Are Windfall Taxes Becoming the New Normal in the UK?

Even though energy prices have declined from their recent peak, the United Kingdom is one of the few countries in Europe continuing to rely on windfall profits taxes to support households with the rising cost of living. Though the windfall taxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. was initially set to expire at the end of 2025, the UK’s labor government is extending the tax to 2030. But just because the wind is almost always blowing in the North Sea oil fields, that does not mean that a windfall profits taxA windfall profits tax is a one-time surtax levied on a company or industry when economic conditions result in large and unexpected profits. Inheritance taxes and taxes levied on lottery winnings can also be considered windfall taxes on individual profits. should be a long-term part of UK tax policy.

Windfall profits taxes are usually intended to target extraordinary profits created by extraordinary circumstances, but that’s not how the UK is using the policy. The constant changes in the “energy profits levy” and its extension to 2030 create an unpredictable and blustery tax environment that would hurt oil and gas production, investment, and long-term growth. Instead, the UK should raise revenue through more neutral tax policies that make room for the additional investment needed to support growth.

The UK is not the only country in Europe that implemented a windfall tax following record-high prices of oil and gas driven by Putin’s invasion of Ukraine. In October 2022, the Council of the European Union agreed to impose an EU-wide windfall profits tax, or “solidarity contribution,” on fossil fuel companies (oil, gas, coal, and refining sectors). However, in 2024, the UK departed from the path that many EU countries took, and not in a beneficial manner.

A Temporary Tax Set to Last for 9 Years

While the UK’s reasons for introducing a windfall tax were similar to the EU’s, the UK’s design diverges significantly from the EU’s regarding the targeted sectors, tax rate, tax baseThe tax base is the total amount of income, property, assets, consumption, transactions, or other economic activity subject to taxation by a tax authority. A narrow tax base is non-neutral and inefficient. A broad tax base reduces tax administration costs and allows more revenue to be raised at lower rates. , and tax period.

The UK government first approved the windfall tax on 11 July 2022, exclusively targeting companies engaged in oil and gas extraction.

The 25 percent tax (35 percent since January 2023) applicable to profits generated on or after 26 May 2022, came on top of an existing 40 percent headline tax rate on oil and gas, generating an effective tax rate of 65 percent. However, an 80 percent investment allowance together with other reliefs already available enabled taxpayers to obtain relief of up to 91.25 pence per pound when they reinvest profits in the UK oil and gas sector. In January 2023, the 25 percent tax rate was increased to 35 percent resulting in an overall effective tax rate of 75 percent. Additionally, in 2023, the investment allowance was lowered from 80 percent to 29 percent, while restricting the 80 percent allowance to upstream decarbonization projects.

While the EU regulation imposed a temporary windfall tax that would end after 2023, the UK opted to tax all profits of the targeted companies from May 2022 to December 2025. However, in June 2023, the conservative government at the time announced that the windfall tax would remain in place until March 2028, while oil and gas prices remain higher than historic norms. Additionally, in March 2024, the tax was extended for one more year to March 2029.

However, in July 2024, the new labor government extended the tax for an additional year to March 2030 and increased the rate to 38 percent, starting from 1 November 2024. The government’s new budget also eliminated the current 29 percent investment allowance and lowered the decarbonization investment allowance from 80 percent to 66 percent, starting from November 1.

Windfall Taxes Could Undermine the UK’s Energy Security

These constant changes to the windfall tax have triggered a strong response from the business sector. Forty-two companies have warned that the official plans threaten 80 percent of new investments in oil and gas and over £200 billion of investment in all forms of energy, including renewables. Maintaining the windfall profits tax, raising the rate (by 3 percent from November 1), and eliminating the investment allowance would make almost half of additional oil and gas production unfeasible. However, this will not threaten only the oil and gas industry but also the firms that invest in renewable energies.

Not only are these windfall taxes taking capital away from more carbon-intensive energy production, but they are also removing greatly needed capital from the companies that are investing in clean energy.

Apart from reducing investment, windfall profits taxes can accelerate the decline of domestic oil and gas production in the UK. Companies might choose to invest in regions with more stable and predictable tax environments, leading to a loss of jobs and economic activity in the UK. This shift can also reduce the country’s energy security as domestic production declines.

Temporary crisis measures cannot become the new normal, and windfall profits taxes in the oil and gas sector are not principled tax policy. The UK should learn from Spain’s experience with windfall taxes and abolish them instead of perpetually extending them.

Rather than pursuing temporary policies, the UK’s policymakers should implement long-term, pro-growth tax reforms that stimulate economic activity and incentivize energy diversification by supporting private investment.

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