While we struggle to make ends meet, suffering the worst bout of inflation in 40 years, corporations serving and supplying us not only pass on their higher input costs with impunity, but also raise their profit margins for good measure. Never is this more galling than when it is done with food and energy. Fuel prices keep ticking up, the supermarket bill is shockingly high, and heating or air-conditioning becomes unaffordable for struggling households.
Penalising corporations which make a killing in taxing times is therefore too good a political opportunity to let pass. Politicians don’t have to be populists to understand that the electorate expects decisive action.
Policy measures range from the introduction of windfall taxes levied on corporations, to household subsidies, VAT reductions and price caps. All this comes with unintended consequences as I will try to exemplify.
The reduction of taxes on petrol (in some countries petrol is even subsidised) will not tackle the underlying problem of insufficient supply, but maintain demand unsustainably. We will not drive less as long as taxpayers, even those who do not own a car, are asked to make up for the difference. We might be better persuaded to fuel thriftiness by free public transport ‒ a boon to the environment.
Equally, a subsidy of energy bills to households will hardly induce economising with gas or electricity. Raising transfer payments to deserving poor households in the same amount would not only better counter inequality but leave it to families if they’d prefer to turn on the air con or rather buy a better meal and prevent subsidising the better-off unnecessarily. (Introducing such policies in Malta would be untenable though, as the construction and energy profiteers would have a hard time expanding business.)
As recently as last month, both the UK and Hungary introduced ‘windfall taxes’, eyeing ‘extraordinary profits’ made in tough times. Victor Orban could not be bothered with chiselled policies, extra-taxing not only energy companies, but also banks (not all foreign, this time), telecom companies, airlines, insurers, retailers, pharmacies and advertisers.
To add drama to this populist move, Orban assumed emergency powers, which was technically unnecessary, as his own party holds a constitutional majority in parliament anyhow. It was just meant to bolster his strong-man image. There’s of course a higher justice to this, as most industries are run by his cronies, who Orban has a habit to advantage in mutual interest. Not much harm was done, apart from further deterring foreign investment, inducing corporate exile and consumers picking up the final bill.
Much more care went into UK Chancellor Rishi Sunak’s “energy profit levy”, named such as a similar, albeit weaker proposal by the Labour opposition has been labelled a “windfall tax”. Many pitfalls of a brute extra tax were avoided.
Support went mainly to poorer households, production-boosting oil investments were almost fully exempted, and the punishing 25 per cent extra tax were exclusively levied on the domestic North Sea oil and gas production, thus avoiding the arbitrariness of taxing oil companies unfortunately headquartered in the UK.
Yet the threat of levying a similar tax on electricity producing companies later in the year remained – a potentially larger source of policy mistakes. These include the possible stifling of badly needed investment in renewables and a modern grid fit for purpose, but also threatens the viability of household suppliers.
A regime where investors lose when times are bad and get taxed when profitability returns is not a good system to support capital accumulation- Andreas Weitzer
In terms of political strategy Sunak’s was an astute move. The opposition was muted, Boris Johnson’s ‘partygate’ shrank to a side show, inflation readings were improved with the stroke of a pen and millions of people are at least temporarily better off.
Yet the extra-tax comes with unavoidable trade-offs. It is never a confidence-building measure for industries to be taxed because they are profitable and successful. Since 2014, when the oil price was damagingly low, energy companies were in the doldrums. My shares had suffered big time all the while, making me doubt the sensibility of my investments.
A regime where investors lose when times are bad and get taxed when profitability returns is not a good system to support capital accumulation. Such arbitrariness blemishes the rule of law and invites corporations to seek calmer waters elsewhere. Sunak’s flash tax was made even more disquieting as the measure was not a one-off but introduced to last until 2025 and as long as the oil price stays elevated.
To add insult to injury, the levy excludes depreciation, making it impossible to avoid the surcharge by offsetting it against past losses. Shell, for instance, must have hoped that they could continue looking into the future without paying any tax on earnings.
On a national level, the tax, which is essentially an increased North Sea royalty, will harm the upkeep of the UK’s diminishing oil reserves. Britain’s ageing reservoirs, emergency back-up for current and future energy deficits, demand ever higher investments to squeeze out some yield ‒ hence the chancellor’s offer of generous write-offs. It will misfire.
Exploration is budgeted over long periods of time. Enhanced write-offs offered for the next three years will only profit those which are investing already and punish independents that have taken over low-yielding oilfields from the majors.
By focusing on exploration, this energy tax leaves out the plight of refineries, which suffer from high oil prices, while procuring the petrol which costs us so dearly. And it leaves the enormous profitability of crude and fuel trade out of the picture. Half of the profits racked up by oil majors consist of trading profits these days, while pure traders like Gunvor, Vitol and Trafigura have a field day, profiting from high volatility and futures price differentials.
I do not even want to mention Glencore here, which has a knack for manipulating benchmarks at the point of sale, as we learned from recent court filings.
Perhaps the biggest irony in the UK government’s attempt to demonstrate empathy for the plight of the many is the fact that the shares of the likes of Shell and BP, reliable payers of high dividends, are the staple stock of most British pension funds, which have started to profit from the late revival of domestic oil and gas companies. If the now spontaneously taxed energy companies cannot find their way around the levy, it could hurt the last shares standing in already bear-market-ruffled pension pots.
To the extent that Sunak’s move to alleviate energy inflation is not covered by the tax levied on energy companies it will be demand-inducing, and as such further increase inflationary pressures. Without palpable fiscal restraint, the Bank of England will be on its own fighting inflation. It will have to raise interest rates sharper to do so. Households with mortgages and credit card debt they can ill afford will derive less comfort from their fuel support cheques. Windfall taxes are easily popular, yet anything but plain sailing.
The purpose of this column is to broaden readers’ general financial knowledge and it should not be interpreted as presenting investment advice, or advice on the buying and selling of financial products.