Arguments against windfall tax 'essentially nonsense'

Something that supporters of a windfall tax on energy companies haven't managed to do is to refute the arguments made against the tax. Opponents have claimed that it would damage investment in renewable energy and the costs would be passed on to the customer anyway, to which groups like Compass have concentrated on political arguments about its popularity rather than providing detailed, technical arguments to support their claims.

All of which might lead people to suspect that whatever the moral force of the argument, a windfall tax is one of those left-wing ideas which sounds nice but in the Real World is not actually very realistic and would have negative consequences.

So I asked a friend who knows about these things whether it was true what the energy companies and John Hutton were saying about the negative consequences of a windfall tax. And it turns out that, well, read it for yourself:

"We’ve been hearing a lot about windfall taxes recently. The ‘Big 6’ energy companies have came out with two main counterarguments. Firstly that this would hurt ‘UK pensioners’ as dividends were cut and secondly that this would harm ‘vital investment in infrastructure’.

I’m a firm believer that economic quick fixes are often a bad idea – and both arguments sound convincing.

The problem is, if one bothers to open an annual report and look at the actual numbers… then both arguments against the windfall tax are essentially nonsense.

The basic point is that the energy companies are natural monopolies and enjoy very high profit margins.

To take just the example of BG Group – old British gas – which is typical:

Post tax profits in the year to 30th June (most recent numbers) were £2,411mn.

It had a pre-tax operating margin of 41.7% - i.e. for every pound of revenue it made pre-tax profits of 41.7p.

That is excessive. For comparison's sake most business operate on between 3% and 15%!

It had a operating cash flow of £3,718mn. Cashflow is more useful than profit (as lots of non-cash items are charged to ‘profit’, ‘profit’ is a number made up by accountants, cashflow is recordable).

So the company, after tax, and meeting its costs, generated £3,718mn of cash.

Of that it paid out just £314mn as dividends (about 8.4%).

It spent £498mn on buying back its own stock (generally something companies do when they can’t think of anything else to do with the cash).

Finally it spend £2,249mn on capital expenditure – i.e. maintenance and upgrading of its physical infrastructure.

So that still leaves spare cash of £657mn. Excluding useless buy backs that leaves £1,155mn!

In other words a windfall tax would neither –

(i) Lead to a cut back in dividends – to ‘UK pensioners and insurance companies’ as they claim.

(ii) Lead to a cut back in vital ‘infrastructure spending’.

Profits are expected to rise this year…

The only potential issue would be stopping them passing on any rise to the consumer. And the best way to stop them passing on the tax is by sitting them down and saying – ‘if you pass this along to consumers, then we are getting to get OFGEM to ‘investigate’ your monopoly position’."