Should Australia tax the windfall profits of energy companies?

Levying windfall taxes on energy companies reflects a poor understanding of business practices and economic cycles, writes UNSW Business School's Mark Humphery-Jenner

Windfall taxes, which are an extra government levy imposed on a company, have become popular with politicians. They seem like a convenient way to raise revenue while also scapegoating evil corporations for society’s problems. They are also controversial and have met with scepticism. Michael Burry – of Big Short fame – has scorched them as “stupid” and “short-sighted”. Windfall taxes can also be legally questionable: Exxon Mobil has sued to challenge the EU’s windfall tax. However, legal challenges turn on the specifics of the law and regulatory regime. 

Let us analyse three key problems with windfall taxes to see the controversy.

1. Windfall taxes set a bad precedent

The biggest issue is that windfall taxes set a dubious precedent. In 2022 and 2023, governments targeted energy companies. This responded to high energy prices, which politicians painted as profiteering. This manifested in jingoistic terms, such as the UK creating an “unearned profits” tax. These euphemisms smack of Orwellian double-speak.

The issue is, then, when is it “appropriate” to impose a “windfall tax”? Against whom can a government “legitimately” impose such a tax? What is the limiting principle? Is there a limiting principle, or is it acceptable for the government to simply deem when a profit is “unearned”?

The ‘windfall tax’ could apply equally to farmers during periods of high prices. Or banks when interest rates are high. Or doctors. Or lawyers. Or anyone else in demand. Indeed, the windfall taxes appear to belie a complete lack of understanding of the basics of supply and demand.

Without clear limits on authority, that authority ought not to exist: Unlimited authority is open to abuse, arbitrariness, misconduct, and incompetence. Or, put differently: your job could be next in the government’s sights.

2. Windfall taxes are counterproductive

Windfall taxes are counterproductive. They are a response to high energy prices. But, they ignore the fundamental reason why energy prices are high: a lack of supply.

Windfall taxes exacerbate supply shortages. This is clear from Exxon Mobil’s litigation in which they have specifically stated that the tax deters their investment. This is not a hollow argument. Total Energy cut investment in the UK following its windfall tax.

The tax also creates sovereign risk. Investors will hardly trust a government if it treats them as a personal piggy bank if they are successful. Ironically, this attacks business success, which creates economic growth and jobs, which the government should encourage.

Read more: Should billionaires drive company policy? Even if they’re doing good?

3. Windfall taxes don't mix with business

The windfall taxes further misunderstand two fundamental aspects of business.

First, they interrupt the ordinary supply/demand equilibrium. This is because they reduce the after-tax income a company might expect from its production. In turn, this reduces the desirability of devoting resources to goods impacted by windfall taxes. That is, the marginal benefit of producing a windfall-tax-good is lower than that of any other good. The companies would then distribute cash to shareholders rather than increase the number of goods supplied. 

Second, they ignore the business cycle. In the ordinary business cycle, there are positive and negative periods. Downturns are often associated with low profits. Firms must obtain profits in positive periods in order to offset negative periods. This is the case in most commodities, including agricultural commodities and natural resources. By removing profits in good periods, regulators offset the natural counterbalance to bad periods.

Thus, the windfall taxes show little understanding of ordinary business practices and economic cycles. However, this is not a major consideration for policymakers pursuing windfall taxes.

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What, then, should regulators do?

Regulators must do more to encourage supply. This is a long-term project. Short-term knee-jerk policy decisions, which undermine supply, and create sovereign risk, are not a coherent solution.

This requires logical policy decisions. New supply can take years of capital expenditure and has a long payback period. 

Fossil fuel supply will not increase if companies fear the government will eliminate their industry, especially if the time period for such regulation is unknown or subject to change. Such regulations, and uncertainty, deter investment. Governments cannot demonize oil and gas on the one hand and then bemoan the lack of supply on the other.

Regulators might want to shift from fossil fuels. However, this requires sensible policies that properly consider immediate supply needs. Windfall taxes do little to support supply requirements.

Mark Humphery-Jenner is an Associate Professor in the School of Banking & Finance at UNSW Business School. He has been published in leading management journals, and his research interests include corporate finance, venture capital and law. For more information, please contact A/Prof. Humphery-Jenner directly.