What is a windfall tax and why does the UK need one?

Anyone who hasn’t been living under a rock will know that the UK is currently in the middle of a cost of living crisis, with household bills rising by £1000 per household. To soften the effects of the crisis, Labour leader Keir Starmer recently called for a windfall tax on the profits of North Sea oil and gas producers, including companies such as BP and Shell. A windfall tax is a tax on “exceptional profits”, meaning that a company has made significant profits in an unexpected way and the government decides to take a higher slice of them, usually to bolster the welfare system in times of need. Labour have calculated that a 10% increase on corporation tax, taking the tax rate for these companies to 50%, would create £1.2bn in revenue which could be used to cut household energy bills.

The gas price crisis has pushed millions into poverty while gas companies like BP are gaining billions of pounds in “excess” profit due to the country’s energy bills being hiked by £700 per home. The call for a greater tax comes after BP announced profits of £9.5bn in 2021, compared to a loss of £4.2bn in the previous year, followed by Shell’s £14bn profits, four times their 2020 profits. Their profit margins were severely expanded as the price of extraction remained largely the same, while the value of gas and oil swelled along with the volume of consumption as the world opened back up following the pandemic. The taxes on these profits could be used to reduce the public’s energy bills and prevent more families being pushed into poverty. A portion can also be used to invest in clean energy and in structural solutions, such as insulating our homes so households use less energy.

An issue with windfall taxes is how these “exceptional profits” are determined, as some companies simply have up-and-down periods. If the government is happy to take a share of a company’s profits, they may be expected to provide financial support when the same company’s profits have dropped. Taxing a company during high-profit periods can also be damaging to the business and their ability to invest and innovate, and could deter investors which will damage the company in the long run. Therefore, a balance needs to be struck between energy companies being made to pay their fair share in tax while still being able to invest in innovative technologies that will help to reduce emissions that are causing the climate emergency. The impact that a windfall tax would have on a companies’ ability to invest in carbon-cutting technologies depends on the size of the increase. Labour modest 10% increase, setting the total tax at 50%, will still leave companies with plenty of money for investment and will continue to provide their shareholders with bumper profits.

It is already evident that energy companies don’t invest nearly as much as they should in ways to tackle the climate crisis, especially since they are one of the biggest reasons for the crisis in the first place. Oil and gas companies are known for “greenwashing” by over-emphasising their minute investment in new technology and making it look like they’re more environmentally-friendly than they are. BP, for example, “changed their name to Beyond Petroleum and publicly added solar panels on their gas stations” but were promptly called out by ClientEarth who lodged a complaint against BP for misleading the public with adverts focusing on BP’s low-carbon energy products, while more than 96% of its annual spend is on oil and gas.

Arguments against the increase, usually by right-wing economists and Conservative MPs, state that corporation tax on energy companies is already 40% which is twice the amount that other companies pay. This argument conveniently omits the significant tax relief that these companies benefit from. Oil companies receive relief when they spend enough on activities like decommissioning North Sea oil platforms to cancel out any profits they were making in the UK. As a result, most UK oil and gas companies have paid very little tax over the last five years. The campaign group ‘Uplift’ produced research that showed how BP’s oil operations in the North Sea have paid zero tax for five years and have actually received money from the taxpayer in the form of tax rebates amounting to £493m since 2016. Their financial situation has been further cushioned by their 2019 negative tax rate of -54%. BP’s own reports from 2015 to 2020 show overall refunds, meaning they received more money from the UK government than they paid out. This isn’t a unique case either, as 19 energy companies have received £2.4bn in tax rebates from the UK government since 2016, making it one of the most generous tax regimes in the world for energy companies. In comparison, the average tax on each barrel of oil in the UK is under $2 compared to $21 in Norway who require oil companies to pay a special tax rate of 56%, potentially rising to 71.8%.

Granted, these companies provide hundreds of thousands of jobs and invest billions in clean energy, but when The National Audit Office is claiming that “in some years the government paid more to oil and gas companies in tax relief than it received from them in taxes”, it’s hard to argue against a modest 10% tax rise.

The potential revenue procured by this tax has been calculated by various political parties to be somewhere between £1.5 billion to £5 billion, and more.

This tax has been used sparingly but effectively since its introduction by Margaret Thatcher in 1981. Her chancellor, Geoffrey Howe, used it to extract roughly £400m from the banks that were avoiding the pain of the recession at the time. In the following year, the Treasury “sought to share the benefit of high oil prices by imposing a special tax on North Sea oil and gas”, raising £2.4bn. The Blair government also utilised a windfall tax to tax utility companies that had made “excessive” profits after their privatisation by the Tories. £5bn was scalped off the top of profits from the likes of BAA, British Gas and British Telecom (BT).

It’s important to look at the technicalities of this tax and how it can be implemented, and we can use Labour’s usage of it as an example. According to the Guardian, “Their [the companies’] value was calculated on the basis of profits and the market value at flotation [on the stock market] was subtracted. The companies then had to pay 23% of that figure to the exchequer in two instalments.” The resulting revenue was used to fund Labour’s welfare-to-work programme. That was the last time that a windfall tax was used, but there have been calls since then for it to be used on energy companies such as BP and Shell who regularly register huge profits, often at the public’s loss.

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