This is why all the hyperventilating over Hungary’s windfall tax makes no sense

Some have been calling it “idiotic,” others believe it’s “dictatorial,” but in reality, it is nothing out of the ordinary. Yes, I’m talking about Hungary’s tax on windfall profits, why it’s absolutely necessary, and why many other European countries – Spain, Italy, Bulgaria, Romania, to name just a few – have also employed them.

Following the inauguration of PM Orbán’s fifth government around three weeks ago, the cabinet moved swiftly to enact measures that will protect Hungary’s national interests and Hungarian families. One of these measures was the establishment of a utility cost reduction fund and a defense fund, both of which will draw money from taxes on large companies’ extra profits, or “windfall” profits.

But what exactly are windfall profits?

The level of profit a company can make depends in part on its market position, the intensity of competition in the market, the innovative content of its product, and the volume of sales. The profit, however, can also be influenced by a number of external factors, which can lead to a much higher profit during some periods, contrary to the expectations of the company's management and owners.

Extra profit therefore represents an increase in profit for companies as a result of a scenario that was not foreseen and therefore not planned for. Extra profit arises when a company's business planning is overruled by an unforeseen external shock (e.g., a war) that causes the company to end the year with a much better result than in previous years, despite the same management as before.

In such cases, the imposition of a windfall tax can be an innovative solution. Several international examples show that in extreme situations, when companies' profit margins are unexpectedly boosted by market conditions they did not expect, the extra profits generated can be diverted by the central budget and then returned to consumers.

The coronavirus outbreak and the war between Russia and Ukraine have created an energy crisis on the international stage, causing inflation to soar at a rate not seen for decades. In the EU, most economic sectors have been adversely affected by these factors, but in some sectors, rising interest rates, high energy prices, a changed business environment, and shifting consumer habits are generating higher profits than in previous years.

While windfall taxes have been routinely utilized by the United States and the United Kingdom throughout the 20th century to mitigate the shocks caused by the two world wars and the oil crises of the 70s, Hungary is not the first EU member state to introduce similar measures in recent years.

In Romania, due to the excessive rise in energy prices, a law was passed last November imposing an 80 percent tax on all electricity producers, except fossil fuel power plants, that applied to energy revenues above €91/MWh, effective until March 31, 2022.

Spain introduced a similar measure in September 2021, also valid until the end of March 2022. The new tax applied to facilities with a capacity of more than 10 MW and to power plants not benefiting from public incentives. The tax is payable if the gas price is higher than €20/MWh. The rate of the tax depends on the energy produced, the gas price, and the price of the energy produced by gas-powered plants. The Spanish government is also preparing a tax on nuclear and hydroelectric power plants. According to the government, these power plants do not pay for CO2 emissions but still generate extra profits due to high electricity prices. The tax revenue will be used by the Spanish government to finance VAT cuts.

Recently, British Chancellor of the Exchequer Rishi Sunak announced an extra profit tax on energy companies (e.g., British Petroleum, Shell) that have made windfall profits in the past. On this basis, British energy companies will pay an additional 25 percent extra tax on individual company profits over the next 12 months. The finance minister said the oil and gas sector had made "extraordinary profits" in recent times, not because of changes in risk-taking, innovation or efficiency, but because of rising global commodity prices, driven in part by Russia's war against Ukraine. The measure was also supported by opposition parties in the British parliament.

In Italy, extra profit taxation was implemented in two stages. First, a 10 percent profit tax was imposed on certain energy companies to finance a €4.4 billion package of measures to protect consumers and businesses from rising prices. The tax liability is calculated on the basis of the increase in profits of energy companies between October 2021 and March 2022 compared to the same period in the previous year. Continuing this practice, in a second step, in May 2022, the government aims to tax extra profits of all energy companies where prices have risen by at least 30 percent in the last period. The extra tax rate has been increased from 10 percent to 25 percent. The proceeds of the measure are to be used to finance a €15 billion aid package to replace Russian gas and protect the economy.

In Bulgaria, the government announced in October 2021 that it would provide electricity to companies at €55/MWh for two months. The total amount of the measure reached €225 million, funded by the extra profit tax on the Kozluduy nuclear power plant.

So, when big companies like Irish airline Ryanair start calling Hungary’s government ugly names, and even labeling our measures “idiotic,” they’re ignoring the fact that this practice is not unprecedented and, clearly, not uncalled for. The imposition of windfall taxes is pretty customary in these war-torn times.

On the rare occasion that Ryanair leaders hit an acceptable tone while talking to us, they aim to sell us the fiction that it is only companies in the energy sector that have been reaping extra profits recently. With the end of quarantines and COVID restrictions in most countries worldwide, demand for air travel has increased significantly, with passenger numbers in Budapest expected to almost return to the 2019 level of 7-8 million departures this year. Both tourist and business trips will increase significantly, generating significant additional revenue for airlines.

It is therefore only understandable that the government would introduce an extra tax of merely HUF 3,900 per departure for airlines. “Departure taxes” are, by the way, in force in most European countries, including Sweden, the UK, France, Italy and the Netherlands.