Jeremy Warner's Outlook: Windfall taxes are a sign of Treasury desperation

Is there a reasonable case for a windfall profits tax on energy companies? With poll ratings pummelled, the Prime Minister is under pressure from backbenchers for populist measures to revive Labour's fortunes.

Ministers are also in a state of such disarray that it seems more than possible they'll haphazardly embark on policies which in happier times they would have dismissed as misguided. The Treasury is meanwhile desperate for every penny it can get, and would have few scruples about whacking the energy companies for more to pour into the widening black hole of the public finances.

Yet whatever the demands of political expediency, windfall taxes are nearly always a bad idea, even when imposed on companies enjoying bumper profits for exceptional reasons. There was arguably some justification to the windfall tax that Geoffrey Howe imposed in his 1981 Budget on bank deposits, as the high profits being earned by banks were a direct result of public policy: high interest rates to choke off inflation. Yet even on that occasion the question raised by all windfall taxes was the same: having taxed the excess, would not the Government be duty-bound to give it all back again when, as frequently occurs with banks, excessive profits become excessive losses?

Labour made no attempt similarly to justify its windfall profits tax on utilities in 1997. Here the purpose was simply that of raising money to fund the New Deal. Subsequent analysis has shown the New Deal to be largely a waste of money, while the windfall tax itself stands condemned for what it is: a piece of ex post facto expropriation.

Even in the limited manner proposed yesterday by the Commons Business and Enterprise Committee, a windfall tax on energy companies would be equally hard to justify. Energy companies are facing a massive programme of expenditure on renewables and renewal. According to a recent government consultation, the industry faces £100bn of investment on wind power alone by 2020 to meet the Government's targets on emissions. On top of that, money has to be found for a new programme of nuclear power stations, new gas storage facilities and the replacement of ageing infrastructure elsewhere.

As energy prices rise and incomes are squeezed, ever more people are being dragged into the Government's official definition of "energy poverty", where 10 per cent or more of disposable income is spent on fuel bills. The Government's chances of meeting its target of eradication of fuel poverty by 2012 are zero. Nor are the measures taken so far – the winter fuel allowance, the "warm front" initiative, and forcing the distribution companies to increase the amount spent on social tariffs to £150m annually – making noticeable inroads into the problem.

Yet it is hard to see how the energy companies could be taxed more without damaging investment or running into the law of diminishing returns. The Business and Enterprise department seems to understand this better than the Treasury. The evidence of profiteering in downstream activities is limited, and upstream in oil and gas production, the Government is already participating generously in any windfalls being earned. For instance, taking everything into account, the marginal rate of tax on Centrica's Morecambe Bay gas field is already 75 per cent. The Government gets far more out of rising gas prices than do Centrica's shareholders.

MPs on the Business and Enterprise Select Committee think there is "compelling rationale" for "top slicing" the notional £9bn free ride older generating companies are getting from the European Emissions Trading Scheme. That MPs have said this almost certainly makes it a done deal for a Government casting around for vote-winning ideas, but that doesn't make the retrospective taxation this would amount to any more justifiable. Nor, given that it would be a one-off, would it provide any more than temporary respite for "fuel poverty", even if the proceeds were applied to this purpose. There are no magic wands the Government can wave to make the present squeeze on disposable incomes go away. As ever, the pain falls hardest on the poorest.

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