Why in news?

• The government has hiked windfall profit tax levied on domestically-produced crude oil as well as on the export of diesel and ATF.
  • Crude oil pumped out of the ground and from below the seabed is refined and converted into fuels such as petrol, diesel and ATF.
• According to the notice, the levy on crude oil produced by companies such as Oil and Natural Gas Corporation (ONGC) has been hiked to ₹5,050 per tonne from ₹1,900 per tonne.

What’s in today’s article?

• Background
• Windfall tax – About, rationale, current reason for imposing this tax, issues with this tax, etc.

Background:

• India first imposed windfall profit taxes on July 1, joining a growing number of nations that tax super normal profits of energy companies.
  • At that time, export duties of ₹6 per litre ($12 per barrel) each were levied on petrol and ATF and ₹13 a litre ($26 a barrel) on diesel.
    • The export tax on petrol was scrapped after first review.
  • A ₹23,250 per tonne ($40 per barrel) windfall profit tax on domestic crude production was also levied.
• The tax rates are reviewed every fortnight based on average oil prices in the previous two weeks.

Windfall tax

• It is designed to tax the profits a company derives from an external, sometimes unprecedented event— for instance, the energy price-rise as a result of the Russia-Ukraine conflict.
• The United States Congressional Research Service defines a windfall as an unearned, unanticipated gain in income through no additional effort or expense.
• These are profits that cannot be attributed to something the firm actively did, like an investment strategy or an expansion of business.
• Governments typically levy a one-off tax retrospectively over and above the normal rates of tax on such profits, called windfall tax.

Rationale behind the imposition of windfall tax

• Redistribution of unexpected gains, when high prices benefit producers at the expense of consumers
• To fund social welfare schemes,
• As a supplementary revenue stream for the government,
• As a way for the Centre to narrow the country’s widened trade deficit.

Why have countries all over the world started levying windfall taxes now?

• Prices of oil, gas, and coal have seen sharp increases since late last year and in the first two quarters of the current year, although having reduced recently.
• The increase stems from a combination of factors, including a mismatch between energy demand and supply during the economic recovery from COVID-19, further amplified by the Russian war in Ukraine.
• The rising prices meant huge profits for energy companies while resulting in hefty gas and electricity bills for household in major and smaller economies.
• Since the gains stemmed partly from external change, multiple analysts have called them windfall profits.

Criticism of windfall taxes

• Brings uncertainty in the market
  • Since windfall taxes are imposed retrospectively and are often influenced by unexpected events, they can brew uncertainty in the market about future taxes.
  • This may affect the future investment in the related sectors.
• Populist in nature
  • Many analysts believe that such taxes are populist and politically opportune in the short term.
  • The IMF also said that taxes in response to price surges may suffer from design problems—given their expedited and political nature.
• Profits earned in such instances are reward for the risk taken
• Who should be taxed is another issue
  • Another issue is who should be taxed- only the big companies responsible for the bulk of high-priced sales or smaller companies as well.
  • This raises the question of whether producers with revenues or profits below a certain threshold should be exempt.