Taxing Windfall Profits in the Energy Sector

IMF Notes, August 30, 2022

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Taxing Windfall Profits in the Energy Sector

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Bibliographic details

• Authors: Thomas Baunsgaard
• Published: August 30, 2022
• Series: IMF Notes
• DOI: https://doi.org/10.5089/9798400218736.068

Summary

• The surge in fossil fuel prices in 2022 generated substantial windfall profits in the energy sector.
• Policymakers in many countries are exploring policies to tax part of these profits.
• Excess profits can be taxed by tax instruments targeted at economic rents that avoid discouraging investment and limit any impact on further price increases.
• Many fossil fuel producing countries already have an adequate rent-capturing fiscal instrument in place.
• Some countries may consider introducing a permanent tax on windfall profits from fossil fuel extraction, while being more cautious about temporary and possibly poorly designed windfall profit taxes.
• Given the importance of encouraging decarbonatization of energy generation, it seems counter-intuitive to introduce exceptional tax measures on renewable electricity generation.

Key findings

• 2022 fossil fuel price surge → substantial windfall profits in the energy sector.
• Targeted taxation of economic rents is preferred because it:
  • avoids discouraging investment, and
  • limits any impact on further price increases.
• Existing rent-capturing fiscal instruments in many fossil fuel producing countries are adequate.
• Permanent taxes on extraction-related windfalls are a plausible option for some countries.
• Temporary or poorly designed windfall taxes carry greater risks and warrant caution.
• Exceptional taxes on renewable electricity generation are counter-productive to decarbonatization goals.

Policy recommendations

• Use tax instruments targeted at economic rents to capture excess profits while minimizing distortions to investment and prices.
• Favor established rent-capturing fiscal instruments where they already exist.
• If considering windfall taxation of fossil fuel extraction, prefer well-designed permanent measures over temporary ad hoc levies.
• Avoid introducing exceptional windfall taxes on renewable electricity generation to preserve incentives for decarbonatization.

Thomas Baunsgaard, "Taxing Windfall Profits in the Energy Sector", August 30, 2022.

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