What is a windfall tax?

Governments impose a windfall tax on certain businesses when economic circumstances permit such companies to generate noticeably higher profits than usual. Companies in the targeted industry that have profited most from the financial windfall are the ones that are most subject to windfall taxes; they are often enterprises that deal with commodities.

How Windfall Taxes Work

Windfall taxes are often levied on oil and gas firms. The International Energy Agency projects that net revenue for natural gas and oil producers will treble between 2021 and 2022, reaching an unprecedented $2 trillion. This is what sparked the recent debate and implementation of windfall taxes.

In the case of crude petroleum, natural gas, coal, and refinery enterprises, for instance, the Council of the European Union decided on September 30, 2022, to impose a “temporary solidarity contribution” on earnings that are “above a 20% increase of the average yearly taxable profits since 2018.” This is in addition to the taxes they already owe their nations. The money raised goes toward supporting businesses and individuals in each member state and mitigating the consequences of rising power costs.

Additionally, President Biden warned in October 2022 to pursue a windfall gains tax on oil and gas firms that had maintained high prices while reporting very high profits. He advised them to enhance the oil supply or lower consumer prices with their “outrageous” bonanza—the result of the conflict in Ukraine.

Debate over Windfall Taxes

Much as with every government-imposed tax, there is usually a split between supporters and opponents of the measure. One benefit of a windfall tax is that governments can use the money they raise to increase funding for social initiatives. People who oppose windfall taxes argue that they discourage businesses from pursuing profits. Companies should also reinvest their earnings to foster innovation, benefiting society.

The issue of whether windfall taxes boost the estimated amounts also has to be addressed. Take the most recent example in the United States, the Crude Oil Windfall Profit Tax of 1980, which Congress enacted in the latter part of President Jimmy Carter’s presidency.

The windfall gains tax (WPT) brought in $80 billion in gross revenues between 1980 and 1988, “significantly less than the $393 billion projected,” according to a 2006 analysis from the Congressional Research Service. The total net WPT revenues were around $38 billion, a substantial decrease from the $175 billion estimated since the WPT is deductible from income taxes.”

A more recent example comes from The Washington Post, which states that Italy’s windfall tax “yielded only about one-fifth the income the government had hoped for as of September 2022.”

However, taxes bring in money that would not have been available to compensate for the burdens that high prices impose on society.

Critics highlight further unfavorable outcomes. Although the tax on windfall profits is intended to incentivize taxed entities to lower their prices to benefit consumers, the tax may discourage investment because the additional tax makes the profit after taxes unprofitable. As per the report by the Congressional Research Service, this occurred with the tax of 1980. It states that “the WPT may have decreased domestic oil production from 1.2% to 8.0% (320 to 1,269 million barrels) between 1980 and 1988.” Between 3% and 13% of the population became dependent on imported oil.”

In 1988, the tax was removed.

Unexpected Taxes on Persons

People who receive a large quantity of money as a gift, inheritance, or via victories from game shows, casinos, or lotteries may also be subject to windfall taxes. Life insurance payouts, gifts from friends or family, and inheritances are frequently tax-free for the recipient.

Nonetheless, the giver or the estate from which the inheritance is received may be required to pay federal, state, or local taxes. Any money won from gambling or lottery winnings is subject to taxation. The wins are subject to total taxation, and the individual tax return must be filed to report them to the Internal Revenue Service (IRS).

After winning a lawsuit, a person who receives a sizable financial settlement will probably have to pay federal tax on that sum. Most other compensations are subject to ordinary income tax, although the IRS does not tax certain payments, such as those for physical illness or personal injuries.

Who is liable for windfall taxes?

Businesses and industrial sectors seeing significant profit increases—typically due to war, the scarcity of certain commodities, or other events and circumstances that drive up prices—may be vulnerable to windfall taxes. Individuals may also be taxed on windfalls, such as those from inheritances or lottery prizes.

Who Benefits from Windfall Tax Revenue?

Governments impose taxes, which can be used for a variety of purposes. During World War I and II, windfall profit tax income went to help the war effort. The 1980 taxes contributed to general government budgets. Revenue from the new EU Council 2022 tax is to be used to “provide financial support to households and companies and to mitigate the effects of high retail electricity prices.”

What Was the First Windfall Tax in America?

Before the United States joined World War I in 1917, U.S. Steel and DuPont’s yearly earnings had surged by more than 1,000% apiece, and calls for a “war efforts profit tax” had grown. Introduced in October 1917, the levy produced approximately $7 billion in revenue—nearly 40% of all revenues earned for the war—and was the most significant source of wartime taxes. The tax impacted smaller businesses, while bigger businesses discovered methods to avoid it. In 1921, the tax was eliminated.

The Bottom Line

Windfall taxes are and always will be a divisive topic of discussion between the general public and the shareholders of successful businesses. The current catalyst for the conversation is the enormous rise in net revenue for oil and natural gas producers—the International Energy Agency projects that these earnings will quadruple between 2021 and 2022, reaching a historic $2 trillion.

Exxon’s stockholders have gained as the corporation declared a roughly $20 billion profit for July through September. As a result, the dividend was increased for them.

Windfall taxes may be levied on firms in specific parts of the economy, such as oil and gas, that gain from events such as commodity shortages that dramatically boost the pricing of their goods at the expense of consumers. Individuals may owe tax on a windfall, depending on its source and the tax regulations of the federal government or their state or town.

Conclusion

• A windfall tax is a surtax governments impose on businesses or economic sectors that profit from economic development.
• The purpose is to redistribute excess profits in one area to raise funds for the greater social good; however, this can be a contentious ideal.
• Some individual taxes—such as inheritance tax or taxes on lottery or game-show winnings—can also be construed as a windfall tax.