Nigeria’s government is proposing a 70% windfall tax on the foreign exchange profit made by the financial institutions in the country, following the country’s devaluation of its currency.
So what is windfall tax?
A windfall tax is a levy imposed by governments on companies that have benefited unexpectedly from circumstances they did not contribute to, such as surging market prices, regulatory changes, or geopolitical events. Typically, this tax targets extraordinary profits generated from industries like oil, gas, banking, and other resource-based sectors.
For Nigeria, part of the gains from the foreign exchange transactions by the banks will go to the government’s coffer. A Finance Amendment Bill 2024 is already before the National Assembly.
Breaking Down the Terminology
Levy: A legal imposition or charge, typically referring to taxes.
Unexpectedly Benefited: Companies that gain profits due to unforeseen events, not necessarily due to their business strategies or efforts.
Extraordinary Profits: Significant gains above regular earnings, often viewed as excessive or unfair in a short period.
How Windfall Tax Works
Imagine you’re running a small business, and due to an unexpected change in the market, such as a sharp increase in the demand for your product, your profits soar. If the government sees this as an excessive gain not aligned with normal business conditions, it may impose a windfall tax.
An example on a larger scale is the oil industry. If global oil prices spike due to geopolitical tensions, oil companies may see their profits multiply without altering their production levels. The government may then impose a windfall tax to capture some of those excess profits for public benefit.
The Origin of Windfall Tax
The concept of windfall tax dates back to the 1980s, though it gained prominence during crises such as the energy crisis of the 1970s and the global financial crisis of 2008. Governments introduced these taxes as a way to balance economic disparity by redistributing profits made under extraordinary circumstances.
It gained prominence in the United Kingdom during the reign of Margret Thatcher, specifically in 1981.
The chancellor at the time, Geoffrey Howe, recommended that some big financial institutions be taxed because some of them were not affected by the recession. The special budget levy he introduced imposed 2.5% on the extraordinary profits made by the banks. The government generated about £400m in extra revenue.
Again in 1982, the Treasury Department came up with the same revenue strategic moves when oil prices soared. The government raised £2.4bn in the process.
Similarly, when Gordon Brown was the chancellor in the 1990s, he taxed utilities that had been privatised. He believed they were bought off at give-away prices and were making excessive profits from their monopolies.
At the end, companies such as Powergen, British Gas, BAA, and British Telecom among others paid about £5 billion from their unexpected profits to the government.
Since then, the windfall tax has gained prominence in the UK and other territories around the world.
Who Does the Windfall Tax Target?
Windfall taxes generally target industries and companies that reap the benefits of sudden and uncontrollable economic conditions. These typically include oil and gas companies, commodity traders, and large corporations whose earnings are influenced by global events rather than by increased productivity or innovation.
Why Governments Focus on Windfall Tax
Governments across the world implement windfall taxes for several reasons:
Revenue Generation: Windfall taxes provide additional income to governments, which can be used to fund public services or social programs, especially during economic downturns.
Economic Fairness: By imposing this tax, governments seek to redistribute excessive profits to maintain fairness in the economy, particularly when certain sectors prosper while the wider population may struggle financially.
Preventing Price Gouging: It can serve as a deterrent to companies that may increase prices unjustifiably to benefit from a crisis, thus protecting consumers.
Advantages
Fairness and Equity: It ensures that companies benefiting disproportionately from societal conditions contribute more to the public good.
Revenue for Public Services: The funds collected can be directed toward essential services, such as healthcare, education, or infrastructure projects.
Economic Stabilization: Windfall taxes can help reduce inflationary pressures caused by excessive profit-taking during times of crisis.
Disadvantages
Deterrent to Investment: High taxes may discourage businesses from investing in industries subject to windfall taxes, fearing unpredictable tax policies.
Administrative Burden: Determining what qualifies as “excessive” profit can be complicated and lead to disputes or legal challenges.
Reduced Incentives for Efficiency: Companies may become less motivated to increase efficiency or innovate if they anticipate a significant portion of their profits being taxed.
Companies to engage in tax evasion: Windfall tax may push firms to devise means of increasing the maintenance expenditure so that they won’t pay the actual amount they should pay to the government from their unexpected profits, leading to underpayment of taxes.
Countries that impose windfall tax on firms
The UK
Czech Republic
Germany
Italy
Finland
Spain
Hungary
France
Netherlands
Poland
Romania
Greece
Nigeria has sent a finance amendment bill to its lawmakers to make windfall tax a law.
Conclusion
Windfall tax is a tool used by governments to address economic imbalances, particularly in times of crisis. While it helps ensure that companies profiting disproportionately from societal circumstances contribute more to the public good, it also has its downsides, such as potentially discouraging investment and creating administrative challenges.