The midterm elections’ “red trickle” has not curbed some Democrats’ enthusiasm to begin proposing controversial legislation. One of the most divisive and consequential is the proposed windfall tax on energy companies. Proposals from Senator Sheldon Whitehouse (D-RI), Senator Elizabeth Warren (D-MA), and Representative Ro Khanna (D-CA) have gained the tacit support of President Joe Biden but are unlikely to pass congress. Washington does what it does best: political theater and posturing. However, just because a bad idea isn’t translating into policy, doesn’t mean it’s not worth refuting.
It may be true that some energy companies are enjoying profits that exceed the already-high rate of inflation. However, the energy business is cyclical: the peaks and the troughs alternate as the seasons.
The problem is that the windfall tax is feeding the government that for decades demonstrated a lack of fiscal discipline and is gorging on already-high taxes – regardless of who enjoys the majority in Congress, Republicans or Democrats. George W. Bush contributed to the rise in the US budget deficit and the national debt, and so did Barak Obama, Donald Trump, and Joe Biden.
Another problem is that windfall taxes tend to fuel inflation. This is an economic phenomenon that renowned economists such as Nobel Prize winner Paul Krugman and Biden’s Vice Chair of the Federal Reserve Lael Brainard (who are certainly not right-wing partisans) have publicly acknowledged. Even if a windfall tax could have slowed down energy price hikes, it would almost certainly be at the expense of every other aspect of the economy making the cure worse than the disease.
Even if inflation were magically not a concern, the Biden administration still has another fundamental problem. A windfall tax runs directly contrary to the administration’s stated goal of increasing American energy security and supporting American allies in Europe with their own energy supplies. Increasing taxes on something you want to promote the production of is a bad strategy.
A windfall tax will not only not hurt Biden’s energy agenda, but it will also hurt decarbonization. Lower margins for many industries associated with renewable energy (such as the mining of rare earth elements — REEs) mean that higher energy prices are a requirement for their sustained operation. Targeting energy producers with a windfall tax will lead to shortages in everything from the minerals needed in electric cars to the balsa wood used in wind turbines. Even if renewable companies are theoretically exempt, the energy supply and production industry is so integrated there is no way for “green” companies to avoid this penalty.
The incentive to address the intermittent nature of decarbonization will be diminished if clean energy companies have their profits constrained. To transition to carbon net zero, there needs to be enough investment and profit in renewable energy for the transition to be sustained. If wider energy profit margins are eroded or the corporate actors necessary for implementation are punished, don’t expect a cooperative private sector willing to take risks for the massive investments required to transition to renewable energy.
Any sound tax system should be based on fairness and predictability. It should state how an individual or entity will be taxed — in advance. Stability based on the rule of law is key to promoting investment and spending, which drive economic growth. Windfall taxes compound uncertainty.
None of this is merely theoretical, as we have plenty of examples of this exact same strategy being tried in the past (and you know what Einstein said about insanity). In the late 1970s, Jimmy Carter attempted to help fight inflation and surging energy prices with a windfall tax. There is a reason he was a single-term president, with the non-partisan Congressional Research Service finding that this punitive tax led to domestic oil production declining by as much as 8% and imports climbing by 13%. Another 2018 paper in the American Economic Journal concurred.
Most recently, windfall taxes have been futilely employed to solve this crisis elsewhere. In Italy, a windfall tax of 25% tax on energy profits turned up far less capital than anticipated, created a series of costly legal battles, and has driven the Italian energy sector off a cliff. Unfortunately, the United Kingdom appears likely to accompany the Italians off the cliff with its own windfall tax.
A million lemmings can’t be wrong, right? Don’t be a lemming. Don’t follow others off the cliff.
Economics was once termed the “dismal science” because of the morally unsatisfying, yet demonstrably provable, conclusions it often reaches. Windfall taxes are not, in principle, unacceptable tools but like all tools must be judiciously employed. Taxing war profiteers or big oil companies that squeeze profits out of people during a time of inflation may fill us with righteous indignation, but the result won’t be a rectification of societal wrongs but rather an intensification of societal ills. Unsatisfying as it may be a windfall tax is not the best way to realize energy security and ensure affordable electricity and heating. The best way to do that is long-term reform aimed at increasing domestic energy production.