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How to Tax Energy Companies’ Windfall Profits

Given the sharp increase in electricity prices across Europe this year, it is no surprise that politicians and policymakers are considering new measures to skim off corporate profits that are seen to be unjustified. But if such policies are not properly designed, they could do more harm than good.

MUNICH/COLOGNE – The energy crisis incited by Russia’s war in Ukraine has triggered intense debates in many countries about whether the windfall profits that energy companies are now making should be taxed. While this question concerns all companies that produce coal, gas, or oil, the focus currently is on electricity producers. Since a high gas price is driving up electricity prices across the board, suppliers with power plants that use other fuels or renewables can reap extremely high profits. And the immense burden of rising electricity prices on consumers has ratcheted up political pressure to tax “unjustified” profits.

Of course, windfall taxes face fundamental objections relating to tax symmetry and trust in applicable taxation rules. But, given the extent of recent energy-price increases, politicians want to skim energy companies’ profits nonetheless, just as they also want to protect other companies from unjustified losses associated with the crisis.

That is understandable. But if policymakers insist on taking this path, they will need to be mindful of the considerable implementation problems they will encounter along the way. Unless managed properly, any windfall profits tax that is imposed could make today’s energy shortages even worse.