Excess profit taxes in times of crisis: The example of the inframarginal revenue cap in the EU electricity market

We conduct a data-based policy evaluation of the first large-scale, EU-wide excess profit tax, implemented during the 2022 European energy crisis to tax the windfall profits of inframarginal electricity producers. In particular, we evaluate the inherent trade-off of excess profit taxation: the benefits from generating additional tax revenues for crisis mitigation versus the costs of potential distortions to production and investment decisions. On tax revenues, our analysis indicates that the inframarginal revenue cap could cover almost one quarter of the crisis-related government support, although the distribution of tax revenues and thereby the cost coverage is highly uneven across EU Member States. On distortions, we distinguish between impact on long-run investment and short-run production decisions. While we find only a limited negative impact on profitability, which could discourage investment in the long run, we find, using a difference-in-differences design, that electricity producers slightly adapt their short-run production decisions to improve their profitability. Our conclusions help to guide policymakers in future supply shocks. Excess profit taxes only provide a beneficial cost-benefit perspective under specific conditions. Policymakers must carefully time the implementation and accurately identify excess profits. Even with a generous definition of profits, excess profit taxes can be distortionary and, hence, fail to be pure windfall taxes. While retroactive implementation could be an avenue to enhance the cost-benefit profile of excess profit taxes as a crisis measure, it may undermine the credibility and predictability of the tax framework.