After weeks of insisting that a windfall tax on oil and gas companies would discourage them from investing in the UK, Rishi Sunak performed a U-turn on Thursday by announcing the government would impose a one-off levy on energy companies to pay for a £15bn emergency aid package.
The new Energy Profits Levy is a 25 per cent surcharge on the extraordinary profits the oil and gas sector is making and is expected to raise around £5bn over the next year.
Here the Standard looks at how a windfall tax works and asks whether the move – while popular with the public – will work.
So what is a windfall tax?
A windfall tax is a one-off tax paid by a company or particular sector.
Governments target businesses which are considered to have profited from something not necessarily linked to decisions they have made or risks they have taken.
In the case of the levy, announced on Thursday, it will be paid by oil and gas giants like BP and Shell which have posted record breaking profits following the surge in gas and poil prices caused by post pandemic supply crunches and the war in Ukraine, which has led to sanctions on Russia, one of the world’s biggest oil and gas providers.
How will the new Energy Profits Levy work?
The Treasury explained that the one off windfall tax was an additional 25 per cent tax on UK oil and gas profits on top of the exisiting 40 per cent headline rate of tax firms pay, made up of 30 per cent corporation tax and a one off supplementary charge. It takes the combined rate of tax on profits for UK oil and gas companies to 65 per cent.
The tax will take effect from Thursday and will be legislated for via a standalone Bill to be introduced shortly, the Treasury added.
It added that in future years, if oil and gas prices return to historically more normal levels, the one off levey will be phased out with the legislation due to end in December 2025.
When have windfall taxes been imposed in the past?
According to a paper by the think-tank the Institiute for Government, Margaret Thatcher’s Chancellor Geoffrey Howe introduced a one-off levy on banks, charged at 2.5 per cent of their non-interest-bearing current account deposits in 1981. The IfG said this was expected to raise £400m (equivalent to around £3bn in today’s terms).
Tony Blair’s New Labour government introduced a windfall tax on privatised utility companies in 1997, applying the levy to regulated utility companies such as BT and Scottish Power and raising £5.2bn - £13bn in today’s terms.
Then in 2011, former Chancellor George Osborne, increased the supplementary charge on North Sea oil and gas producers from 20 per cent to 32 per cent, a move which was estimated to raise around £2 billion a year at the time.
What are the arguments against a windfall tax?
The IfG paper says the main objection to windfall taxes is that they may discourage investment by reducing company profits and therefore the amount left over to invest. But low tax Conservatives also fear that such taxes create uncertainty for businesses and undermine the UK’s economic reputation making other country’s with lower tax regimes more attractive.
The CBI’s chief economist Rain Newton-Smith said the new levy would be “damaging to investment needed for energy security and net zero ambitions”, adding: “It sends the wrong signal to the whole sector at the wrong time against a backdrop of rising business taxation elsewhere.”
Other economists also argue that governments should clearly set out their tax systems in advance to promote stability. Politically there has also been questions raised over whether the amount raised from the levy – while likely to be in the order of billions of pounds – will ever provide more than a sticking plaster to the longer term economic effects of inflation being felt at the moment.
What is Rishi Sunak doing to try and encourage investment?
At the same time as announcing the levy, Mr Sunak announced what he called a new ‘super-deduction’ style relief for firms. The Treasury said the new 80 per cent investment allowance will mean businesses will overall get a 91p tax saving for every £1 they invest – providing them with an additional, immediate incentive to invest.
And what are the arguments in favour?
Because they are a one-off and are based on past economic activity they should be “far less damaging to economic activity”, the IfG paper explains. “This is because companies cannot change behaviour to reduce their tax liability (for example, by reducing production) as they might with an annual tax announced in advance,” it adds.
Another think-tank, the Nationale Institite for Economic Research, says windfall taxes are also “relatively easy to impose on firms, easy for firms to comply with, and hard to avoid.” It goes on: “This results in a relatively predictable tax yield, which is particularly helpful if the funds received are aimed at a particular problem (such as helping to alleviate the burden of energy bills on struggling households).”