Tax Talk – CIOT/IFS online debate: Is it time for a windfall tax?

Tax Talk is a series of articles brought to you by FSL’s own Tax specialist, Alex Ranahan.

On the 1st March, the Chartered Institute of Taxation (CIOT) and the Institute for Fiscal Studies (IFS) ran a joint online debate on the proposal for a windfall tax on the profits of North Sea gas and oil companies.  Initially suggested by the Labour Party as a way of raising approx. £1.2bn in revenue, which could be used to help low and middle income households afford the impending rises in energy costs.  The proposal has picked up traction among campaigners, commentators, and politicians from all major parties in recent weeks, particularly in light of the invasion of Ukraine.  Although the UK imports only 4% of its gas from Russia, there is no doubt that, were Russia to restrict its exports in response to Western sanctions, the result would be global gas price rises which would be felt here too.

In this context, four leading commentators on tax and economics debated the merits and drawbacks of a windfall tax as a way of paying for the expected price rises.

First up was IFS senior research economist Stuart Adam.  His presentation looked at the conditions required for a windfall tax to be successful, fair and economically efficient.  Giving the examples of the 1997 windfall tax imposed on privatised utilities, the 1981 special budget levy on banks, the 2008 windfall tax on energy companies and the 2009 tax on bankers’ bonuses, he argued that the best windfall taxes were those which were prospective, not retrospective.

To be efficient, a tax should not induce changes in taxpayers’ behaviour to reduce their tax bill, nor should it cause investors to choose to invest less money in the UK.  By basing the proposal on retrospective profits it appears to meet this test; however, behaviour can also be affected by concerns about future tax – so might it concern those companies that they could face future ‘one-off’ taxes?  Of course, this consideration is not unique to windfall taxes.

His final point was on fairness.  The justification for this tax is that the shareholders benefited from a fortune they did nothing to earn, and which perhaps could not be legislated for through normal taxation.  Why not legislate to tax all companies which gain unexpected wealth?  Because North Sea oil and gas taxation is different – The location is fixed, thus international competitiveness does not matter, and therefore the Government should be able to tax all profits at a higher rate.

The next speaker was Chris Sanger, global government and tax risk leader at EY, who advised the Labour Government on the 1997 windfall tax on private utilities.  He emphasised the importance of providing a roadmap for taxpayers, pointing out that the windfall tax eventually imposed in 1997 had been discussed in public since 1993 and was in the Labour election manifesto – utility companies had had plenty of time to prepare.  Indeed, the value of the companies hardly moved during this period because the expectation of a windfall tax had been embedded into the price.

The 1997 windfall was structured to avoid contamination – Investors should not become wary of UK investment but should simply account for the impending tax as another cost of investment.  The UK’s attractiveness as a place to invest could be undermined by uncertainty over tax rates.  They were also careful, in 1997, to ensure the amount of tax demanded would not imperil the companies involved – As a partial offset for the windfall tax, the Government reduced the gas levy at the same time.

His final point was on the one-off nature of a windfall tax – Agreeing with Stuart Adam, Chris Sanger noted that a windfall tax is a recognition that the tax system is not right at that time.  If a Government looks at a windfall tax, that is an acknowledgement that it hasn’t properly taxed those companies before.  The tax system should be prospective in nature in order to rectify a wrong for the future.

The third speaker was Heather Self, partner at Blick Rosenberg.  Taking a firmer approach against the current proposal, she noted that 1997 had been well constructed, with a narrow and defined group of target companies, and declared in the manifesto.  But despite this there had still been some anomalies – Scottish Power, where she worked at the time, had acquired a company and was required to pay taxes twice on its profits (an appeal against this failed at judicial review).  Ultimately, no matter how well a windfall tax is designed, some people will be worse affected than others.

Her greatest concerns were around the principle of fairness to the taxpayer.  A taxpayer should know in advance their tax burden, so a better proposal would be to tax North Sea companies at a permanently higher rate in future – for example, whenever oil or gas prices are higher than a certain level, the company pays higher tax.

Furthermore, the impact of a windfall tax on investment is often underestimated – If it has happened once, there is always the fear it can happen again.  As seen in Ukraine, big companies have rapidly changed their investment priorities in response to new developments.  Scottish Power stopped some investments in response to the 1997 windfall tax, and sold its profitable US business in 2006 for return on capital because of the risk of another windfall tax.

Her final point was on the amounts involved.  The current proposal will bring around £1.2bn to the Treasury, or 2% of HMRC’s annual Corporation Tax take.  Contrast with £5.2bn in 1997, £400m in 1981, and £2bn in 2009.  Does the additional tax take justify the potential downsides?  She felt not.

The final speaker was Michael Jacobs, professor of political economy at the University of Sheffield.  His arguments focused on the context and reason for the tax.    He reminded the audience that there is a crisis for people on low incomes with the energy bills they now pay.  For perspective, using figures from the Joseph Rowntree Foundation, the average family living on Universal Credit will pay 18% of their income on energy bills, a lone parent 25%, and a single person on Universal Credit will pay a whopping 54%.  Contrast that with a middle income family paying about 6% of their income towards energy bills, up from 4%.

At the same time that people face these higher bills, the Chancellor cut the Universal Credit uplift of £20 per week, while prices across the economy are rising.  BP’s profits increased to £9.2bn from a £4.2bn loss in the previous year for the exact same reason that households will have less money this year – Rising energy prices.  The proposal would not do all of the work but it would do some of it.

He argued that unearned income is generally seen by economists as a good source of tax, and these profits are not expected or planned profits of the companies.  There is therefore “no behaviour to chill”.  A windfall tax once every 20 years should not discourage investment, and furthermore the tax is not 100% of their profits so there will still be plenty of money in the companies to invest.  He also argued that the companies have been net recipients from taxpayer over the last five years when taking reliefs and allowances into account.

To conclude, he noted that the International Energy Agency has already budgeted all oil and gas extraction from now on from 2021.  If we take global warming seriously then the whole carbon budget has already been taken up, so there is no room to invest further anyway.

After the speakers had finished, there was a Q&A session.  All speakers agreed that a roadmap was far preferable to a retrospective tax charge, and all preferred changes to the tax system overall to deal with changes needed regarding global warming.  There was also a discussion on taxing property wealth in some way, including by bringing Council Tax up to date by revaluing properties.  But perhaps the most interesting moment was at the end when asked how they would deal with the current situation:  Heather’s proposal was to raise the escalator on fuel duty, which has been frozen for 11 years, as this would raise £11bn – But she noted she would be swiftly booted out as Chancellor!

Overall it was an fascinating debate, with lots of strong views and well-made points.  We will see how the Treasury reacts to recent developments, and whether the Spring Budget and forecast statement will contain new announcements in response.

Please remember, this is not financial or tax advice.  Please consult a qualified adviser for further details.