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The imposition of a windfall tax on energy companies is supported by a majority of the public and many politicians. Revenues would be used to support low-income households struggling to pay gas and electricity bills following a series of steep price rises.

Yet consideration of the economic impacts of such a measure should lead to its outright rejection. Firstly, the arbitrary imposition of an extra payment would increase the risks to businesses of investing: as a result, they will demand higher returns on their investments or choose not to invest at all. Secondly, the tax would reduce the dividends paid out to energy company shareholders. These companies are not owned by “fat cats” but by us all through pension funds and insurance companies. Finally, it would reduce the funds available for investment in new sources of supply, thereby increasing energy costs in the long term.

Given the above effects, a windfall tax could harm many of the people it was designed to help and actually reduce long-term tax revenues. More generally, harsh though it may seem, it is a very slippery slope trying to protect parts of the population from particular price increases – especially in the energy sector. That is the way to stop people adjusting to a new environment of greater scarcity and is precisely the best way to induce shortages of supply in the future.

Richard-Wellings-2012b.JPG

Director

Richard Wellings was educated at Oxford and the London School of Economics, completing a PhD on transport and environmental policy at the latter in 2004. He joined the Institute in 2006 as Deputy Editorial Director. Richard is the author, co-author or editor of several papers, books and reports, including Towards Better Transport (Policy Exchange, 2008), A Beginner’s Guide to Liberty (Adam Smith Institute, 2009), High Speed 2: The Next Government Project Disaster? (IEA , 2011) and Which Road Ahead - Government or Market? (IEA, 2012). He is a Senior Fellow of the Cobden Centre and the Economic Policy Centre.

12 thoughts on “The economics of windfall taxes”

  1. Posted 09/09/2008 at 15:00 | Permalink

    Nice writing. You are on my RSS reader now so I can read more from you down the road.

    Allen Taylor

  2. Posted 09/09/2008 at 15:00 | Permalink

    Nice writing. You are on my RSS reader now so I can read more from you down the road.

    Allen Taylor

  3. Posted 09/09/2008 at 18:57 | Permalink

    Excellent post Richard, and spot on. Did anybody hear Prof Dieter Helm on Today on Sat totally demolishing the case for a windfall tax? He rightly stressed that investors will demand a higher risk premium against arbitrary appropriation of profits, which will have to be passed on to consumers – thereby negating any benefit. Unfortunately the majority of the population and politicians are economically illiterate.

  4. Posted 09/09/2008 at 18:57 | Permalink

    Excellent post Richard, and spot on. Did anybody hear Prof Dieter Helm on Today on Sat totally demolishing the case for a windfall tax? He rightly stressed that investors will demand a higher risk premium against arbitrary appropriation of profits, which will have to be passed on to consumers – thereby negating any benefit. Unfortunately the majority of the population and politicians are economically illiterate.

  5. Posted 09/09/2008 at 22:17 | Permalink

    Short jab. Nice

  6. Posted 09/09/2008 at 22:17 | Permalink

    Short jab. Nice

  7. Posted 10/09/2008 at 06:20 | Permalink

    The argument of protagonists often explicity ignores the economic argument and instead concentrates on the emotional side of thing: “we have to help these people now, without delay, they cant wait any longer in the face of crippling price rises.” Almost a case of “to hell with what happens in the future”.

    This isn’t a direct quote but its Roy Hattersley’s attitude when he was on the radio two or three weeks ago (sorry I can’t give a more precise reference).

  8. Posted 10/09/2008 at 06:20 | Permalink

    The argument of protagonists often explicity ignores the economic argument and instead concentrates on the emotional side of thing: “we have to help these people now, without delay, they cant wait any longer in the face of crippling price rises.” Almost a case of “to hell with what happens in the future”.

    This isn’t a direct quote but its Roy Hattersley’s attitude when he was on the radio two or three weeks ago (sorry I can’t give a more precise reference).

  9. Posted 15/09/2008 at 01:39 | Permalink

    In the 1980s, the United States tried a windfalls profits scheme on oil. The Congressional Research Service (CRS is the non-partisan research arm of the U.S. Library of Congress which performs research for the U.S. Congress) estimated the $38 billion in revenues that were diverted to the U.S. Treasury lead to approximately 6% less domestic oil production and increased imports as much as 16%. This madness was repealed in 1988.

  10. Posted 15/09/2008 at 01:39 | Permalink

    In the 1980s, the United States tried a windfalls profits scheme on oil. The Congressional Research Service (CRS is the non-partisan research arm of the U.S. Library of Congress which performs research for the U.S. Congress) estimated the $38 billion in revenues that were diverted to the U.S. Treasury lead to approximately 6% less domestic oil production and increased imports as much as 16%. This madness was repealed in 1988.

  11. Posted 27/10/2008 at 23:31 | Permalink

    Great stuff bond is impressed and let me tell you BOND is not easily impressed

    i’ll be back

  12. Posted 27/10/2008 at 23:31 | Permalink

    Great stuff bond is impressed and let me tell you BOND is not easily impressed

    i’ll be back

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