Why an increased energy windfall tax is not a solution to plug the fiscal “black hole”
Chris Denning · November 7th 2022 · read
The recent results announcements of BP and Shell, raise questions about whether a potential increase in the current windfall tax on UK oil and gas producers is an appropriate measure to deal with the “fiscal black hole” in public finances.
The current windfall tax applies to ring fenced profits from UK continental shelf oil and gas production and treasury receipts for such profits in 2021 were £1.4bn. At a 40% corporation tax rate this implies taxable profits were circa £3.5bn. The treasury projected generating tax revenues of £5bn from the windfall tax this year which implies a 6-fold increase in UK oil and gas profits from last year. So even an additional 10% rate increase in the windfall tax would only generate circa £2.0bn of additional tax revenues. This is not a “golden bullet” in terms of funding the UK’s fiscal black hole, which is estimated to be at least £50bn. Whilst contributory, it would need to be weighed against the potential further negative impact an increase would have on UK investment decisions.
Alternatively, it has been suggested that rather than increasing the rate, tax relief on investment in UK extraction should be scrapped. This would seem counter to the desire that the UK becomes more energy self-sufficient, albeit this is something of a misnomer, unless the government is considering banning UK continental shelf producers from participating in global oil and gas markets which drive wholesale prices.
Perhaps the suggestion is that the tax base of the windfall tax should be extended beyond oil and gas extraction profits, but how would that work in practice?
The major UK energy producers such as BP and Shell derive their profits from both different geographies and product lines. If the government decided to tax UK based multinationals in the UK on their worldwide windfall profits, that would destroy the UK’s capital markets reputation as one of the best fiscal jurisdictions in the world in which to locate and invest.
Creating additional taxes and increasing tax rates, particularly in response to a short term crisis, are often blunt instruments that do not produce the desired outcomes and unless fully considered, can have significant negative impacts on economic behaviour.
Aside from dealing with the fiscal black hole, the way in which the UK’s energy market is structured needs to be addressed.
UK energy policy has historically focused on power generation; however the current energy crisis is undoubtedly exacerbated by the lack of investment in grid infrastructure, connectivity and storage capacity.
As an example, the UK already has enough wind farm capacity to power Scotland twice over and yet they have still committed to a further £85bn of offshore wind farm capacity over the near term. The reality is that due to lack of grid connectivity and congestion the power this creates cannot be channelled to the south of the UK, so when the wind blows UK households have to pay (through network charges on their energy bills) the wind farm operators to turn off. At the same time, to meet power demand in the south, energy providers must burn more fossil fuel and pay volatile market rates for gas which again, gets passed on to bill payers.
To change this situation, the government need to create an environment where the investment focus in the UK is on improving grid capacity/connectivity, and on creating scalable and sustainable energy storage solutions. Any new green fiscal incentives and energy market policy should be directed to create investment in these areas.
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