The failure of windfall taxes

INESS // 25 January 2023

The energy sector is in dire need of investments. However, the new government-imposed taxes in Slovakia are instead adding to the financial burden already experienced by energy companies. Slovak politicians like many in Europe (who have engaged in reckless fiscal spending in the recent past) and the EU (which was indecisive on which energy sources should be supported) are now trying to make us believe that only more regulation will solve all our problems.

In general, the EU directive on energy windfall taxes is nothing more than direct interference in Slovak national legislation and a step in the wrong direction.

The whole idea is based on two unconfirmed theories: 1) price hikes are temporary, and prices will settle back to pre-covid levels within two years, and 2) that politicians are the most qualified to set the ‘reasonable’ prices for energy bills.

With respect to the first theory, using pre-covid pricing levels as a benchmark for ‘justified’ prices is wrong, as there were several market characteristics that had kept prices down. These include the low market price of natural gas, extremely low interest rates, the low penetration of renewable energy sources, and the excess supply of fossil fuels in national energy mixes. These realities have not only influenced prices but have also starved the energy industry of capital investments, a key example of which is the shutdown of French nuclear reactors.

It is very likely that the dream of energy prices falling below €‎50 per megawatt-hour (MWh) is nothing but a fantasy. Yet, the Slovak government has passed a law that would impose a windfall tax on the profits of energy companies above €50/MWh. What is even worse is that, when introducing this law, the government did not take into consideration factors such as past losses or profits, the need for loan payments, and real production costs. This, in combination with the rising price of CO2 vouchers, will make it more expensive for companies to operate.

The second theory, as noted above, is that the EU has spent many years building a liberalised energy market that has generated lower prices and plentiful supply for almost 10 years. However, political decisions (or the lack thereof) have led to a decrease in investments in other forms of energy such as nuclear or green hydrogen. National economies have been pushed to use natural gas as a transition fuel and, consequently, have seen an increase in their reliance on Europe’s biggest supplier – Russia.

The politicians responsible for creating this situation are now attempting to solve it through increased regulation. However, regulating prices will not result in cost savings or improved energy efficiency in either industrial consumption or personal use.

The energy sector needs to be able to ‘adapt’ to fundamental changes in today’s world. To successfully adapt, it will need new investments. The key mechanism to attracting new investments are high prices. But if politicians continue to tax these so-called ‘excessive’ profits, then all they will accomplish is a further decline in investment.

The lack of specific parameters in the new law for taxing energy companies will necessitate further changes during implementation, causing uncertainty for investors. A textbook example of what happens when politicians artificially interfere with prices were obvious around the petrol stations of Hungary that were running low on fuel as a result of price caps across 2022.

Additionally, this two-year windfall tax will most likely become a permanent tax, as it gives governments a steady flow of income. The biggest issue in the case of Slovakia is that this legislation will undoubtedly lead to a decrease in future investments in new energy projects and even in renewables. This is because the windfall tax imposes a 90 per cent tax on any excess profit. Private and national energy companies drive investments in energy projects – this will leave them unable to use their profits for future investments and instead force them to pay for mandatory national expenses.

The original article was published in Slovakian by INESS and translated by Christopher Jakoubek. 

EPICENTER publications and contributions from our member think tanks are designed to promote the discussion of economic issues and the role of markets in solving economic and social problems. As with all EPICENTER publications, the views expressed here are those of the author and not EPICENTER or its member think tanks (which have no corporate view).


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