Out-of-this-world windfall profits to fund otherworldly promises

Extra profits are a bit like aliens: everyone talks about them and many are certain they exist, but no one can explain how to recognise them. They are also contagious, given that they were first spotted in banks, now in energy companies, and who knows where tomorrow. In a letter to Corriere della Sera, Elly Schlein proposes taxing them to fund support for families and businesses, without answering the crucial question of what, exactly, an ‘extra profit’ is.

Let’s start with the basics: profit is an accounting figure, equal to the difference between revenue and costs. The term ‘extra’ does not exist in financial statements and must be defined in relation to a value considered ‘normal’, which could be the previous year’s profit, the average of the last four years, or the profit expected before the war. In 2022, the European Union classified profits exceeding 20 per cent of the average of the previous four years as ‘excessive’, adopting a convention that produced paradoxical consequences because, if a company had recorded losses, almost any subsequent profit became ‘extra’, whilst if it had made high profits, even a gain generated by the crisis might not be classified as such.

A rise in energy prices does not automatically mean higher profits, because to determine who has profited, one must analyse the supply chain, distinguishing between producers, importers, refineries and distributors, and examine their revenues, costs and volumes sold. As Marco Leonardi and Leonzio Rizzo have explained in this newspaper, there are several stages between the price of crude oil and that of diesel. The difference between the former and the latter – that is, between the value of refined products and the cost of crude oil – is the gross refining margin. If production capacity is low relative to demand, this margin increases, which is what has happened in recent months. A high margin may indicate a scarcity rent and warrant competition investigations, but it does not prove abuse or a mysterious ‘extra profit’, because when a good becomes scarce and demand reacts only slightly, the price rises.

But let us assume for the sake of argument that windfall profits do exist. The key point is that taxing them does not solve the problem: if margins stem from scarcity, the solution is to increase supply; whereas if they stem from market power, competition must be increased. Suppose that a few firms keep the price of diesel above the competitive level: taxing their profits does not increase the number of competitors, does not expand refining capacity, does not facilitate imports and does not reduce barriers to entry; consequently, it would be reasonable to expect the price to remain high, as would the rent. The state would thus become a fiscal partner of the monopolist, because higher margins generate greater tax revenue, whilst the consumer would continue to pay the same high price. If, on the other hand, the tax were to target accrued profits, it would be retroactive, in contravention of Article 3 of the Taxpayers’ Charter. In Italy, retroactive taxation is not absolutely prohibited by the Constitution, but the Constitutional Court requires a reasonable justification and a link that is still relevant to the taxpayer’s ability to pay, whilst legal certainty and the legitimate expectations of those who have made decisions and invested in accordance with the rules in force remain important. Changing the rules after the game is over is a method befitting a paternalistic state, not a serious legal system.

This is where the contradiction in Schlein’s proposal becomes apparent, because the PD secretary implicitly highlights a problem of competition, yet proposes a fiscal measure as the solution. If she believes that companies are abusing their market power, she should call for an investigation by the Competition Authority, greater transparency on profit margins and the removal of barriers. If global refining capacity is insufficient, we are faced with a scarcity rent; whereas if a small number of operators can restrict supply, there is a problem of market power. Taxation leaves the mechanism that keeps prices high intact and therefore constitutes redistribution, not energy or competition policy. The proposal does not tackle windfall profits; rather, it implies that the state should share in them.

Before proposing a tax, one should at least define what is meant by ‘extra profits’, specify who has made them and explain how they will be measured; otherwise, they remain an otherworldly tax base, having arrived from Mars just in time to finance very down-to-earth election campaign promises.