Select Committee on Environmental Audit Second Report


Effectiveness of the Climate Change Levy
1.Given the intrinsic difficulties involved in calculating its effects, and in order to improve transparency, we recommend that the Government should give an estimated range of uncertainty for its projections of the Levy's impacts. (Paragraph 12)
2.According to the evaluation of the Levy relied on by the Government, most of the impacts of the CCL were already established before the policy actually came into effect in 2001, and have only marginally increased since then. (Paragraph 16)
3.Overall, it seems that the Climate Change Levy has not worked as originally planned —particularly for less energy intensive firms and SMEs. While concerned by the weaknesses of the Levy, we welcome the fact that the Government has not ignored these problems. In responding to the recommendations of the Carbon Trust by bringing forward plans for the Carbon Reduction Commitment, the Government is targeting some of the sectors for which the Levy has proved less effective. This shows a commendable flexibility of approach and ability to learn through doing. (Paragraphs 22,23)
Effectiveness of the Climate Change Agreements
4.While in theory the use of carbon trading has no adverse effect on the amount of carbon savings generated by the system as a whole, this depends on the stringency of the original targets: if some targets are weak, then the firms to which they apply may be able to overachieve relatively easily, and thus provide a high volume of cheap credits with a concomitantly lesser effect in driving emissions reductions. Regarding the UK ETS, the first source of credits up to 2006, a Defra report from 2007 describes it as having provided an "over-allocation of allowances […] linked to generous baseline setting and the inclusion of non-CO2 GHGs [greenhouse gases]." This points to a serious weakness in the rigour of the CCA system so far, and underlines the fact that in all carbon trading schemes it is the level of the cap, rather than the trading mechanism, which is the key element. It also makes looking at the number of firms and sectors which have passed their Agreements targets an even less useful measure of the environmental impacts of the CCA system. (Paragraph 33)
5.It appears to us that isolating and enumerating the impacts of the Climate Change Agreements is even more complex and uncertain than accounting for the impacts of the Climate Change Levy. It is remarkable that the performance of most sectors is measured from a variety of different starting points that predate the start of the Agreements, in three cases stretching all the way back to 1990. While measuring the impact of Agreements by reference to business as usual projections avoids some of these problems, it also creates new ones of its own: as we have argued in previous reports, BAU projections intrinsically lack certainty, and depend very much on the quality of the assumptions and data used to generate them. For these reasons we recommend that, when reporting figures for the impacts of the Agreements, the Government gives a range of uncertainty attaching to them. (Paragraph 35)
6.Although there are difficulties in arriving at a firm evaluation of the carbon savings driven by the Agreements, the anecdotal evidence suggests that the process of complying with CCAs has had a very positive effect, leading to a widespread improvement in energy management systems, greater sharing of good practice, and a general raising of energy efficiency as a boardroom priority among participating firms. (Paragraph 41)
Stringency and value for money of the CCA system
7.We are highly surprised that the Government has not tightened the Agreement targets since data from the first milestone period revealed that both the initial set of targets, and those revised in 2004, were too lax. We recommend that CCA targets should be reviewed at every milestone period. (Paragraph 47)
8.Given both that targets have been readily overachieved so far and that meeting them should have saved participating firms money, and given the overall imperative to accelerate carbon reductions, we recommend that targets are considerably toughened at the next milestone period. To help preserve a constructive relationship with industry, protect competitiveness, and accelerate emissions reductions, the Government should increase public investment in low carbon technology, as well as grants or loans to aid its procurement. (Paragraph 53)
9.The NAO has drawn attention to a significant number of businesses which have both failed to meet their CCA targets through their own actions, and failed to make up the difference to these targets through other mechanisms such as carbon trading—and yet which continue to enjoy their CCL discount. Regulations should be tightened to ensure that this cannot continue. The trading mechanism established within the CCA system should make this straightforward: any firm that does not meet its target through its own actions should be required to purchase credits to make up the difference, or lose its Levy discount. (Paragraph 56)
Recycling CCL revenue
10.The effects of implementing a cut in employers' National Insurance Contributions alongside the introduction of the CCL should have been both to win the support of businesses for the idea of the Levy, and to help genuinely change their spending priorities. With the subsequent increase in NICs, announced in 2002, we are far from convinced that these have been the effects. Overall, as we have long recommended, the Government should be far bolder in altering the balance of taxation between 'goods' and 'bads'. (Paragraph 62)
11.We note that there appears to be significant demand for the Carbon Trust's SME loan scheme. It is reducing emissions, and it should bring about a net benefit to the UK economy through reducing overheads and increasing the growth of energy efficient products and services. For these reasons we recommend the Government provides funds to expand the scheme significantly. (Paragraph 69)
12.Despite the significant efforts already directed by the Carbon Trust to large firms, some evidence suggests there is a shortfall in provision for energy intensive sectors in terms both of very specialist advice and loans for energy efficiency investment. We recommend that the Government reviews the needs, for more assistance from the Carbon Trust, of larger and more energy intensive sectors, and assesses how best this demand can be met. (Paragraph 70)
13.Some evidence suggests a lack of awareness of the Enhanced Capital Allowances scheme. This could be linked to the restricted scope of the scheme, which excludes many technologies, such as insulation products. We recommend that the scope of the scheme be expanded, to include a wider range of energy efficiency products, including those relating to thermal efficiency of buildings, lighting efficiency, whole systems, and sector-specific products. The Government should also state an estimate of the costs to the Exchequer, and effects on the use of the scheme, of increasing the allowance from 100% in the first year to 150% and to 200%. (Paragraph 74)
