House of Commons - Environmental Audit

Select Committee on Environmental Audit First Report

PRE-BUDGET REPORT

Specific measures and principles

39. This inquiry was aimed at examining the Government's statements on environmental taxation and the potential of the tax system to deliver environmental objectives and encourage sustainable development rather than an in-depth appraisal of individual measures. However the evidence we have received on some of the measures in the last Budget and those discussed in the Pre-Budget Report do merit consideration and where we can draw conclusions we do so.

40. For all environmental tax measures we conclude that it is important that the Government produce a clear statement of its objectives. There is potential for confusion between taxes levied according to estimates of specific externalities but which also have broader aims such as providing incentives for better environmental behaviour.

VAT on domestic fuel and energy efficiency measures

41. The imposition of VAT on domestic fuel has been presented to us as an example of poor implementation of an environmental tax in contrast to, for example, the introduction of the landfill tax. VAT on domestic fuel came after little consultation. This Government reduced the rate to 5 per cent in the July Budget at an environmental 'cost' of 0.24 million tonnes of CO₂ but a social benefit in reducing a disproportionate tax burden on low income households. The Financial Secretary told us that the environmental cost was compensated for by the increase in the road fuel duty escalator.[37] It has been argued that a better answer would be to levy even the full rate of VAT and address the regressive effect separately. Compensation could be delivered through the benefits system or by introducing a tax-free energy allowance. The Treasury told us that the justification for a reduction in the rate across the whole population, to deal with an impact on low income households, was the application of the overall principle of avoiding unnecessary complexity and the potential for unintended effects within the tax system.[38] We do not accept that perceived demands of simplicity should override the Government's pursuit of the integrated objectives of sustainable development.

42. An associated issue is that of energy efficiency. Increasing energy efficiency is a clear example of win/win policy. Lower costs, lower emissions and social equity could all be enhanced by encouraging business to invest in energy efficiency measures and by addressing the UK's relatively poor quality of housing stock in this context.[39] The Government is committed to the reduction of VAT from 17.5 to 5 per cent on installations of energy saving materials under certain Government schemes. On Customs and Excise's own estimates this will have an insignificant effect on emissions of CO₂ but will allow at least 40,000 homes to benefit from such improvements each year.[40] The application of the reduction in VAT is limited by EC VAT law. We received a large amount of evidence from the Association for the Conservation of Energy strongly contesting the interpretation of the EC directive and suggesting that the real block was a lack of political will.[41] The Financial Secretary told us that the matter had been discussed with the European Commission and that the conclusions were the result of the UK Government's interpretation of its legal obligations.[42] We remain concerned at the existing anomaly whereby relative tax levels on the consumption and conservation of energy favours the former. This can only work against the achievement of higher efficiency.

43. We note the Treasury's evidence on the application of European law to the reductions of the UK's rates of VAT on domestic fuel and power and on the installation of energy efficiency materials under certain Government funded schemes.[43] We also note the fact that, at the time this Report was being prepared, the Government had not yet raised the issue of a wider relief of VAT on energy saving materials with any other EU Member State as was its stated intention in the Pre-Budget Report.[44]

44. We recommend that the Government pursue its negotiations within the European Union as a matter of urgency to widen the scope of the reduction of VAT on energy saving measures. Over the longer term we recommend that the level of VAT on domestic fuel and power be fully appraised as part of the response to the UK's obligations under the Kyoto Protocol and that this appraisal include examination of the feasibility of using a tax-free allowance for domestic fuel and other measures to address issues of distributional impact.

VAT on building and reclamation

45. Further candidates for action should include the harmonisation of the rate of VAT levied on renovation and new build. We believe the existing tax treatment to be anomalous as it militates against the achievement of the Government's environmental objectives for housing policy in so far as there is a target for brownfield development. A broader approach to these objectives would need to include incentives to develop derelict and contaminated land.

Water pollution charges

46. We are conscious of the extensive consultation process conducted by the DETR on this issue and the fact that we have received no evidence on this subject from the agricultural sector. We note the evidence we have received concerning the large body of legislation on water quality standards (much of it from the European Communities).[45] However, we note the existence of water pollution charging schemes in Germany, the Netherlands and France which appear to operate in concert with European legislative requirements.[46] The arguments advanced over the continuing incentive effects of an environmental tax on water pollution, which produce improvements over and above statutory requirements, appear to us to be compelling. We recommend that the Government consider levying a tax on water pollution from point sources to provide a continuing incentive for abatement.

