Windfall Tax Woes

In response to large profits posted by BP and Shell, the UK government is considering a so-called “windfall” tax on oil and gas companies. The aim of this measure is to redistribute, to consumers, the proceeds from those profits so as to ease the burden of the spiralling retail cost of fuel and heating.

In a free market, a sudden rise in price in response to an influx of demand – usually due to an equally sudden change in circumstances, such as a natural disaster – can, indeed, furnish handsome profits to companies which happened to purchase their inputs while prices were still low. Ordinarily, this would serve as a signal to entrepreneurs that there is a grave shortage of capacity in that particular industry, relative to the height of demand. Such entrepreneurs would then rush to expand their investment in the industry, increasing production of the heavily demanded commodity so that its price could be brought down again. Indeed, it is likely that the initial, extraordinary profits – rather than being distributed to shareholders to be spent on mansions and yachts – will be the first source of that fresh investment. Such profits are, therefore, of a benefit to the consumer, but it is also worth noting that they are just as temporary as high, consumer prices. Increased investment in the industry will have the effect of raising the cost of inputs while lowering that of outputs, shrinking profits back to relatively “normal” levels.

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