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Artillery Row

Teaching leftists about tax

Sometimes, an argument about economic policy is like an oil spill

A useful guide to sensible public policy is to never — ever — do anything suggested by Professor Richard J Murphy, a political economist on whom I may have commented occasionally

The exemplar here is something put forward under the guise of the Green New Deal groupuscule — the idea of banning the investment allowance for the windfall tax on North Sea investments. As usual, given the source, not only is the underlying system not understood but there’s a certain inability to grasp reality involved.  

Here is the claim, in all its glorious detail

When Russia’s invasion of Ukraine led to skyrocketing gas prices, the government bowed to public pressure and introduced a temporary ‘windfall tax’ – a 35% Energy Profits Levy, on top of existing corporation tax, meaning oil and gas companies theoretically pay a tax rate of 75% on their profits. However, the windfall tax was accompanied by a huge 91% investment allowance, meaning that for every £1 oil and gas companies invest, the post-tax cost to them is just 9p. As well as representing a cost to the Treasury, this incentivises oil and gas expansion, worsening the climate crisis and increasing investors’ exposure to assets that are likely to collapse in value. Abolishing this tax break would end this dangerous incentive and help redirect investment elsewhere. It would raise an estimated £6bn a year. 

Those in the know — that is, other than those writing this dreck — will know that the only possible outcome of this proposal is lower tax revenue over time. Yes, lower. The idea that this will lead to higher revenues is an absurdity. But, you know, Green New Deal and all that. 

Think about it for a moment. The claim is that if this tax break is not allowed, if oil companies face that full fury of the Treasury, then oil companies will invest less in the North Sea – this must be true, otherwise how will the absence of the tax make climate change worse? That’s the normal, likely response to the reduction in an incentive to invest, yes? Well, if there is less North Sea investment in oil and gas then we’re going to have less such investment and thereby lower tax revenues in the future. This isn’t hard to work out — but as with that old saw, the larger the lie the more will believe it. 

So, the idea doesn’t even work at this first pass. But it also doesn’t work because of the way that tax itself works. The claim that every pound of investment only costs 9p post-tax? Tosh. Investment always costs nothing post-tax because that’s how tax works. That is, despite that first claim of higher revenue being wrong, it’s also wrong for a different reason.

We tax corporations upon their profits and this is true whatever the rate we use. We look at their revenues, deduct their costs, and that balance, the profit, is what we tax. Investment is a cost. Building an oil rig, a pipeline, running the exploration teams, they’re all a cost — also all an investment in that they’re paid out before there is any revenue. 

Any and every tax system in the world says that all of those costs are deducted from revenues to calculate the tax due. Because, again, we tax profits and profits are revenues minus costs. 

However, governments are greedy for their money right now. So, “investment costs” cannot be counted as simple and straight costs right now. If you invest in something that’s going to work for 20 years then you’re only allowed to knock off one twentieth of that cost each year from your revenues before profit is declared. Okay, it gets more complex but that’s the idea. 

This year’s costs — fuel, employees, paperclips — are this year’s expenses to deduct from this year’s revenues before profit is declared. Investment is knocked off that revenue sum dependent upon how long that thing invested in is likely to last. Just the way the system works.

But note what happens even with this system. All those investment costs are still costs. They are still deducted from revenues — over time to be sure — before we calculate the profits which are then righteously taxed. This does not change depending on the tax rate. Investment is a cost, costs are deducted from revenues before profit is calculated, it is profits which are taxed. 

So, what is this “investment allowance”? It’s only, for the purposes of this special higher rate profit tax and for this special higher rate profit tax only, that investment costs will be taken to be costs this year, not in those future ones. That’s it. Nothing else. 

So, over time, the exact same amount of tax will be paid. Because all we’re doing is moving through time when we acknowledge those investment costs — and we do, always, eventually, recognise those investment costs. 

Really, just stop believing economic or taxation claims from weird groupuscules

That really is it — that’s all. The investment allowance is that you get to recognise costs this year not in future ones. No more — and no less — than that. And yet here we have a claim that allowing this will increase North Sea drilling, Further, that not allowing it — entirely inconsistent with that first claim — will increase tax revenue from the North Sea by decreasing North Sea production over time. All by claiming that a change in the timing of cost recognition is a tax break.

Oh, just one more thing — this, the current UK system, is exactly how the Norwegian system works.  

Really, just stop believing economic or taxation claims from weird groupuscules — and, obviously, anything stemming from Professor Murphy. 

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