With the global economy reeling from the effects of the Covid-19 pandemic, few could have anticipated the added shocks to energy supply and global food systems wrought by Russia’s recent invasion of Ukraine and a pandemic-related slowdown in the Chinese economy. The result is a cost-of-living crisis that is global in scope.
Energy is a major contributor to the inflationary updrafts, with prices that have climbed 30% in many markets. Yet the cost of energy production hasn’t changed in a meaningful way since the crisis began. This means that extra money coming out of the pockets of energy consumers is going dollar-for-dollar onto the bottom lines of energy producers—a true windfall for their executives and investors.
So now, where there is a windfall, should there be windfall tax?
The debate over whether to impose a windfall tax has been disorienting for many, not least because one must look back to the 1980s for instances when the UK and US governments imposed similar forms of taxation on energy companies. But with high energy bills once again putting the budgets of many households under severe pressure, it seems reasonable to consider the windfall profits of energy companies in light of two questions.
First, did the companies do anything extraordinary to create the extraordinary levels of profitability? If the answer is yes, putting an extraordinary tax on those profits would seem to be bad policy. In the capitalist system, it is important for rewards to flow to those who successfully confront risks. If taking on risk is not commensurately rewarded, risks will go unconfronted to the detriment of society. In the case of the energy companies’ windfall profits, however, there is no evidence of any extraordinary assumption of risk. The companies conducted business as usual, and, without their being in any way responsible, an interlocking set of global crises is causing extra profit dollars to rain into their coffers.
The second question is whether energy companies will use windfall profits to further social goals that will generate benefits for the consumers who are the source of the windfall profits. Indeed, given the choice, many consumers experiencing financial challenges today may be willing to make the sacrifice if doing so will allow society to avoid the worst consequences of the climate crisis. And who better to lead that charge than the energy companies?
The problem with this argument is that the leaders of large companies must pursue many objectives. Environmental, social, and governance (ESG) goals are increasingly on their lists. But investments in the long-term success of their companies are, too. And often, the most compelling objective is providing rich returns to investors—right now. To a significant degree, therefore, leaving the energy companies to determine the disposition of windfall profits is likely to net out to a transfer of wealth from those lower on the socioeconomic hierarchy to those above them, which is hardly an argument for refraining from a tax on windfall profits.
If windfall taxes are to be enacted, it’s fair to ask one more question. Will governments do any better than companies in deploying the windfall? In this case, there is every reason for optimism. Democratic governments have the ability and motivation to apply the windfall in socially beneficial ways. Most directly, they can hand the funds back to the taxpayers. Indeed, the UK has announced a multifaceted program to do just that as part of their windfall tax program.
But that is just the start. Governments have a unique role to play in funding the energy transition. Many of the elements of a climate-sustaining energy economy will need governmental support to reach economic viability. The reality is that most new ideas for products, services, financing mechanisms, etc., go through a lengthy gestation and market emergence process. Many fail to reach maturity regardless of their intrinsic merit.
The occasional arbitrariness of this process is a feature we’re happy to live with, as it accompanies capitalism’s extraordinary capacity for innovation. We’re happy to accept it, except when the idea in question is urgently needed to address a looming global crisis. In this case, governments can be a critical provider of resources and incubation processes to make sure truly valuable ideas make it through the gestation process.
The solar and wind industries are prime examples of the kinds of new markets and services that can flourish when smart governmental support is applied. There are many other innovative ideas whose progress could be accelerated with enhanced government investment and support. For instance, funding could be used to provide tax credits for cleaner forms of energy production, such as the proposed hydrogen production tax credit in the US, which formed part of the Build Back Better Act in February.
Although the proposal fell short in the Senate, the tax credit promised to make green and blue hydrogen competitive with gray hydrogen produced from natural gas. Government investment could also help deliver much-needed funding for critical energy transportation, storage, and distribution infrastructure; improvements to energy efficiency; and the reliability, security, and resilience of energy supply.
In short, windfall taxes could give governments the additional resources needed to accelerate essential investment at a critical time. We are at a moment of enormous challenge, with little time to avert catastrophic outcomes. Let us use the energy sectors’ windfall profits to help people now—and for generations to come.
This article does not necessarily reflect the opinion of The Bureau of National Affairs, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.
Stephen Crolius is president of Carbon-Neutral Consulting, a business strategy consultancy dedicated to helping clients around the world navigate the opportunities and challenges they encounter in the energy transition.
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