Select Committee on Environmental Audit Minutes of Evidence

Further memorandum from HM Treasury



  1.  This memorandum sets out the further details on the design of the climate change levy contained in the Pre-Budget Report, published on 9 November.


  2.  In Budget 1999, the Govenment announced that, as part of its wider climate change programme, it would bring forward legislation in Finance Bill 2000 to introduce a climate change levy on energy use by business with effect from April 2001. This followed the recommendations made by Lord Marshall in his report published in November 1998.

  3.  Immediately after the Budget, HM Customs and Excise launched a major consultation exercise with business and other interested parties on the design issues surrounding the levy.

  4.  The aim has been to design the levy in a way that maximises its environmental effectiveness whilst safeguarding the competitiveness of UK business. Views from a wide range of organisations have fed into this consultation process. In the light of the responses to the consultation exercise, and other representations made, the Government intends to:

  Increase the environmental effectiveness of the levy by:

    —  exempting from the levy electricity generated from "new" renewable sources of energy and in "good quality" combined heat and power plants; and

    —  trebling the support for energy efficiency measures arising from the levy package from £50 million to around £150 million in 2001-02, to allow for the introduction of a system of enhanced capital allowances for energy saving investments.

  Protect competitiveness by:

    —  reducing the overall size of the levy to £1 billion in 2001-02, with a commensurate reduction in the main levy rates;

    —  offering an 80 per cent discount for those energy intensive sectors that sign energy efficiency agreements that meet the Government's criteria; and

    —  recycling all the revenues raised back to business as a whole through a 0.3 percentage point cut in employers' National Insurance Contributions and the additional support for energy efficiency measures.

  5.  Draft legislative clauses reflecting the revised design of the levy were published on 26 November.

  6.  The exemptions for "new" renewables and "good quality" CHP will increase the environmental effectiveness of the levy (see below for details). As a result of this, and the trebling of support for energy efficiency measures, it has been possible to set the levy at a lower level than the illustrative rates contained in the HM Customs and Excise consultation document, whilst increasing the environmental benefits of the package as a whole. This underlines the Government's commitment to design the levy in such a way as to achieve its environmental goals whilst protecting UK business.


  7.  The climate change levy is designed to be revenue neutral for the private sector, with the revenues raised being fully recycled to business, primarily through a reduction in employers' National Insurance Contributions (NICs). This is consistent with the Government's policy of switching the burden of taxation from "goods" like labour, to "bads" like pollution. In 2001-02, the levy is expected to raise £1 billion, all of which will be recycled back to business as a whole via a 0.3 percentage point reduction in employers' NICs and the additional support for energy efficiency measures. The rates of the levy are expected to be:
Energy Product Levy Rate in 2001-02 (pence per kilowatt hour)

  8.  The Government will continue to monitor and evaluate the contribution the levy makes to the UK's targets for reducing greenhouse gas emissions. As with other excise duties, the Government expects that the rates of the levy will at least keep pace with inflation over time.

  9.  Responses to the HM Customs and Excise consultation document and other representations made on the design of the climate change levy indicated widespread support for increasing the resources directed to energy efficiency measures within the climate change levy package. In light of the representations made, the Government is minded to treble its support for energy efficiency measures under the climate change levy package—meaning the £50 million announced in Budget 99 for 2001-02 would rise to around £150 million. This would allow for a system of 100 per cent first year capital allowances for energy saving investments to be introduced alongside the £50 million energy efficiency fund announced by the Chancellor in Budget 99. Subject to any practical or legal considerations, such enhanced allowances—which businesses would be able to set against their corporation or income tax bills—could be introduced alongside the climate change levy in April 2001.

  10.  A consultation document was issued on 9 December asking for views on which energy efficient products and technologies might qualify for the enhanced allowances.

  11.  Views are also being sought on the Government's detailed proposals for using the energy efficiency fund announced in Budget 99, which is intended to:

    —  provide energy efficiency advice/audits to non-domestic energy users, especially small and medium sized enterprises;

    —  promote the development of "new" sources of renewable energy; and

    —  encourage the research and development and take up of low carbon technologies and energy saving measures through a "Carbon Trust".

  Final decisions on the use of the energy efficiency fund will be made in the spending review 2000. The aim will be to provide a fully integrated and coordinated package of measures to facilitate both technological innovation and the diffusion of new technologies in the business community, building on existing programmes like the Energy Efficiency Best Practice Programme (EEBPP).


  12.  The Government recognises the case for giving special consideration to the treatment of energy intensive sectors given their high energy costs and their exposure to international competition.

  13.  The basis for determining eligibility for special consideration will remain sites in those sectors covered by the EU's Integrated Pollution and Prevention Control (IPPC) Directive. These installations will be subject to a regulatory requirement, in terms of having to operate in an energy efficient manner, that other non-IPPC sites are not subject to. This definition covers the main energy intensive sectors exposed to international competition and the majority of energy use in the manufacturing sector. This definition also provides the legal certainty required for determining who is, and is not, eligible to enter into negotiated agreements. The Government has indicated that small sites in sectors covered by the IPPC Directive, but which fall beneath the Directive's size threshold, will be eligible to be covered by a negotiated agreement.

  14.  The Government remains willing to consider suggestions for alternative definitions which would target the relief on energy intensive sectors exposed to international competition. But any alternative definition would have to have a clear rationale, provide legal certainty, administrative simplicity and be consistent with EU State Aids rules. The Government does not intend to extend eligibility to all firms, since that would involve offering lower rates of the levy to firms who are already net gainers from the levy/NICs package.

  15.  Participants in eligible sectors who enter into climate change levy agreements to achieve demanding energy/CO2 savings targets and who meet the terms of those agreements will qualify for an 80 per cent discount from the levy rates.

