Select Committee on Environmental Audit Second Report


103. In looking at suggestions for streamlining the range of climate change policy instruments, we also considered two other major proposals for reforming the structure or principles of the Levy package: changing the focus of the Levy to target carbon emissions directly rather than energy use; and recasting CCA targets in the form of absolute reductions in carbon emissions rather than relative improvements in energy efficiency.

Refocusing the Levy on carbon would be difficult and of questionable benefit

104. The original recommendation for the Climate Change Levy in the Marshall Report had been for a tax based on carbon emissions, and applying equally to electricity generators as well as other sectors. This proposal was only half-accepted by the Government: the CCL was implemented as a downstream tax, thereby excluding electricity generators, and based on energy consumption not carbon emissions. One reason for this, as already mentioned, was the Government's desire to protect householders, who would otherwise have been affected by the rise in electricity prices resulting from taxing generators.

105. The other main reason was identified by the then Trade and Industry Committee (TIC), when it examined the Government's early proposals for the Levy package in 1999: "the Government's desire to protect the coal industry […] at least partly, explains the reluctance to link the taxation of energy use to the carbon content of fuels."[151] The point here being, of course, that coal is more carbon intensive than gas; a carbon-based tax which applied to electricity generators would therefore have incentivised power companies to switch from coal to gas. As it is, since 2001 market forces have made coal cheaper than gas, resulting in power companies switching from gas to coal.

106. One of the implications of the focus of the Levy on energy efficiency is that the price differential of Levy rates on different fuels does not match their difference in carbon intensity. Levy rates are currently calculated according to the energy content of different fuels; on this basis, electricity attracts a higher rate, reflecting the energy inefficiency in transmitting electricity through the national grid. This means that the direct burning of coal by industrial users attracts a lower rate of Levy than their use of electricity, even though the carbon emissions from burning coal will be higher than the average carbon profile of electricity (Table 2).

Table 2 Carbon price equivalents for the Climate Change Levy

Source: National Audit Office, The Climate Change Levy and Climate Change Agreements, p 13

107. As a result of anomalies such as this, the fundamental design of the Levy package has received considerable criticism from a variety of organisations. Not least, in a report published in 2002 the Royal Society concluded:

    We believe the Climate Change Levy, in its current form, is an inefficient way to reduce CO2 emissions, primarily because it excludes certain energy users (including households and transport) and targets energy use in general rather than carbon emissions in particular. It also acts somewhat crudely on the demand for energy, but fails to provide anything significant for the supply side of the equation.[152]

108. This passage makes it clear how the call for the Levy to be based on carbon emissions, and the call for it to encompass power companies, go hand in hand. Indeed, once the Government decided to implement a downstream tax, the scope for basing it on carbon emissions was both complicated and restricted. There are two essential reasons for this.

109. The first is the difficulty in calculating a carbon-based rate for electricity—or, more usefully, calculating different rates for different suppliers—given the different and changing proportions in which electricity is generated by different fuels. The then DTI, in its response to the Trade and Industry Committee in 1999, thought it too complicated to set even one average carbon-based rate for electricity, given that "The carbon content of electricity supplied is changing all the time".[153] Some witnesses in our inquiry did consider the possibility that different CCL rates could be calculated for different electricity suppliers or tariffs, reflecting the carbon profile of each; however, the general conclusion was that it would be very difficult to do so, and its impacts uncertain.[154] Professor Ekins told us: "Conceivably you would be able to differentiate an electricity tax based on the carbon intensity of that electricity, but it would not be simple and it would certainly greatly [complicate] what at the moment is a relatively administratively easy instrument."[155] His hope, instead, was that the next Phase of the EU ETS would prove more effective in giving power companies an incentive to switch from coal to less carbon-intensive fuels. Professor Grubb was a little more encouraging about the potential effects of differentiating different electricity rates—"I would think that the impact could be non-trivial"—but equally stressed that it "would be pretty complicated to implement, […] and I honestly do not know [about its impacts] until we have looked at it."[156]

110. The other reason why there is limited scope to target carbon emissions follows from the first. If there were only a single Levy rate for electricity, based on the average carbon profile of all generators (or even if there were different rates for different generators, but these did not vary significantly), then the differentiating of Levy rates could only really incentivise the switching between different fuels—e.g., between coal and gas, or coal and electricity—rather than between different electricity companies or tariffs. And as the Carbon Trust established when it looked at the likely impacts of differentiating Levy rates in this way: "our modelling studies indicate that this has very little impact on business and public sector emissions. This is because the opportunities for businesses to switch between fuels in response to the carbon differentiation between coal, gas and electricity are in fact extremely limited."[157] Switching electricity suppliers would be simple; but switching from using electricity (e.g., to run lighting and appliances) to buying gas and using that to generate the electricity on site—or trying to substitute electricity for coal in certain industrial processes—would be at best difficult and expensive, and at worst impossible.

