We Need to Talk About Fuel Duty

Net Zero

We Need to Talk About Fuel Duty

Posted on: 1st March 2021
Tim Lord
Senior Fellow | Net Zero

There is plenty of speculation about what the Chancellor will say when he stands up to deliver his Budget on Wednesday.  There is, though, one area where we can be confident: if the pre-Budget leaks are true, there will be no increase in fuel duty.  But there’s another problem he can’t ignore for long – the rise of electric vehicles is going to rapidly erode a key revenue-raiser for the Treasury, and we need to work out what to do about it.

Fuel duty is a big deal. It raises around £30 billion per year – equivalent to around 6p on the basic rate of income tax.  Fuel duty has not risen since 2010 and over that time, emissions have been up to 5% higher than if duty had increased as planned, and revenues over £10 billion lower. 

Tim chart1

Source: https://www.ifs.org.uk/uploads/GB2019-Chapter-9-A-road-map-for-motoring-taxation.pdf

While the costs from repeated freezes – in terms of lost revenues and increased emissions – are real, it would be naïve to ignore the political challenges of increasing fuel duty.  The Chancellor can sidestep this political problem by keeping fuel duty frozen.  But he can’t control the bigger problem coming down the line: the rise of electric vehicles is going to eat into fuel duty revenues quickly, and we have no plan for how to respond.

As the Treasury pointed out in its recent report, this is by far the largest “carbon tax” in the economy.

Tim chart 1

But “carbon tax” is a bit of a misnomer here.  Fuel duty does much more than put a price on carbon: with one or two exceptions (like the London Congestion Charge), it’s the main disincentive to driving more.  Without it, congestion – already a bigger problem for the UK than comparable economies – will only get worse.

So why is the current approach to fuel duty not sustainable?  The Government has committed to ending the sale of petrol and diesel vehicles by 2030.  There could be over 10 million electric vehicles on the road by that point.  That would mean around a third of the cars on the road will be electric – and not paying fuel duty.  That number will rise quickly through the 2030s.  This is a serious fiscal challenge that threatens to put a £30 billion hole in the public finances over the next 15 years.

Fundamental changes to taxation are always a political problem, so the easiest option might be to do nothing.  If we follow that course, there will be three highly predictable outcomes: the Treasury loses £30 billion in revenue; congestion gets worse, as driving gets cheaper; and impacts are worst for those on lower incomes, who are less likely to be able to afford an electric vehicle. 

The downsides are clear, so let’s assume we rule out “do nothing”.  What then are the options for tackling these problems of revenue, congestion, and fairness – and doing so in a way which does not slow down the transition to electric vehicles?

We could follow the approach used for cigarettes, where we’ve increased the level of tax as smoking has fallen, keeping revenues relatively stable.  For fuel duty, that would mean increasing the rate to recoup the revenues lost as the number of electric vehicles increases. But that won’t work: the level of impact on those still in petrol and diesel vehicles would be politically unsustainable as fuel duty trebled or quadrupled over time, and it only delays the problem a few years.

We could try to replicate fuel duty for electric vehicles, by taxing the electricity used to charge them.  But that has real downsides too – it’s difficult to differentiate electricity for vehicle charging from electricity used for other purposes, and the transition to EVs would be slowed.

So that leaves road pricing. This could secure the revenue we need, and target the right outcomes (i.e. avoid increases in congestion).  But it is technologically complex, and opens up new issues around equity: do we charge a flat rate everywhere or vary the charge by location and time to reflect the true cost of congestion – meaning those who need to use congested roads pay more?

At the moment, we are treating this fundamental change to our tax revenues as something that might happen.  But, with the falling cost of EVs, it’s something that will happen – and there’s an urgent need to grip the problem.  The Transport Committee’s forthcoming inquiry is welcome – and we at TBI will be developing work on road pricing to look at how it could be made to work in a way that’s politically acceptable, equitable, and delivers the right outcomes for emissions.

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