Oil tax to leave a slippery slope?

Stuart Adam – North Sea oil and gas could bear permanently higher tax

Stuart Adam, Senior Research Economist, IFS, said that windfall taxes can potentially be an economically efficient way to tax the fortunate but only if they do not increase worries about future windfall taxes. On whether a windfall tax is fair, Adam accepts that beneficiaries of a windfall, such as energy company shareholders, did nothing to earn their recent good fortune, but also that there are concerns about the arbitrary and retrospective nature of windfall taxes. His suggestion is that it is usually better to say in advance how much tax should be paid in different circumstances, and you should need a strong reason to deviate from that.

He added that North Sea oil and gas could be at permanently higher tax than today. Companies do pay more tax when they make bigger profits. If politicians think that does not go far enough, why not simply increase tax rates?, he asked, suggesting the answer is a fear that higher taxes will discourage UK investment. He said: “A windfall tax is a way to tax brute luck more than productive activity.” But Adam gave a couple of reasons why the UK can tax North Sea profits at a high rate even when they are the result of productive activity. He said that North Sea oil and gas is an unusual case because its location is fixed which means international competitiveness does not matter. And it is close to cash-flow tax which means higher rates should not discourage investment.

Chris Sanger – what we can learn from the 1997 windfall tax

Chris Sanger is Global Government and Tax Risk Leader, EY, and was a policy adviser on the 1997 windfall tax on the privatised utilities, but was speaking in a personal capacity. Sanger explained the approach to that 1997 windfall tax, saying it had a long lead-in time because Labour outlined it as a potential policy back in 1993. Importantly, he said, the market had factored the expectation of the windfall tax into the share price of the utilities by the time of the Budget that introduced it. Sanger also remarked that this advance notice helped to avoid ‘contamination of the tax system’ through tax uncertainty driving people and companies to fear future windfall taxes.

It was necessary to identify both what was the ‘windfall’ that Labour wished to tax and the factors that determined which companies were impacted, explained Sanger. There was a need to agree the basis for the tax, such as simply on turnover or assets or profits, or whether it should be something more complicated such as excess profits or excess shareholder return. They agreed to target utilities that were privatised at too small a gain for the taxpayer (which meant companies that provide ‘rolling stock’ were not caught). Labour argued it was a tax on a gain and you can tax a gain at any point. He said the £5.2 billion revenue received was what was predicted.

He warned of potential harm to the international view that the UK is a great place to invest.

Heather Self – windfall tax only appropriate in clearly one-off circumstances

Heather Self, who is a Partner at Blick Rothenberg and was Group Tax Director at Scottish Power 2002-6, agreed with Sanger that the 1997 windfall tax on utilities was ‘well structured’, especially as the policy was set out in advance and passed her ‘no surprises’ test.

But Self said that she objects in principle to windfall taxes unless there are clear one-off circumstances which cannot be dealt with by changes to the general tax rules. Such taxes break a fundamental principle in her mind that companies should be able to make investments based on a clear understanding of what the tax consequences will be. She said that tax risk is factored into investment decisions, and that capital is highly mobile -  large companies can switch quickly where they will make investments, as shown in the response by oil companies to the invasion of Ukraine

In an aside, Self observed that the new and unexpected addition of the Public Interest Business Protection Tax to the most recent Finance Bill was ‘close to a confiscatory tax’.

On the fairness of a windfall tax on oil and gas companies, she expressed concern that no matter how it is designed, it will not hit everyone equally, not least because different companies are at different stages of an investment cycle. She added that companies that make more profit pay more tax now anyway. If a windfall tax were to be extended more generally to companies that had made ‘excess profits’ during the pandemic, it would be ‘hideously complicated’, not least to identify which companies to tax.

Michael Jacobs – windfall tax is fair and necessary

Michael Jacobs is Professor of Political Economy, University of Sheffield, and former Special Adviser on energy, environment and climate policy at the Treasury and 10 Downing St (2004-10). Jacobs spoke specifically on the oil and gas sector. He said a windfall tax is justifiable because people on low incomes are experiencing a ‘windfall loss’ because they spend a higher proportion of their income on energy and are therefore hit by the increase in energy costs, while energy companies are experiencing a ‘windfall gain’. (The proposal that he was advocating was the Labour Party’s proposal for the revenues from a windfall tax to be spent on helping low income households pay their higher energy bills. So it is a redistribution of the losses and gains of the oil and gas price shock.) He feels that such unearned income is ok to tax, adding that it does not affect behaviour.

The professor referred to an article in Financial Times on the day of the debate (‘Windfall taxes on energy companies are a bad idea – One-off sugar hits cannot solve looming revenue challenges’) which had suggested an oil and gas windfall tax would chill investment. But his take on it is that it will not chill investment because the money taxed would be money not expected by these companies, adding that we cannot seriously say that tax rates will never change.

On the argument that a windfall tax is not symmetrical, Jacobs said huge tax reliefs are available to oil and gas companies, with some paying ‘negative tax’ in recent years because their profits were offset by generous allowances. It will not prevent investment because ‘nobody is suggesting a 100 per cent tax’ and concerns about energy security are a ‘red herring’. He is not even sure such a tax will damage pension funds and therefore UK people as much as feared, not least because these are global companies with global shareholders.

Questions and answers

In the Q&A session, the first question was about whether a windfall tax should exclude investment in renewables. Michael Jacobs said there are plenty of incentives already for investment in low carbon and that oil and gas companies should be treated the same as other companies in relation to these. Stuart Adam said a windfall tax is not the way to incentivise investment in low carbon schemes because it is a one-off tax.

Chris Sanger said that you should never be in a position where you repeat a windfall tax. You should fix the tax system so retrospective tax like this is not needed. Sanger and Heather Self agreed on the value of tax ‘roadmaps’ from governments to give business certainty of direction.

Sanger said he was not keen on hypothecation. You should raise taxes where you can and spend where you need to, was his view. However Jacobs, while recognizing the misgivings of some over hypothecation, thought that in this case there is a clear relationship between the source of revenue and what it should be spent on.

The next question was about the possibility of more progressive taxes on corporate profits. Self said that as a business if you pay a higher rate of tax on higher profits it creates an incentive to break bigger businesses into smaller ones, in a way that doesn’t exist for personal taxation. Sanger noted the 750m euro turnover threshold for the inclusive framework agreement on a global minimum tax rate. He also observed that we have different rates for smaller companies in part because of recognition of the admin burden of paying tax. Adam noted that the government are reintroducing the small profits rate; he is not keen on this. Bigger companies don't necessary translate into better off people, he observed.

Asked for a view about a windfall tax on the rise in commercial and property prices in London and the South East of England, Jacobs and Adam both said revaluation of council tax is a more pressing need if the goal is fairness. Rather than trying to pick out what is exceptional we need a system which is resilient over time, said Adam.

The panel were asked, if they were in Chancellor Rishi Sunak’s shoes, would they choose a windfall tax? Adam and Sanger both said they would lean away from one. Self suggested ending the freeze on the fuel duty escalator would make a big contribution to the Exchequer. Jacobs said he would support both a windfall tax and looking further at property wealth.

CIOT President Peter Rayney chaired the debate.

A video of the 1 March 2022 event is here.

By Hamant Verma, CIOT Senior External Relations Officer