Western governments have recently made changes to cope with the cost-of-living crisis. Among these is the windfall tax on energy companies, which have reported record earnings.
The EU and the UK have approached the matter differently. While European governments imposed a short-term ‘solidarity contribution’ taxing excess profits, the UK put in place several more stringent measures. All in all, in addition to the permanent 40% tax rate paid by oil and gas producers, the new British windfall tax raised the combined headline tax rate for the sector to 65% by the end of 2022 and to 75% from January 2023 until March 2028.
With energy giants reporting record profits in 2022, including £23bn for BP and £32bn for Shell, governments are under growing pressure to charge energy producers even more, both through further tax rate increases and the elimination of the investment allowance.
This is concerning, according to Wioletta Nawrot, an assistant professor in the law, economics and humanities department at the ESCP Business School. “Proceeds from windfall taxes are unlikely to solve the current crisis, even if further changes to the taxation of the energy producers would be introduced,” she said.
In the EU, the new fiscal measure is expected to raise €140bn. However, Germany alone is expected to spend €200bn on its ‘protective shield’ to help fight soaring energy prices. Meanwhile, in the UK, windfall taxes are expected to raise around £55bn (€62.48bn) by 2028, while the energy package aimed at easing the cost of the energy crisis will likewise cost the government more by the end of this winter.
On the other hand, such changes in taxation expose economies to substantive risk. “It is risky for public finances to rely on receipts from windfall taxes for too long as it may prove difficult to wean them off when they come to an end,” said Nawrot.
Moreover, new taxes create uncertainty for businesses and may impact their market valuation, impacting all capital market participants, including pension funds. Most importantly, uncertainty and excessive taxation could undermine energy producers’ investments, including the crucial transition to net zero.
“It is important to think carefully about how the overall formula of the profits taxation is likely to impact investment by energy companies transitioning to net zero,” explained Nawrot. “Evidence suggests that the climate has been changing more rapidly than we thought, and that the impact of human interference is more worrying.”
In the context of global climate action goals, Nawrot said that the taxation of energy producers should not come at the cost of slowing down their investments towards net zero. With careful planning and governments working alongside energy players, it should be possible to share the burden and progress towards net-zero targets.
As well as investing in renewable energy, fossil fuel extractors should contribute to climate action by disposing of carbon dioxide safely and permanently.
“The structures needed to capture and store it underground are already in place, and the recent record energy profits provide the chief polluters with the ideal source of funding of these still very expensive technologies,” argued Nawrot. According to climate scientists, it is impossible to reach net-zero targets without carbon capture, usage and storage.
Striking a balance between taxing energy players more and helping them to achieve net zero would be a great outcome. This would help to meet both short-term budget needs and longer-term critical climate targets.