11 September 2008

Windfall Taxes - A Slap in the Face for the Rule of Law

One of the fundamental principles of the rule of law is that there should be no punishment for an act which was not a crime at the time it was committed. This prohibition of ex post facto laws, as they are known, is reflected in both the European Convention on Human Rights and the American Constitution.

So, if I had a cup of coffee yesterday and the government made coffee illegal today, it shouldn't be possible for somebody to charge me with breaking the law, as what I did was legal at the time I did it. Similarly, if I was arrested for being drunk and disorderly yesterday and today the government increased the maximum sentence for being drunk and disorderly to life imprisonment, it shouldn't be possible for me to be imprisoned for life, as that was not the maximum sentence when I committed the offence.

As well as applying to criminal acts, the avoidance of ex post facto taxation is a valuable principle in a democracy, not just because it is consistent with the rule of law, but also because the ability to restrict the tax flow to the government is an important form of protest for those who have serious objections to government policy. This can only happen if the taxpayer is aware the tax before it is levied.

Thankfully, almost all taxes pass the test of not being retrospective. If the government says it is going to levy a tax on my car, I can sell it. If the government says it is going to increase income tax, I can get a lower paid job. If the government says it is going to increase the tax on land or buildings, I can downsize. If the government says that is going to increase the tax on tobacco or alcohol, I can stop buying them. Even with a poll tax, I can leave the country or even kill myself if my moral objections to the government are so severe. Whatever you think of these taxes, it is clear that each of them is levied on an activity which occurs after the government has enacted the tax.

There is one set of taxes which completely ignore this principle and that is windfall taxes. There is currently pressure to levy a windfall tax on the previously declared profits of energy companies, but such a tax would clearly be ex post facto; the companies didn't know about the tax when they earned the profits and there is nothing they could now do to avoid the tax.

As well as being unjust, these taxes are often based on ideas that arise out of anger rather than rationality. Often the taxes are levied on the basis that the companies are making "excess" profits, without any justification of what excess means, but an underlying implication that the customer is somehow being ripped off. This ignores the possibility that the companies may be making a profit because they are simply doing a good job. A gas supplier, for example, may make a profit by predicting the wholesale market in gas correctly and buying gas when it is cheapest.

Creating uncertainty around tax issues can also discourage investment, causing companies to move into more predictable markets, resulting in weakened competition and potentially a poorer deal for the customer in the long run.

Calls for windfall taxes may be well intentioned, but in the long run they can harm the people they are supposed to help. The whole thing looks even more absurd when you consider that there is already a tax on profits, in the form of corporation tax, which ensures that companies pay more tax as they make more profit, but in a much more open and honest way.

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