The case against windfall taxes

August 01, 2008 5:13 PM

Labour MPs, unions and the energywatch quango, who are trying to cover up the Government's complicity in high energy prices, have all been lining up to demand windfall taxes on energy firms.  They're wrong to do so on a number of grounds:


1)  Energy companies are not responsible for massive increases in prices


Yesterday evening I wrote an extended post for CentreRight.Com setting out why energy prices have been rising: the international price of oil is going up as supply fails to keep pace with demand, gas prices are linked to the oil price in the European market and our electricity supply is heavily dependent on gas.  Blaming energy companies for all that is just foolish.  Ofgem have shown (PDF) how our energy prices are around the EU average.


Another reason that prices are going up is that the government are putting in place new charges and regulations such as the European Union Emissions Trading Scheme, the Renewables Obligation and the Climate Change Levy.  These haven't been very effective at reducing emissions but do now constitute 14% of the average household electricity bill, and significant portions of industrial and gas bills, as set out by the Renewable Energy Foundation.  The Government could reduce prices tomorrow by scrapping some of these ineffective regulations.


Of course, the energy companies do quite well out of some of these regulations, like the EU Emissions Trading Scheme that allows them to sell spare permits to other emitters of CO2.  The solution isn't to further complicate the situation by adding new taxes but not to put these poorly conceived regulations in place to start with.


To impose big windfall taxes on energy companies would be shooting the messenger.  They aren't the ones who are really responsible for increases in prices.


2)  Energy company profits aren't necessarily the result of collusion or exploiting hard-pressed consumers


Put yourself in the shoes of a company like British Gas.  If you set your prices too low you'll make big losses, set them too high and you'll risk losing business to your rivals.  At times firms will make bumper profits after they ovestimate the price they'll be able to get gas at on international markets, at times they'll see profits fall as they underestimate price rises.  This year British Gas has seen its profits slump.


I can't prove a negative and establish conclusively that there isn't any collusion.  However, as I've set out above, we can see the factors driving high gas prices and unless we're going to treat energy companies as guilty until proven innocent there is little reason to punish them for problems not of their making.


3)  Windfall taxes discourage investment


Geo_thermal4_2We should be all in favour of firms making investments that will yield high profits.  If a firm is not making a profit from its investments then it is not producing something that we really need.


Energy companies that have invested in the capacity to import and distribute gas and produce electricity are producing things that are extremely valuable to us.


Imposing a windfall tax sends a message.  It tells business that if they make important investments, that need to pay off with substantial profits later on, we will punish them for it.  We might try and convince them that the windfall tax is just a one off, and future investments won't be punished for being useful, but they have no good reason to believe us.  We have signalled that they are fair game.  A windfall tax right now would mean even higher prices and probably even blackouts in the years to come.  A windfall tax on extraction companies, BP for example, would hasten the decline of oil production in the North Sea, as firms invested in more hospitable political environments, and increase our dependence on unreliable imports.


4)  Windfall taxes encourage fiscal irresponsibility


A windfall tax can only provide temporary revenues.  The Government has few one-off spending commitments, unless you really want to use a windfall tax to pay for the Olympics.  If the Government increases spending to make use of the revenue from a windfall tax, or fails to take action to plug ongoing gaps in the public finances, then they have stored up fiscal problems for the future - once the windfall is spent.   


Conclusions


It is understandable that people want to find someone to lash out at when they are struggling with high energy prices.  However, a windfall tax on energy companies would be the wrong policy targetted at the wrong people.  If the Government really wants to help it should reduce the burden of regulations and taxes that push up the price of energy instead of taking symbolic shots at companies.

Labour MPs, unions and the energywatch quango, who are trying to cover up the Government's complicity in high energy prices, have all been lining up to demand windfall taxes on energy firms.  They're wrong to do so on a number of grounds:


1)  Energy companies are not responsible for massive increases in prices


Yesterday evening I wrote an extended post for CentreRight.Com setting out why energy prices have been rising: the international price of oil is going up as supply fails to keep pace with demand, gas prices are linked to the oil price in the European market and our electricity supply is heavily dependent on gas.  Blaming energy companies for all that is just foolish.  Ofgem have shown (PDF) how our energy prices are around the EU average.


Another reason that prices are going up is that the government are putting in place new charges and regulations such as the European Union Emissions Trading Scheme, the Renewables Obligation and the Climate Change Levy.  These haven't been very effective at reducing emissions but do now constitute 14% of the average household electricity bill, and significant portions of industrial and gas bills, as set out by the Renewable Energy Foundation.  The Government could reduce prices tomorrow by scrapping some of these ineffective regulations.


Of course, the energy companies do quite well out of some of these regulations, like the EU Emissions Trading Scheme that allows them to sell spare permits to other emitters of CO2.  The solution isn't to further complicate the situation by adding new taxes but not to put these poorly conceived regulations in place to start with.


To impose big windfall taxes on energy companies would be shooting the messenger.  They aren't the ones who are really responsible for increases in prices.


2)  Energy company profits aren't necessarily the result of collusion or exploiting hard-pressed consumers


Put yourself in the shoes of a company like British Gas.  If you set your prices too low you'll make big losses, set them too high and you'll risk losing business to your rivals.  At times firms will make bumper profits after they ovestimate the price they'll be able to get gas at on international markets, at times they'll see profits fall as they underestimate price rises.  This year British Gas has seen its profits slump.


I can't prove a negative and establish conclusively that there isn't any collusion.  However, as I've set out above, we can see the factors driving high gas prices and unless we're going to treat energy companies as guilty until proven innocent there is little reason to punish them for problems not of their making.


3)  Windfall taxes discourage investment


Geo_thermal4_2We should be all in favour of firms making investments that will yield high profits.  If a firm is not making a profit from its investments then it is not producing something that we really need.


Energy companies that have invested in the capacity to import and distribute gas and produce electricity are producing things that are extremely valuable to us.


Imposing a windfall tax sends a message.  It tells business that if they make important investments, that need to pay off with substantial profits later on, we will punish them for it.  We might try and convince them that the windfall tax is just a one off, and future investments won't be punished for being useful, but they have no good reason to believe us.  We have signalled that they are fair game.  A windfall tax right now would mean even higher prices and probably even blackouts in the years to come.  A windfall tax on extraction companies, BP for example, would hasten the decline of oil production in the North Sea, as firms invested in more hospitable political environments, and increase our dependence on unreliable imports.


4)  Windfall taxes encourage fiscal irresponsibility


A windfall tax can only provide temporary revenues.  The Government has few one-off spending commitments, unless you really want to use a windfall tax to pay for the Olympics.  If the Government increases spending to make use of the revenue from a windfall tax, or fails to take action to plug ongoing gaps in the public finances, then they have stored up fiscal problems for the future - once the windfall is spent.   


Conclusions


It is understandable that people want to find someone to lash out at when they are struggling with high energy prices.  However, a windfall tax on energy companies would be the wrong policy targetted at the wrong people.  If the Government really wants to help it should reduce the burden of regulations and taxes that push up the price of energy instead of taking symbolic shots at companies.

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