14.We note the fact that the Treasury has explicitly accepted the principle of hypothecating funding in the case of the Climate Change Levy. This only makes it more important that the Government be more transparent and consistent about its use of CCL money. We recommend that the Government clarifies whether CCL revenues are offset by the 2001 cut in NICs, or whether they are available to fund low carbon programmes—since Levy receipts are too small to fund both. If the CCL is being used to fund low carbon investments, the Government should report on what it is funding each year, and how much if any revenues are left over to go into the Consolidated Fund. (Paragraph 78)
15.Whether or not the Levy receipts are treated as replacing the tax lost from the 2001 cut in NICs in terms of meeting general spending commitments, we believe that devoting only around 10-15% of the size of these funds to the work of the Carbon Trust is short-sighted. We note that the Climate Change Levy brings in around double the amount in each year that the Government's new domestic Environmental Transformation Fund will spend over three years. We recommend funding for the Carbon Trust and the domestic Environmental Transformation Fund is increased, to match or go beyond receipts from the Climate Change Levy. (Paragraph 80)
Levy exemptions for renewable electricity and combined heat and power
16.It seems clear that the exemptions from paying the Levy on electricity from renewables and combined heat and power plants have had very limited effects on the construction of new renewables and CHP generation. Where the exemptions have had an effect in helping to increase business demand for supply contracts offering electricity generated by renewable sources, this can face the same problems widely reported as facing private consumers who switch to 'green tariffs' for their household supplies: power companies may simply brand as 'green electricity' a certain amount of their supply contracts, up to the proportion of their overall output already generated by renewable sources, without this necessarily having any real effects on the building of new renewable sources. (Paragraph 90)
17.What effects the Levy exemptions do have are reduced almost entirely in respect of companies covered by Climate Change Agreements, since they already benefit from an 80% reduction in the Levy in any case; this affects CHP particularly badly. We recommend the Government re-examines ways in which to increase the incentives to install CHP plant, or buy CHP electricity from outside sources, available for industrial firms within CCAs. (Paragraph 91)
Economic impacts and administrative complexity
18.Given the relatively limited price impact of the Levy, and the cost-savings that should accompany meeting Agreement targets, we believe that the CCL package has not been a damaging burden for UK business overall. In many cases it may have been good for the economy, given the savings in energy costs available for investment elsewhere, and the stimulus given to providers of energy efficiency products and services. (Paragraph 96)
19.A common call from business groups was that the number of different instruments be reduced, with measures such as the Climate Change Agreements and EU Emissions Trading Scheme becoming increasingly consolidated. We would urge the Government to treat these calls with caution, at least for the time being. In the future it may be possible to rely on fewer instruments to set a single carbon price to deliver all the Government's climate change policy outcomes. Until carbon markets have matured, however, it is wise to continue to target carbon emissions with multiple policies. Furthermore, one of the lessons that the CCL and CCAs teach is that simply increasing the cost of energy (or emissions) may be a necessary component in any attempt to increase energy efficiency, but not enough in itself; in which case multiple instruments will always be necessary. (Paragraph 99)
20.Another common theme from business groups has been to argue that the criteria for inclusion in each carbon reduction scheme should be widened, so that, for instance, it was easier for businesses to qualify for a Climate Change Agreement, and easier for an Agreement to apply to the whole of a site. Given the extra progress on energy efficiency which the process of complying with Climate Change Agreements appears to have driven, we recommend that the Government look favourably on such proposals. (Paragraph 100)
21.Overall, we have sympathy for businesses, dealing with a multiplicity of policy instruments; the climate change policy landscape in the UK is messy, and is only going to become more so with the introduction of the Carbon Reduction Commitment. However, we are also aware that much of this complication has arisen from the evolving recognition that one size of instrument does not fit all, and we welcome the constructive efforts of Government to tailor its policies to the needs and drivers of different types of business. (Paragraph 101)
22.The reason given by the Government for introducing the CRC applies equally to all the SMEs too small for inclusion. The Government must set out what it is going to do instead to help drive down emissions from SMEs while addressing the particular obstacles they face. (Paragraph 102)
Further options for reform
23.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. 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. 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. (Paragraph 111)
24.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. (Paragraph 114)
Overall lessons for climate change policy
25. Time and again throughout our inquiry, we heard witnesses argue that there was a gap between economic theory and the actions of businesses in the real world. According to economic theory, businesses should already have been focusing far more on the rational goal of reducing their costs by increasing their energy efficiency. The theoretical basis for introducing the Levy was that it would harness this rational interest. Yet we heard repeatedly that on its own this was not enough to capture the interest and innovation of the majority of firms; they require an extra stimulus to create new organisational structures and cultures, focused on energy efficiency. This has obvious implications for climate change policy, not just covering the business sector, but all sectors of society: it says that the Government cannot rely simply on increasing the cost of carbon to achieve incremental reductions in emissions. If even large energy intensive companies require additional policy measures, then this must go even more so for small businesses, public bodies, and domestic households. We recommend the Government report on how it is applying this lesson in other policies, across the whole of the UK Climate Change Programme. (Paragraph 117)

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