There is a common saying that every tax has the effect of discouraging some kind of private behavior – whether it is good, bad, or careless.
This recognizes that taxes have behavioral responses. Increase sales taxes, for example, and you’ll see marginally less retail spending.
In the case of corporate income tax, the conventional wisdom is that if we increase the rate, we will see less capital investment.
The capital is highly mobile; Those investment dollars will go elsewhere. A possible exception to this line of thinking relates to windfall profits taxes – which are discussed in Europe in relation to the energy sector.
Earlier this year, outgoing Prime Minister Boris Johnson’s government approved a type of windfall profit tax called an energy dividend tax. It was basically a 25 percent surcharge on oil and gas sector profits that accrued on or after May 26.
The purpose of the timing restriction was to target only those profits generated by the destabilization of global oil and gas markets attributed to the Russian invasion of Ukraine.
Instead of raising taxes across the board on all corporate taxpayers, the new tax would only reach those companies that – in fact – accidentally benefit from someone else’s suffering.
Amidst the recent news coverage of the UK’s new king, you may have noticed that the country also has a new Prime Minister. Liz Truss replaced Johnson a few days before the death of Queen Elizabeth.
Truss has presented itself as an aggressive tax cutter. There is a growing list of taxes you don’t like and plan to reduce or eliminate. This includes the energy dividend tax. The stated reason for opposing the tax is that it would discourage investment in the local economy, which presupposes an undesirable behavioral response.
Such a response might be reasonably predictable to changes to the core corporate income tax – which Truss also wants to cut in the coming months – but is that true of the windfall tax? I am not convinced.
If applied correctly, windfall profits taxes should not produce the same distorting effects as income tax. They will not influence investment decisions because they target a subset of profits that investors never expected to realize in the first place.
No investor puts his capital into a project because it guarantees extraordinary profits. That wouldn't be realistic. By definition, windfall economic gains are non-routine gains made at the expense of good luck. We should think of the energy dividend tax as a tax levied on companies that have been fortunate (out of a scarcity caused by the war) rather than a tax on companies that were smart, innovative, and productive.
If Truss wants to cut taxes on British corporations, so be it. However, it might be a smart political move for it to keep the energy windfall tax - expected to raise £5 billion over the next year - and use the receipts to offset the cost of temporary emergency measures to cut home heating costs over the coming period. winter months.
Even a painted tax breaker should realize that not all profits are the same, economically speaking. So it should follow that taxing windfall profits is unlikely to produce the adverse behavioral reactions that Truss wants to avoid.