The pattern looks something like this: oil prices spike, energy companies report extraordinary profits, and consumers absorb the shock. Politicians denounce profiteering while suspending gasoline taxes and, eventually, someone proposes a windfall tax.
In the best cases, governments collect some money, offer some relief, and then everyone tacitly agrees to pretend the system worked as intended—until the next crisis.
In the latest iteration of the pattern, five European Union (EU) countries are pushing Brussels to tax oil and gas profits extracted thanks to surging prices tied to the Iran war and the closure of the Strait of Hormuz.
But the details almost don’t matter—the pattern is the point.
What a Windfall Tax is Supposed to Do
A windfall tax is, at base, an admission of market failure. It is usually defended as an emergency measure when companies make extraordinary profits because of events outside of their control. In other words, oil and gas companies didn’t invent a better product, deploy capital more efficiently, or take on a new productive risk—they just continued to exist during a period of turmoil.
When, at the same time, households and firms are made to pay more for an essential input they cannot avoid, windfall taxes can be used to claw back some of the producer upside and direct it toward relief. If consumers, also known as voters, are forced to pay crisis prices, and producers earn crisis profits, then perhaps the state should step in and redistribute some of the gains. And if lawmakers earn some political points in the process, so be it.
Markets reward risk-taking, efficiency seeking, innovation, and productive investment. But what is being rewarded when an oil company books extraordinary gains because a war squeezed a shipping choke point?
That begins to look less like efficient capitalism and more like a private tollbooth set up on a burning bridge.
Either Markets Work—or They Don’t
If energy markets are functioning properly, then higher costs for oil and gas is just the pricing signal doing its job. The price spike tells producers to invest in more capacity, consumers to conserve, and alternatives to start spooling up competition. In that case, a windfall tax is distortionary meddling—doubly so if the price is passed on to consumers.
If governments believe profits are excessive enough to justify special taxation, then they are also admitting, albeit implicitly, that the market is not working as intended. The price signal is not allocating resources efficiently, it is instead extracting money from consumers who have limited short-term alternatives.
Either high profits are normal market returns, or they are evidence of market failure. And if they are market failure, then a one-off tax is inadequate.
Windfall Taxes—Politically Useful but Structurally Weak
Temporary windfall taxes have obvious appeal: they raise revenue quickly, loudly signal something like fairness, and let governments tell voters that someone is being made to pay. And in an acute crisis, consumer sentiment matters.
But they also create problems. First, they are reactive; governments wait for the crisis and then scramble to cobble together a patch. They are also legally messy—with issues involving retroactive taxation, unclear benchmarks, and unequal treatment inviting litigation. Their issues stem from the fact that their main utility really lies in political theatricality, rather than a solution to the underlying exposure.
2022 Precedent: Not a One-Off, a Warning
In 2022, the EU imposed a temporary “solidarity contribution” on fossil fuel companies after Russia’s invasion of Ukraine and the attendant energy price spike. The levy raised revenue, but in the process also triggered legal challenges and definitional debates.
Now Europe is revisiting the same playbook, with no indications for follow-up policy shifts.
If the same temporary tax appears after every major energy shock, maybe the shocks aren’t temporary in any meaningful policy sense. Maybe volatility is in fact a recurring feature of fossil fuel dependence.
Tax Energy Shock Rents, Not Just Oil
The goal should not be to punish oil companies for being oil companies—unless we are willing to also cut our dependence on them. That is emotionally satisfying and politically expedient, but not useful. Firms respond to incentives, and if crisis conditions allow them to capture extraordinary rents, they will capture them. The policy question is what society does with those rents.
A better system would create a standing framework for energy shock rents—treat the shocks more as status quo than one-off “who could have predicted this?” events.
That necessitates establishing a clear benchmark for normal energy profits, based on a multi-year average or return-on-capital measure. An energy shock tax should be applied only when profits exceed that benchmark by a defined margin and during specific conditions—from major geopolitical disruptions, to supply shocks, or other extreme price movement divorced from producer efforts.
Ultimately, the system would need to be prospective, not retroactive. And revenue should be dedicated to specific uses, from consumer relief to grid upgrades, storage, electrification, efficiency, and energy security. Sunset and review provisions should then be tied to market conditions, with similarly situated firms treated similarly.
The tax system already contains automatic stabilizers. When incomes fall, safety-net spending rises and prevents savings from growing unchecked. When profits rise, corporate tax receipts rise and commit more money to the public fisc. The question is why energy shock rents, which are just profits generated by public vulnerability to disruption, should remain outside of a similar framework.
From Windfall Tax to Permanent Fix
The standard objections to windfall taxes should not, and indeed cannot, be simply brushed aside. Badly designed windfall taxes can discourage investment by setting a ceiling on profit returns and do so in periods where a coming shock could be ameliorated by increased prospective investment. They invite litigation, create uncertainty, and give politicians an excuse to treat the tax code like a panic button.
In short, they may satisfy an immediate political demand to publicly “do something,” but they also communicate to one sector of the economy that the rules can be rewritten after the fact when their profits become politically problematic.
And that is not a trivial concern. Energy production is capital-intensive, cyclical, and ultimately risky. Years of profits can follow years of losses and failed projects. A tax that simply declares one profitable year “excessive” without accounting for the broader investment cycle is not a carefully calibrated policy.
But at the same time the answer is not to continue to do nothing—the answer is instead to replace ongoing tax improvisation with formal rules. Rebates help households survive the bill, but they do not make the next bill less absurd. If fossil fuel dependence is the vulnerability, then revenue raised from fossil fuel shock rents should help reduce that vulnerability. You don’t just keep renting fire extinguishers every time your house catches fire—at some point you need to rip out the wiring and start over.
Windfall taxes should be temporary only if the market failure is temporary. Clearly, it is not. The permanent fix is a predictable framework that captures energy shock rents and puts them to protective uses for consumers, domestic energy systems, and energy independence. Otherwise, lawmakers are not managing an energy transition, they are just waiting for the next shock and hoping the invoice arrives after the next election.
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