BBC Budget 97

"Shaking the Tree.."
by Les Gibbard © BBC

The Windfall Levy

Almost certain to be in Labour's first budget after a manifesto pledge to introduce a "windfall levy on the excess profits of the privatised utilities." The money raised by the tax will be directed to a 'welfare-to-work programme' aimed at helping the young and long-term unemployed back into work.

Who will have to pay?

Those companies to be considered for the tax are those that have been privatised and are licensed and regulated by Statute. This includes the water and sewerage companies, regional electricity companies, electricity generators, National Grid, British Airports Authority, BT, British Gas and Railtrack.

The Chancellor has made clear, however, that only those utilities considered by the Treasury to have made "excess profits" will be liable for the windfall levy. There has consequently been some confusion about whether companies like BT will be subject to the tax. Indeed BT Chairman, Iain Vallance, threatened legal action after the Paymaster-General, Geoffrey Robinson , said there was no reason why BT should be excluded.

What is the justification for the tax?

The Government argues that:

the privatised companies were undervalued and sold off 'too cheaply';

the regulators have been 'too lax'; and

the companies have been able to exploit a degree of monopoly power

Some of the utilities have also not helped themselves by announcing dividend increases out of line with their profits growth - Yorkshire Water, for example, recently revealed adjusted profits up 3.1% and a rise in their dividend of 19.5%. As the Water Regulator, Ian Byatt has said, "The more you demonstrate you've done frightfully well the more you encourage people to think that a utility tax is a good idea."

How much will the utilities have to pay?

The cost of Labour's 'welfare-to-work' programme has been estimated at around Ł3bn. The Chancellor has said it will 'comfortably' raise that and sums of up to Ł10bn have been reported. How will the tax be calculated?

The Government has never made clear the basis on which they would judge the 'excess profits' made by the utility companies.

Possible options could be:

Company turnover - a measure of the size of the firms.

Shareholder returns - some utility shares have been lucrative investments, and the Treasury could compare the returns shareholders have received in different companies to ensure that those which have risen most are hit hardest by the tax.

Excess profits - this measure would be most closely related to the rationale behind the tax, making those companies who've made the highest profits pay more.

Is there a precedent for a windfall tax?

Conservative Chancellor Geoffrey Howe imposed a Special Tax on Bank Deposits in the 1981 Budget. He justified the tax because an increase in interest rates had resulted in the main clearing banks making higher profits.

The tax was levied at a rate of 2.5% on banks' non-interest bearing current account deposits above a minimum threshold and, according to the IFS, raised Ł350 million (approx Ł700 million in 1996-97 prices).

What is the attitude of the likely tax-payers?

British Telecom and the airports operator BAA have threatened to block any attempt to impose the windfall levy.

Sir Iain Vallance, Chairman of BT, said on the BBC Today Programme,"If we are stung in a big way for this tax, and if it can be challenged legally, then we owe it to our shareholders to challenge it, and we would do that." He has argued that the tax discriminates between companies in the same market (BT and Mercury) and therefore constitutes illegal state aid.

Des Wilson, director of corporate affairs at BAA, has said: "We have made it clear to the Treasury that we would not expect to be included [in the tax], and are taking legal advice."

Wessex Water said: "The government has been given a clear mandate so there isn't much point in us griping about it."

John Devaney, Executive Chairman of Eastern Group, the electricity company, recognises the government's mandate to impose the tax but objects to it as "harsh and inequitable."

Hyder, the Welsh water and electricity group, says that if the windfall levy is set too high it might stop rebates to customers and discretionary environmental spending.

The Electricity Association argues that the profits of power companies have been made as a result of efficiency gains, and that the benefits of these gains have been shared between customers, shareholders and the government. The Association points, in particular, to a fall of 12% for domestic companies (excluding VAT) in real electricity prices between 1991/92 and 1995/96 and the Ł4bn contributed to the Exchequer in taxation.

Legal consequences of windfall tax

The free-market lobby group, Aims for Industry, commissioned a legal opinion on the proposed levy from Gerald Barling QC, James Flynn and Jemima Stratford. The opinion said that the tax plans provided a "powerful cocktail of possible grounds for legal challenge."

