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Windfall Tax in Energy Sector

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.

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