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Windfall profit taxes are pure economic populism and thus bad policy

Germany's government just became the latest to ingratiate itself with angry voters by promising a windfall tax on energy companies

windfall tax
Photo: Bloomberg
Andreas Kluth | Bloomberg
4 min read Last Updated : Sep 06 2022 | 11:22 AM IST
Germany’s government just became the latest to ingratiate itself with angry voters by promising a windfall tax on energy companies. One way or another, these levies aim to seize “excess” profits and redistribute them to needy consumers aching from the soaring costs of electricity and heating. 
 
Several countries, from the UK to Italy and Greece, have already done something similar. Others — including the European Union — are lining up their own proposals.

No matter the specific form, the sheer notion of windfall or excess-profits levies is cynical populism, and therefore bad policy. Proponents offer them as a deceptively simple solution to big but complex problems, thereby playing on the emotions rather than the intellect of voters. 

Here’s their populist narrative: There’s an energy shock, caused by a distant and evil dictator who’s turning off the gas flowing to Europe and causing prices to soar. Greedy and selfish companies in the West are profiteering from this emergency by making oodles of money even as ordinary people suffer. That’s unfair. Let’s confiscate those undeserved winnings.

Like all effective demagoguery, the storyline isn’t wholly wrong, just grotesquely oversimplified. Yes, British companies exploring oil and gas in the North Sea are making unexpected bundles as prices for their output soar. So are German providers of cheap electricity, because prices in that market are set by the suppliers with the highest marginal cost — currently, those using natural gas to generate power. Simultaneously, many households obviously are hurting from higher utility bills.

A proper economic exegesis, however, is more complex and would turn off most of the intended audience. It starts with a reminder that all those companies now catching windfalls already pay taxes — corporate, income and other. 

If they’re able to profit from the unusual market situation, it’s because they invested in the past in equipment, technology and know-how to be ready. When they made those decisions, they knew that the “lucky” scenarios might never pan out. But they took that risk in the hope of a reward — and on the assumption that governments wouldn’t seize that reward arbitrarily.

Trying to assign moral grades to such investments leads nowhere. Oil and gas companies were already loathed before the crisis for keeping us hooked on evil fossil fuels. They stuck around anyway. Was that laudable or deplorable?

Germany’s producers of solar and wind energy, by contrast, placed their now-lucky bets while donning environmental halos. Now their electricity is suddenly the type that has the lowest marginal cost, and under current market rules they get to bag the difference between their cost and that incurred by gas rivals. The same Greens who used to shower them with subsidies suddenly want to cap their gains. 

Recall, for a moment, a few other recent instances in which populists demanded windfall taxes. In the early days of the coronavirus pandemic, there was a shortage of face masks. The companies that quickly ramped up production soon rolled in money. “Speculators” or saviors?

What about the makers of Covid vaccines? Some literally spent unremunerated decades researching the science around mRNA. They didn’t do it for money — the ascetic founders of BioNTech SE struggled for years just to find outside funding for their labs. They dreamed instead of curing cancer and other diseases. Then, one day, a new pathogen showed up, and they were ready. “Profiteers” or heroes? 

There are, of course, specific cases in which profits are objectively excessive, immoral or even illegal. Those include the so-called economic rents that accrue to members in a cartel, for instance. But that’s what antitrust law is for, with rules that are made in advance and enforced in an evenhanded way.

The rest of the time, taking risks in the hope of rewards is legitimate: It’s called investing. But investment will dry up if we threaten to arbitrarily confiscate rewards ex post — whenever we feel like it, perhaps by holding impromptu plebiscites to determine whether a given profit is fair or unfair, and how we should tax it.

Psychologically and politically, the recurring attempts by some politicians to declare returns as deserved or undeserved, good or bad, have two origins. One is ideological — that is, socialist. This worldview is based on envy, and a lust for the power to judge market outcomes. The other is populist. It’s the unprincipled willingness to give mobs — the vox populi — whatever they bay for. Responsible leaders won’t stoop to such lows.

Topics :Excise DutytaxesGermanyUKEuropean Unionenergy industrynatural gaseconomy

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