47. Diffuse sources of pollution, such as the use of pesticides, by their nature are not so amenable to regulatory control and the balance of our evidence was towards the introduction of a uniform tax on pesticide usage. However, there was a strong emphasis on a broad approach to addressing pesticide pollution because of the entrenched incentives for their use in current agricultural practice in the UK.[47] We recommend that the Government consider a package of measures to reduce pollution of water supplies arising from pesticides. These should tackle both the existing incentives for the use of large volumes of such chemicals and introduce a disincentive in the form of a new tax.

The landfill tax

48. The landfill tax is currently under review by Customs and Excise and its conclusions are due to be published with, or shortly after, the Budget. We note that the Environment Sub-Committee of the Environment, Transport and Regional Affairs Departmental Select Committee is currently inquiring into Sustainable Waste Management and will be reporting later in the year. Additionally the House of Lords European Communities Committee (Sub-Committee C) will shortly be reporting on the draft EC Landfill Directive.

49. The CBI Green Taxes Group described the landfill tax as falling at the first hurdle in that it failed to address the accepted externalities of methane emissions and leaching which varied markedly between different sites.[48] However, other witnesses, including the Environment Agency, suggested that the value of the tax was that it began to address the relative environmental values of the various paths for waste.[49] The objective was not necessarily to distinguish between landfill sites but to shift the treatment of waste up the hierarchy which ran from landfill and incineration to recycling and ultimately, minimisation. We note calls by a number of witnesses for an increase in the rate of the landfill tax as well as for an extension of its scope to include other forms of waste disposal including incineration.[50]

50. We believe that in general the introduction of the landfill tax has been very successful, and is a good example of the advantages of having an extended period of analysis and consultation before introducing any environmental tax, so as to ensure that a reasonable measure of agreement about externalities and likely behavioural effects can be established and likely problems identified in advance. It is not surprising however that some teething problems have still occurred, and as with any new tax these need to be carefully reviewed. We have received evidence of some negative environmental effects of the tax such as increased fly-tipping and a reduction of inert materials going to landfill which were necessary for the safe treatment of other wastes. We recommend that there should continue to be close monitoring of the impacts and effectiveness of the landfill tax. This would allow any fine-tuning needed to deal with incipient problems, or consideration of an increase in rates, to be promptly addressed, thereby enabling progress towards the objectives of improving waste management practices to be optimised.

Aggregates extraction

51. Our evidence on aggregates extraction was divided. However, we noted with interest the agreement between Friends of the Earth and the CBI Green Taxes Working Group that the environmental impacts of quarrying may be better addressed by regulations and the planning system.[51] Friends of the Earth went on to argue however, that a tax was appropriate as well because "it provides a longer term incentive for efficiency in the use of aggregates and can make a contribution to shifting the burden of taxation".[52] The Quarry Products Association said that the scope for efficiency improvements in the use of aggregates was limited by substantial current levels of recycling and the limited availability of satisfactory secondary materials to suit specifications.[53] The CBI Green Taxes Working Group told us that another consideration was the geographical distribution of aggregates sources and warned against addressing one environmental problem by increasing another in the form of further pressure on the transport network.[54]

52. We note that the DETR has commissioned research into the environmental costs attached to quarrying, and in particular the supply of aggregates. We recommend that the research be published and there should be full consultation undertaken to determine to what extent a tax might be able to capture any externalities identified therein. Consultation should also explicitly include the question of in what ways, and to what extent, the incentive effects of a tax might alter the practice of the aggregates and construction industry.

