Windfall tax

In News:

The Central government on July 1, introduced a windfall profit tax of ₹23,250 per tonne on domestic crude oil production, which has fluctuating rates.

• Finance Minister defended the windfall tax saying that it was done after full consultation with the industry and explained the introduction of the windfall tax as a way to rein in the “phenomenal profits” made by some oil refiners who chose to export fuel to reap the benefits of skyrocketing global prices while affecting domestic supplies
• It also imposed an additional excise levy on diesel, petrol and air turbine fuel (ATF) exports.

India has been importing discounted Russian oil – the windfall tax was targeted mainly at Reliance Industries Ltd and Russian oil major Rosneft-backed Nayara Energy

About Windfall Tax:

• The U.S. Congressional Research Service (CRS) defines a windfall as an “unearned, unanticipated gain in income through no additional effort or expense”.
• They are called so as the profits are derived from an external or unprecedented event or from something the firm actively did not participate in — for instance, the energy price-rise as a result of the Russia-Ukraine conflict.
• Typically, it’s levied as a one-off tax retrospectively over and above the normal rates of tax.
• In oil markets, price fluctuation leads to volatile or erratic profits for the industry. Hence, tax is levied to redistribute unexpected gains when high prices benefit producers at the expense of consumers.
• It can be used to fund social welfare schemes, and as a supplementary revenue stream for the government.

Need for Windfall Tax

• To narrow the country’s widened trade deficit on account of rising prices of oil, gas, and coal
• Rise in prices due to pandemic recovery and supply issues resulting from the Russia-Ukraine conflict and consequent increase in energy demands.
• The rising prices imply huge profits for energy companies while resulting in hefty gas and electricity bills for households – widening income inequality.
• The “grotesque greed” of big oil and gas companies eg. the largest energy companies in the first quarter of the year made combined profits of close to $100 billion.

Challenges

• Adverse impact on investments: Introducing a temporary windfall profit tax reduces future investment because prospective investors will internalise the likelihood of potential taxes when making investment decisions and avoid uncertainty on account of retrospective nature of tax and influence of unexpected events and surprises.
• Such taxes are populist and politically opportune in the short term.
• The IMF said taxes in response to price surges may suffer from design problems—given their expedient and political nature.
• Difficulty in constituting true windfall profits; their determination and level of normalisation of profit. A CRS report, for instance, argues that if rapid increases in prices lead to higher profits, in one sense it can be called true windfalls as they are unforeseeable but on the other hand, companies may argue that it is the profit they earned as a reward for risk-taking to provide the end user with the petroleum product.
• Issue of determining who should be taxed — only the big companies responsible for the bulk of high-priced sales or smaller companies as well or whether producers with revenues or profits below a certain threshold should be exempt

IMF Guidelines on the matter

• Introduce a permanent tax on windfall profits from fossil fuel extraction.
• Use caution in temporary taxes on windfall profits because these tend to increase investor risk, may be more distortionary (especially if poorly designed or timed), and do not provide revenue benefits above those of a permanent tax on economic rents.
• The tax should be imposed on a share of economic rents (meaning excess profits).

Economic rents generally arise from fossil fuel extraction as a result of the fixed supply and diverse. Rent-targeting taxes raise revenue without reducing investment or increasing inflation.

• Encourage the switch to renewable energy, given the need for decarbonization in energy generation. Transitioning to renewable energy improves energy security.
• Design principles: Tax should apply to a clear measure of excess profit, tax should not apply to revenue as this can be inflationary and reduce investment. The tax should allow for carry forward of losses to ensure symmetrical treatment

Source: The Hindu