy companies making so much money?
Producers are the first point for energy, whether it is electricity generation through renewable measures or the extraction of crude oil and natural gas. These gains are recorded by producers as a result of supply and demand. When a commodity is in high demand, prices rise and in turn, so do profits. Furthermore, they do not simply produce and sell oil; they employ thousands of traders who buy and sell oil produced by other companies and profit from market price fluctuations. The more volatile the market – as has been the case throughout 2022 – the higher the potential earnings.
Refiners made significant gains by increasing fuel exports to deficit countries such as Europe, which has now boycotted Russian oil imports.
Retailers and Suppliers are distinct entities from producers, and as such, they are required to purchase Wholesale Energy at the market price, which means they are also dealing with rising costs. Retailers and suppliers are then forced to pass on these costs to households and businesses.
What are the Issues with Imposing this tax?
Companies are more likely to invest in a sector if the tax regime is predictable and stable. Because windfall taxes are imposed retroactively and are frequently influenced by unexpected events, they can create market uncertainty about future taxes.
It is unclear what constitutes true windfall profits or how to determine what level of profit is normal or excessive. It is believed that such taxes are populist and politically opportune in the short term.
Some rejected such a move, claiming it would “slow down growth” by discouraging investment in the energy sector. A energy giant insists a large amount of its profits are re-invested into green energy projects and improving existing infrastructure.