{"id":6956,"date":"2022-09-05T20:00:00","date_gmt":"2022-09-05T19:00:00","guid":{"rendered":"https:\/\/www.taxpolicy.org.uk\/?p=6956"},"modified":"2023-02-02T09:55:39","modified_gmt":"2023-02-02T09:55:39","slug":"windfallflaws","status":"publish","type":"post","link":"https:\/\/heacham.neidles.com\/2022\/09\/05\/windfallflaws\/","title":{"rendered":"The \u00a35bn flaws in the UK oil and gas windfall tax"},"content":{"rendered":"\n

In May, the Government announced <\/a>the Energy Profits Levy – a windfall tax on UK oil and gas companies. It has two significant flaws, which together mean the tax will raise almost \u00a35bn less than it could have done.<\/strong><\/p>\n\n\n\n

This post is an explanation and expansion of points I make in Panorama’s programme on the energy crisis<\/a>, broadcast on 5 September (and reflects further thinking since I recorded the interview a few weeks ago). I’ve another post looking at how a more ambitious windfall tax<\/a> could raise \u00a330bn.<\/p>\n\n\n

Flaw 1 – this windfall tax misses some of the windfall<\/h2>\n\n\n

The Energy Profits Levy was announced on 26 May 2022 and applies from 26 May 2022. For most taxes that wouldn’t be surprising. But for a windfall tax it’s odd, because windfall taxes are usually retrospective – i.e. taxing a windfall that’s already been made. <\/p>\n\n\n\n

This chart at the top of this post shows the oil price over the last five years1<\/a><\/sup>Data from Yahoo Finance<\/a>. A more serious analysis would probably be looking at natural gas futures pricing, but that’s way outside my expertise… this chart suffices for the basic point that the windfall tax kicks in well after the windfall starts<\/span> – the shaded red section shows the oil price breaking $100\/barrel, at the point of Putin’s invasion of Ukraine<\/a>. The red line shows the point at which the windfall tax starts to apply… it’s clear that this windfall tax misses a large chunk of the actual windfall.<\/p>\n\n\n\n

If the tax had applied from 24 February it would have raised an additional sum of approximately \u00a31.5bn<\/strong>.2<\/a><\/sup>I estimate this by taking the \u00a35bn yield the Government expects<\/a> in its first ten months, and then pro-rating that across an additional three months<\/span>. <\/p>\n\n\n

Flaw 2 – the investment allowance is pure deadweight cost<\/h2>\n\n\n

The windfall tax is charged at 25% of oil and gas profits. So a company with \u00a3100m of windfall tax profits would pay \u00a325m tax.<\/p>\n\n\n\n

But the government was sensitive to claims that a windfall tax would deter investment, and so introduced an 80% allowance for capital expenditure and, in addition, a 100% first year allowance. <\/p>\n\n\n\n

Many tax reliefs are introduced to encourage more of a Good Thing. Those reliefs always have a “deadweight cost” – the cost of giving relief to something that would have happened anyway, as well as a benefit (the Good Things that we will now get more of).<\/p>\n\n\n\n

What are the benefits and deadweight costs of the investment allowance?<\/p>\n\n\n\n

Calculating the benefit<\/strong><\/p>\n\n\n\n

The investment allowance works like this: if a company has oil and gas profits of \u00a3100m, and invests \u00a350m in qualifying capital expenditure, it gets a deduction against its windfall tax profits of up to \u00a390m (i.e. 180% of \u00a350). So its windfall tax profits are reduced to \u00a310m, and its tax only 25% of this – \u00a32.5m.[\/mfn]Needless to say, these are all highly simplified examples.[\/mfn] That \u00a350m investment has cost the company only \u00a327.5m3<\/a><\/sup>i.e. because it is out of pocket \u00a350m plus \u00a32.5m tax; if it hadn’t invested at all it would have had \u00a325m tax; hence the investment actually cost \u00a352.5m minus \u00a325m. It’s actually less than this once we take into account all the many, many, other reliefs against ringfenced oil\/gas corporation tax, but I want to focus solely on the design of the windfall tax.<\/span><\/p>\n\n\n\n

First thought: wow, what a fantastic incentive that is sure to generate lots of new investment!<\/p>\n\n\n\n

Second thought: hang on, the windfall tax isn’t around for very long – it ends 31 December 2025. So for any oil and gas investment to be incentivised by the investment allowance, the project needs to move from drawing-board to breaking ground in 30 months. My understanding from industry contacts is that very few, if any projects will do this. <\/p>\n\n\n\n

It’s even worse than that – 31 December 2025 is the “sunset date” – the tax will be phased out earlier if oil and gas prices return to “historically more normal levels”. A tax relief that lasts for an unpredictable amount of time is not a tax relief many people will be banking on.<\/p>\n\n\n\n

These points suggest there will be little or no upside from the investment allowance – the only projects that will materially benefit from the investment allowance will be those that were already planned<\/strong>. <\/p>\n\n\n\n

A more general point: giving 100% investment relief (aka “full expensing”) is a good idea<\/a>, even an excellent idea, but it absolutely can’t be part of a temporary tax regime. And another important point: there is evidence<\/a> that investment reliefs are ineffective in times of economic uncertainty.<\/p>\n\n\n\n

Calculating the deadweight cost<\/strong><\/p>\n\n\n\n

The deadweight cost is the cost of giving the investment allowance to investments that are already in the pipeline. We have a good idea of what the pipeline looks like, thanks to the ONS’s projections for North Sea capital expenditure (made prior to May 2022)4<\/a><\/sup>See <\/span>here<\/a>, and go to Supplementary fiscal tables – receipts and others, tab 2.14<\/span>. We can pick out the qualifying items from this, and calculate the cost of giving them the 25% allowance:<\/span><\/p>\n\n\n\n

\"\"<\/a>
Click to download the spreadsheet<\/figcaption><\/figure>\n\n\n\n

This gives an estimate of the deadweight cost of \u00a33.2bn. That will be a low-end estimate, because it ignores a number of factors, each of which would increase the actual deadweight cost:<\/p>\n\n\n\n