Will Taxing the Windfall Profits of Oil Giants Fix Countries’ Economies?

Major oil and gas companies have raked in multibillion-dollar profits at unheard-of levels. Households around the world are reeling from soaring energy prices, while governments are struggling with outsize spending and slowing economic growth.

On Thursday, the British government tried to close the gap in those inequities by announcing additional taxes to capture energy companies’ windfall profits and use the money to defray the staggering cost of energy bills — similar to what governments across Europe have done and President Biden has threatened to propose.

The logic seems straightforward. Energy suppliers are benefiting from an unexpected bonanza because of Europe’s sudden move away from Russia’s gas and oil after its invasion of Ukraine, as opposed to any savvy strategy by the companies themselves.

Shell, based in London, recently reported that it had earned $20 billion in just six months, its biggest haul on record, while BP earned $16.6 billion. TotalEnergies, based in Paris, reported profits of nearly $29 billion over the same period. American energy companies are also taking in gobs of profit. Net income for the world’s oil and gas suppliers will reach $4 trillion, the International Energy Agency estimated, double last year’s total.

Such staggering figures spurred the United Nations secretary general, António Guterres, to “urge all governments to tax these excessive profits and use the funds to support the most vulnerable people through these difficult times.”

Yet there is fierce debate over whether imposing an extra tax on windfall profits to subsidize energy users would ultimately worsen the problem rather than solve it: Lower profits could discourage suppliers from producing more energy, while lower prices could encourage consumers to use more.

Such warnings, however, have done little to deter European governments from seeking to plug cavernous budget holes with some of the Smaug-size piles of cash that energy companies have accumulated.

On Thursday, Jeremy Hunt, Britain’s chancellor of the Exchequer, announced that he would raise $16.5 billion next year by increasing the windfall tax on oil and gas companies to 35 percent from 25 percent and introducing a temporary 45 percent levy on electricity producers. Many of these producers — including those that use solar, wind and nuclear power — have enjoyed enormous profits even though their costs haven’t increased.

The European Union last month announced a temporary tax — euphemistically labeled a “solidarity contribution” — on some fossil fuel producers. An additional 33 percent levy will apply to “surplus” profits and is expected to raise $145 billion. There is also a cap on electricity profits.

Individual nations have gone further. Last week the Czech Parliament approved a measure to impose a 60 percent tax on energy companies’ and banks’ windfall profits. Germany is considering taxing by 90 percent profits that electricity companies generated above the cost of production.

Mr. Biden, too, accusing major oil and gas companies of wartime profiteering, has said he wants a new windfall tax unless the companies increase production, although such a proposal is unlikely to win congressional approval.

Designing any kind of energy policy is particularly challenging at the moment because of conflicting goals.

One involves climate change. Policymakers want to quickly step up energy production of coal, gas and oil to meet immediate shortages, but want to phase out all fossil fuels in the long run.

They want to capture some of the huge profits earned by solar, wind and nuclear-powered electricity providers, while encouraging those companies to invest even more in renewable energy sources.

And there is the balance that governments must strike between helping households afford the brutally high cost of heating and fuel this winter and encouraging them to consume much less of it.

Windfall taxes can promote some of these goals but can be extremely difficult to craft because of so many technical complexities. After all, how do you define excessive profits?

David Goldwyn, who was a top State Department energy official in the Obama administration, said he worried about governments sopping up extra profits from renewable-energy companies, because they had often had very lean years.

“Renewables companies are facing cost pressures from inflation and trying to raise massive amounts of capital to scale up their investments,” Mr. Goldwyn said. “It is not clear that Europe can achieve its energy security or energy transition objectives by making these companies less profitable to invest in.”

In Britain, officials wanted to avoid stifling oil and gas investment, so they allowed companies a tax exemption for 91 pence of every pound invested in new production. Yet such government support for new fossil fuel yields not only hampers efforts to cut carbon emissions by 2030, but also significantly reduces the amount of revenue raised.

Shell, for example, has paid no taxes on gas and oil production in Britain since 2017 because of exemptions related to money spent on new investment and decommissioning old fields.

Although many energy companies have challenged particular tax proposals, others have conceded such a policy may now be inevitable. “I think we have to accept it and we have to embrace it,” Ben van Beurden, the departing chief executive of Shell, said after announcing the company’s quarterly profits in September.

Critics also argue that windfall taxes, which tend to apply only to profits earned within a country’s borders, hurt domestic energy production. The Tax Foundation, a research organization that tends to favor low taxes, points to a congressional study of a windfall profits tax introduced by the Carter administration in the 1980s that found it decreased domestic production and increased reliance on foreign oil.

Yet as several economists have pointed out, whatever the drawbacks, a windfall profit tax makes the most sense when energy companies are making gargantuan profits and families and businesses are facing financial ruin from staggering energy costs.

Concerns about crimping investment may also be overstated, they noted, when so many of the oil and gas companies are using the newfound revenue to increase payouts to shareholders and buy more of their own stock to nudge up its price.

“It won’t have any significant effect on long-run supply,” said Richard Portes, an economics professor at the London Business School. It will, he said, “redistribute income to consumers, ordinary households and businesses, from companies that are doing share buybacks and increasing dividends.”

In a survey of more than 30 European economists conducted in June by the University of Chicago Booth School of Business, half agreed that a windfall tax on excessive oil and gas profits should be used to help households afford high energy costs. Seventeen percent were opposed, while a third were undecided.

Antony Froggatt, deputy director of the environment and society program at Chatham House in London, said that “from a political perspective it’s unavoidable,” given the large sums governments were having to pay to help individuals and businesses survive the winter. And, he added, “it is fair.”

John Van Reenen, an economics professor at the London School of Economics, was also in favor of such a policy. “I think there is a pretty good case for having windfall taxes on the producers because the high profits they are currently getting are not rewards for past investment or risk-taking activities,” he said, “but due to the Russian invasion of Ukraine.”

With such “eye-wateringly high” prices facing consumers, Mr. Van Reenen said, this may be one of those fortuitous moments when the economic case and the political case for windfall taxes overlap.