  16.  The Department of the Environment, Transport and the Regions (DETR) is leading the discussions with the main energy intensive sectors, which have been underway since spring 1999. Considerable progress has been made. On 20 December, sector representatives signed Memoranda of Understanding with DETR on energy efficiency targets for their sectors. Smaller trade associations, taking part in a series of "second wave" discussions, are expected to sign Heads of Agreement in the coming months.


  17.  From the outset, the Government has made it clear that it wishes to maximise the environmental benefits of the climate change levy. Subject to legal and practical considerations, the Government intends to exempt electricity generated from renewable sources of energy (other than large scale hydro plant) from the levy. Electricity suppliers will be able to provide electricity to businesses without incurring the levy up to the total amount of any contracts they have with eligible generators of renewable power.

  18.  The Government recognises the environmental benefits that the additional energy efficiency of combined heat and power (CHP) plant can offer. It therefore proposes to exempt electricity generated in "good quality" CHP plant from the levy. Guidelines on the definition of what constitutes "good quality" CHP have been published by HM Customs and Excise.

  19.  In designing the levy the Government has taken into account its wider policy objectives, including the promotion of rail-freight transport. The Government therefore intends to exempt the traction electricity used by rail-freight locomotives from the levy.

  20.  The Government recognises that in some cases energy products are used for non-energy purposes and the amount used is determined by the nature of the process. With this in mind, the Government intends to exempt from the levy those energy products which serve a dual purpose as a fuel and as a feedstock within the same process. The Government also intends to extend the electrolysis exemption announced in July to cover electricity used in electrolytic processes similar to chlor-alkali production and primary aluminium smelting.


  21.  The levy package—including additional support for energy saving measures and environmental exemptions for "new" renewables and "good quality" CHP—is projected to save the equivalent of at least two million tonnes of carbon (MtC) a year by 2010, compared to the 1.5 million tonnes associated with the proposal outlined in Budget 99.

  22.  There are three inter-related factors which explain this change in the expected carbon savings from the levy package:

    —  The lower rates of levy mean that the pure price effect of the levy is now estimated to be smaller than associated with the illustrative levy rates published at Budget time;

    —  However, the exemptions for electricity generated from "new" renewables and "good quality" CHP plants will increase the environmental effectiveness of the levy by encourage switching to more efficient and less polluting forms of electricity generation;

    —  And the additional support for energy efficiency measures should help stimulate investment in new processes and technologies, thereby generating additional carbon savings.

  23.  It is not possible to give a precise breakdown of the carbon savings arising from the different elements of the levy package. In part, this reflects the difficulties in estimating the response of firms to the incentives provided by the levy package, and the fact that some of the detailed design issues, such as which technologies might qualify for the enhanced capital allowances, have yet to be resolved.

  24.  It also reflects the difficulties in separating out the effects of different elements of the levy package. For example, incentives for the take-up of CHP generation could arise through the exemption from the levy itself and the enhanced capital allowances (if investments in CHP form part of the eventual list of qualifying technologies). Separating out these effects is extremely difficult and, where possible, conservative estimates are used to avoid "double counting" of the carbon savings.

  25.  A very rough indication of the possible magnitudes involved is shown in the table below. The figures are shown for illustrative purposes only. All the estimates are subject to wide margins of error and undue weight should not be placed on them.
Element of levy packageEstimated Carbon Savings (MtC) per annum by 2010
Price effect of levy1>1
Renewables exemption1>0.5
CHP exemption2<0.5
Total3 (excluding negotiated agreements) >2

1 Based on estimates from the DTI Energy Model.

2 Based on DETR estimates for forthcoming climate change programme.

3 It is not possible to provide a detailed estimate for the CO2 savings arising from the energy efficiency measures under the levy package at this stage since the details of these measures are still out to consultation and have yet to be finalised.

  26.  The levy's negotiated agreements with energy intensive sectors are expected to deliver over two million tonnes of carbon in addition to the carbon savings arising from the levy described above. This estimate is based on comparing the target offers sectors have signed up with the "Business-as-Usual" projections for 2010 estimated by the energy Technology Support Unit. Further details of the targets for each sector will be made available once the Heads of Agreement have been signed.

  27.  Together, the carbon savings arising from the levy package and the negotiated agreemments with energy intensive sectors will make very significant contribution to meeting the UK's legally binding target for reducing greenhouse gas emissions set under the Kyoto Protocol and moving beyond that towards the Government's domestic goal of a 20 per cent cut in carbon dioxide emissions by 2010.


  28.  In his November 1998 report, Economic instruments and the business use of energy, Lord Marshall urged the Government to "step up its consultations with interested parties to resolve the complex issues involved in designing trading scheme". Following on from this report and subsequent discussions led by the CBI and ACBE, and Emissions Trading Group (ETG) was established to take the work forward.

  29.  The ETG, which now includes around 40 major firms and trade associations, presented their proposals for a UK emissions trading system to the Government on 27 October. The Government has been encouraged by the positive way that the ETG has developed principles for an emissions trading scheme and is considering its proposals in detail.

  30.  The Government believes that emissions trading has a key role to play in the long-term solution to reducing greenhouse gas emissions. A domestic trading scheme would complement other climate measures in the business sector by offering cost-effective and flexible options for achieving emissions reductions. It will also open the way to international trading opportunities and will enhance UK expertise in this field.

  31.  In designing the climate change levy's negotiated agreements for intensive energy users, the Government will seek to facilitate emissions trading between those firms covered by an agreement. The Government shares businesses' aim of having a UK emissions trading scheme operational as soon as possible and will be looking at further ways to encourage participation in a domestic scheme.

January 2000

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