01 September, 2008

Taxing Windfalls


Well, it’s September, and this is the month, you will recall, that we are to expect Gordon Brown’s Economic Recovery Plan. In my opinion there is pretty well nothing that he can do which would have a favourable outcome before the middle of next year and the Labour Party doesn’t have that kind of tolerance, so expect something just for show.

What his party would like is a windfall tax on oil companies, with the proceeds to be directed towards the ‘fuel poor’ (a concept Labour have invented just for this purpose) and it may well be that Brown will be tempted into this for political reasons. To the socialist mind these huge corporations are a fair target, making billions in profit on the back of high oil prices; ‘Unearned Income’ is how they see it.

To do this would be a huge mistake. First, just consider the basic economic theory. The oil price is high because people are demanding more than is supplied. A windfall tax would make the exploration business less profitable resulting in less exploration and less oil. So we reduce the supply of oil and then give money to people to demand more: a worsening on both sides of the equation.

Now the lefties will say that the oil companies will continue to explore because that is what they do, but we have ample evidence to the contrary. For Gordon has form.

Brown has raided the oil companies twice before, in the April 2002 budget when he introduced the North Sea Production Tax and in December 2005 when he doubled the tax rate. The result was a dramatic lowering of North Sea investment culminating in Britain becoming a net oil and gas importer when this need not have happened for years.

Drilling for oil is a 20 year investment and the oil companies need to know that a fickle government will not punish them after the funds have been committed. Taxation on this basis is retrospective legislation: taxing profits after the exploration companies have made the investment decision on the previous fiscal model. And Brown has already done it twice. Naturally the oil companies don’t trust this government.

This is a lesson for Cameron: fix a long term (and attractive) tax regime and declare it will last for as long as they are in power. That way the companies will do their job, there will be more oil on the market and prices will be lower.

That is, as Brown would say, the right long-term decision. But Brown does not have a long term view: he may well pursue a scorched earth policy, knowing he will lose the next election and wanting to make the Tories suffer. Let’s hope not.

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