Barling believes the levy could be considered as state aid for competitors affecting the level-playing field demanded by European law and said legal challenges could take the form of proceedings brought by individual companies or by their shareholders.

European Commission officials have also been reported as warning that the levy would only be legally water-tight if it applied only to monopolies.

The Government has dismissed the claims. A spokesman for Gordon Brown said of the Barling opinion - "Aims for Industry is a Conservative Party-funded organisation and should not be taken seriously by anybody."

Labour obtained its own legal opinion before the election from Michael Beloff QC, who concluded that the tax "could not even attract a challenge under domestic law", and if it did attract a challenge under European law "such a challenge would fail".

Peter Mandelson, Minister without Portfolio said on the BBC's Question Time that he didn't "believe the challenge, if it is made, will succeed. We have checked out the legal foundation of the windfall levy and it is watertight."

Other criticisms of the tax

A number of other criticisms have been made of the tax by different groups: Not hitting those who made the windfalls

However the windfall levy is formulated, it seems certain that the tax won't be payable by the people who have benefited from the 'excess profits' of the privatised utilities.

Much of the burden of the tax will fall on shareholders, but as the IFS report "the shareholders who have really paid the windfall levy are those who have been unlucky enough to be holding utility shares on days when new information about the scale of the windfall levy, or the likelihood or it being imposed, has been discounted into share prices. . . Penalising an arbitrary group of shareholders who owned utility shares in the mid-1990s on account of windfall gains enjoyed by their predecessors in the 1980s is difficult to reconcile with any principles of equity in taxation." (The Green Budget - Summer 1997, p 54)

LibDem Treasury Spokesman, Malcolm Bruce, has argued that the windfall tax is "wrong, in principle, because it's retrospective. . . [and] the windfalls were taken several years ago and the people who've taken those windfalls have now gone." (On The Record, 24 April 1997)

Pensioners hit?

During the election campaign, the Conservatives claimed that the windfall tax could hit the 19 million members of pension schemes. Former Social Security Secretary, Peter Lilley, said that heavy investment by pensions funds in utility shares meant that the proposals "threaten the incomes of the next generation of pensioners."

Questioned on On The Record, Margaret Beckett said this was unlikely as the windfall levy was already "completely discounted in the share price" (24 April 1997)

Higher prices and reduced investment?

Some suggestions have been made that the windfall levy will reduce investment by the utility companies and that they will raise their prices to meet the additional costs.

Hyder, the Welsh water and electricity group, have argued that the tax may prevent them from spending additional funds on infrastructure investment and returning efficiency gains to their customers. The Electricity Association have calculated that the impact of increased borrowing by the Regional Electricity Companies to pay a Ł1bn windfall could mean a reduction in the their annual investment programme of up to 12% over a ten year period.

Malcolm Bruce, LibDem Treasury Spokesman, has backed their arguments saying the tax "could hit investment, which could prejudice electricity supply and water supply or it could hit dividends, which could affect pensions, or it could hit prices, or a combination of all of those things and take billions of pounds out of an industry and assume it has no impact is not credible." (On The Record, 24 April 1997)

The Institute for Fiscal Studies disagree, stating that "provided there is no doubt that the windfall levy will be imposed once and only once, and provided the tax base is one that cannot be manipulated by changes to company behaviour, the windfall tax is likely to have only a limited impact on both prices and investment." (The Green Budget - Summer 1997, p 54)

Poorer customer service?

The Electricity Association has warned that the financial pressure of the windfall levy would result in electricity companies reducing resources to an absolute minimum - affecting their flexibility to respond to unanticipated events - and thereby reducing customer service standards.

Job cuts?

According to calculations by the Electricity Association, the impact of a windfall levy of Ł1bn on the regional electricity companies could be job losses of up to 6,600.

The utility companies already have a considerable tax bill

The privatised utilities are estimated to contribute around Ł2bn a year to the Exchequer through corporation tax - almost one tenth of the total corporation tax receipts.

Water companies, however, have paid relatively little corporation tax because they were granted high capital allowances at the time of privatisation, which they have been able to offset against their tax bills.