Vehicle use

53. The transport sector contributes about 14 per cent of the UK's CO₂ emissions as well as a significant amounts of other pollutants degrading local air quality. And the problem is growing.[55] We expect that the Government's forthcoming statements on the Kyoto protocol, integrated transport and the advanced review of the air quality strategy, will all contain reference to vehicle, particularly private car, use. The use of taxation on road fuel and the differentials applying to different fuel types, has the potential to encourage people to use more fuel efficient vehicles and less carbon-intensive and polluting fuels, to switch from private to public transport, and to travel less in order to achieve a reduction in road traffic. This has been well-argued by the Royal Commission on Environmental Pollution and the Round Table on Sustainable Development amongst others.[56] Professor Davies of the CBI Green Taxes Working Group however, told us that the he did not view duty on road fuel as an environmental instrument and that if vehicle use caused problems of pollution and congestion, these should be tackled directly and not by a general tax on motoring.[57] The Automobile Association drew attention to the high cost of CO₂ reduction through duty on road fuel compared to estimates of tackling emissions from the industrial and domestic sectors.[58]

54. The actual measures in the Pre-Budget Report are modest. We welcome the scheme on vehicle excise duty (VED) as it extends to lorries and buses. However we would like to see consideration given to the issue in relation to private cars. Alternative suggestions were made to us. On the one hand VED could be abolished (except for an administrative fee) and taxation concentrated on car usage rather than car ownership.[59] This would have the advantages of being very progressive as well as increasing the marginal cost of each journey relative to the initial investment.[60] On the other hand the profile of VED is high, as it was paid in one lump, suggesting that incentive effects of a differential based on pollutants and CO₂ emissions might be significant. VED could be targeted on engine size and efficiency and emissions rating. The distributional impact would need examination as older cheaper cars tend to be more polluting although they also tend to have smaller engines.[61] The Royal Society for the Protection of Birds submitted a detailed report on this matter commissioned from the Institute for European Environmental policy.[62]

55. Other witnesses mentioned the perverse incentives in company car taxation. The system rewards drivers for driving further and the full value of complimentary fuel is not taxed (we would add the provision of free parking to this list). As Friends of the Earth put it "it is difficult to find a better example of where the tax system does exactly the opposite to the Government's aims of sending clear signals about which economic activities it wishes to encourage."[63] The Committee was delighted to hear Mr Michael Roberts of the CBI Green Taxes Group say that in business "there is an appetite for change where there is felt to be fiscal distortion, particularly in the transport market".[64]

56. We believe that the duty on road fuel, and the escalation of its rate, acts to check the overall growth of an activity at a rate that has serious consequences for public health, environmental standards and economic efficiency. The specific externalities of the emissions of pollutants and CO₂ and of congestion should also be addressed directly and we look to the Government's eagerly awaited documents on climate change, transport and air quality to tackle these issues head on. It is vital however, that these matters are addressed in the round and account is taken of those sectors of society, particularly those people on lower incomes living in rural areas, who depend on cars for access to vital services. Account should also be taken of these issues in considering other Government policies which may place important services out of reach except by the use of private motor transport. In particular we recommend that:

the Government should fully appraise the environmental effects of introducing differentials to the rate of vehicle excise duty based around emission standards for regulated pollutants and for CO₂ as well as engine size and efficiency;

the Government should appraise the incentive effects of higher rates of escalation on road fuel duty and take account of the most up to date scientific evidence in setting the differentials; and

in the light of the growing consensus we have identified the Government should address the perverse incentives in the taxation of company cars as part of its integrated transport policy if not sooner.

To realise fully the benefits of these measures the integrated transport strategy must match steady increases in the overall cost of motoring with steady improvements in the availability of real alternatives in the form of better public transport, more energy efficient vehicles and alternative fuels.

Conclusion

57. We accept that the introduction of environmental taxes must allow for the application of all the analytical rigour and full consultation that the Treasury and other witnesses have emphasised. We agree with the need for a holistic approach which takes account of effects on both social equity and competitiveness as well as existing regulatory and voluntary arrangements. We welcome signs that the tax system is on notice to deliver environmental objectives and we urge the Government to approach the complementary subjects of environmentally damaging subsidies and incentives to invest in environmental technologies as part of its strategic approach. We believe that our conclusions and recommendations, set out above, will assist in this process and in the Government's reporting to Parliament thereon.

37 Q14 Back

38 Q15 Back

39 Ev p17 Back

40 'Energy Saving Materials: The Scope for a Reduced Rate of VAT', Customs and Excise (26 November 1997), p12. Back

41 Appendix 8, pp70-82 Back

42 Q13 Back

43 Ev p106, paragraphs 14 & 15 Back

44 HC Deb, 25 February 1998, col 234, wa Back

45 Ev p94 Back

46 'Economic Instruments for Water Pollution' Department of Environment, Transport and the Regions, November 1997, annex 3. Back