Context
- Finance Minister defended the Centre’s windfall tax on domestic crude oil producers.
- She proposed the windfall tax as a way to rein in the enormous profits made by some oil refiners.
- These refiners chose to export fuel in order to capitalise on rising global prices while affecting domestic supplies.
Relevance
GS Paper 3: Resource Mobilization
Mains Question
What do you understand by ‘Windfall Tax’? Why has the Union government introduced such a tax recently? Examine its significance for resource mobilization for the country. (150 Words
Background
- On July 1, the Central Government imposed a windfall profit tax of $23,250 per tonne on domestic crude oil production.
- This has been revised four times in the last four weeks.
- Analysts believe that the windfall tax in India was primarily aimed at Reliance Industries Ltd and the Nayara Energy-backed Russian oil major Rosneft.
- According to the government, these companies were making a killing by exporting large quantities of fuel made from discounted Russian oil at the expense of the domestic market.
- With the national interest in mind, India began to import cheap Russian oil following the Ukraine war.
The Windfall tax
- Windfall taxes are intended to tax profits derived from an external, sometimes unprecedented event, such as an increase in energy prices as a result of the Russia-Ukraine conflict.
- A windfall is defined by the United States Congressional Research Service as an unearned, unanticipated gain in income from no additional effort or expense.
- These are profits that cannot be attributed to something the firm actively did, such as an investment strategy or business expansion.
- Windfall tax is a one-time tax imposed by governments on such profits that is in addition to the normal rates of taxation.
The rationale for imposing windfall taxes
- Redistribution of unexpected gains when high prices benefit producers at the expense of consumers,
- Funding of social welfare schemes,
- Supplementary revenue stream for the government,
- Method for the Centre to reduce the country’s growing trade deficit
Why are countries now imposing windfall taxes?
- Oil, gas, and coal prices have risen sharply since late last year and in the first two quarters of this year, though they have recently fallen.
- The increase is the result of a number of factors, including a mismatch between energy demand and supply during the COVID-19 economic recovery, which has been exacerbated by Russia’s war in Ukraine.
- Rising prices meant huge and record profits for energy companies, but it also meant high gas and electricity bills for households in major and minor economies.
- For example, the combined profits of Shell, Exxon Mobil, Total Energies, BP, Chevron Corp, and Saudi Aramco increased from $45.09 billion in the second quarter of 2021 to $107.64 billion in the second quarter of 2022.
- Multiple analysts have referred to the gains as windfall profits because they were caused in part by external change.
Windfall tax support from multilateral institutions
- The International Monetary Fund, the United Nations, and the Organization for Economic Cooperation and Development have all expressed support for windfall taxation (OECD).
- Recently, the United Nations Secretary-General urged all governments to tax these excessive profits and use the proceeds to help the most vulnerable people get through these difficult times.
- He called it immoral that the largest energy companies made combined profits of nearly $100 billion in the first quarter of the year.
Problems with levying such taxes
- Creates market uncertainty
- Because windfall taxes are imposed retroactively and are frequently influenced by unexpected events, they can create market uncertainty about future taxes.
- This may have an impact on future investment in related sectors.
- Populist in nature o According to many analysts, such taxes are populist and politically expedient in the short term.
- The IMF advice note also stated that taxes imposed in response to price increases may have design flaws due to their expedited (quick) and political nature.
- Profits earned in such cases are a reward for the risk taken
- Companies argue that the profit they earned is a reward for the industry’s risk-taking in providing the petroleum product to the end user.
- Another point to consider is who should be taxed.
- Another issue is whether to tax only the large corporations that account for the majority of high-priced sales or also smaller corporations.
- This raises the question of whether producers with revenues or profits below a certain threshold should be exempt.