111. We have sympathy with the Royal Society's argument that the Climate Change Levy should have been set up as an economy wide carbon tax (so long as other measures would have ensured it did not exacerbate domestic fuel poverty). Once the Government decided to implement the Levy as a downstream tax, however, the practical scope for basing it on carbon emissions rather than energy efficiency was greatly reduced. Professor Grubb summed it up well: "in a sense, the whole debate about whether the CCL should really be a carbon tax is probably yes in principle, but actually in practice it makes very little difference."[158] We still recommend that the Government should look into the practicalities and potential benefits of basing Levy rates on carbon content, and in particular the potential to vary rates on electricity depending on the carbon profiles of different suppliers and tariffs. However, the overall environmental value of the CCL does not depend on its being based on the carbon content of different fuels, and this should not be an overriding priority.

Agreements should be based on absolute cuts in carbon emissions

112. A related proposal is to recast all Climate Change Agreement targets in the form of absolute reductions in carbon emissions rather than relative improvements in energy efficiency. This is a much simpler matter than changing basis of the Levy to carbon emissions, since its effectiveness would not hang on incentivising a switch between different fuels. Already the CO2 emissions of CCA participants are calculated from the amount of energy they consume, with energy usage converted into carbon dioxide amounts using known carbon ratios of different fuels (with electricity usage converted using the average carbon profile of the national grid). These methods could easily be used to refocus CCA targets and monitoring regimes on carbon. Setting absolute targets would be equally straightforward, simply setting a specific cut from a previous baseline. Indeed, the CCA system already allows for targets to take this form; although, as the NAO noted, sectors have been able to choose which form their targets take, and "Unsurprisingly, relative targets were more popular amongst businesses"—meaning that only four out of 51 sectors have absolute targets.

113. AEA Energy and Environment argued that, given the increasing need for achieving year on year reductions in CO2 emissions, and the increasing imposition of absolute carbon caps elsewhere (through (i) the national carbon budgets to be introduced by the Climate Change Bill, (ii) the EU ETS, and (iii) the CRC), "the time is right for carbon agreements".[159] Interestingly, the CBI used this argument as a reason to be cautious about introducing absolute targets. Given that the UK economy as a whole is to become subject to an absolute carbon cap, and given that other areas of the economy may able to deliver cheaper emissions savings, the CBI suggests that "a degree of efficient growth in emissions from CCA sectors is manageable and justified on competitiveness grounds (given the inability of many of these sectors to pass carbon costs through to their customers)."[160]

114. We recommend that the Government reform the Climate Change Agreements to express all targets in the form of absolute reductions in carbon emissions. This would help to align CCAs with the EU ETS and CRC, and with national carbon budgets; and be relatively straightforward to introduce. We appreciate the concerns expressed about this idea by some business groups, but do not agree with the suggestion from the CBI that some CCA sectors should be allowed room for "efficient growth in emissions": any sector of the economy whose emissions are allowed to rise exacerbates the problem and increases the pressure on all others to cut theirs. The Government should investigate other means of meeting the concerns of business groups, for example by ensuring that CCA targets were set with reference to the differing scope for carbon reductions in different sectors. Businesses would still be able to use the CCA trading mechanism if they exceeded their targets.

151   Trade and Industry Committee, Ninth Report of Session 1998-99, Impact on Industry of the Climate Change Levy, HC 678-I, para 34 Back

152   Royal Society, Economic instruments for the reduction of carbon dioxide emissions, November 2002, p vii Back

153   Trade and Industry Committee, Eleventh Special Report of Session 1998-99, HC 834, Response to Recommendation m Back

154   Q39, Q165 Back

155   Q201 Back

156   Q165 Back

157   Carbon Trust, The UK Climate Change Programme: Potential evolution for business and the public sector, p 19 Back

158   Q165 Back

159   Q118 Back

160   Ev 127 Back

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