Budget 2011 and Environmental Taxes

Written evidence submitted by the Air Travel – Greener By Design Group

1. This submission by the Air Travel – Greener By Design Group ["GBD"] addresses the theme of the Inquiry covering the scope "for the tax system to create a 'modal shift' from high carbon transportation to low carbon alternatives, including Fuel Duty, Vehicle Excise Duty, and Air Passenger Duty and issues the Government should consider when developing strategies for sustainable aviation and motoring". It focuses on APD.

2. GBD is a BIS-sponsored body with the remit of assessing options for addressing aviation’s environmental impacts. It is based within the Royal Aeronautical Society but is not aligned with any sectoral interest. This submission draws on the interim conclusions of a GBD project that has been running for four years with the objective of testing the thesis, advanced on several occasions by EASC [1] and by many others, that the imposition of additional taxes or charges on airlines and/or passengers would reduce demand, leading to a reduction in capacity/frequency and a stimulus to renew fleet and develop more efficient aircraft. The submission focuses on questions surrounding the effectiveness of such instruments rather than on options such as a change to per plane charging.

3. The genesis of our project was the claim by Chris Huhne, when LibDem environment spokesman, in The Independent in late 2006 that "On flights, there is well-established evidence on responsiveness of air travel to price changes. This suggests a 1% change in price leads to a little more than 1% change in travel, assuming other factors - such as incomes - do not change." Following correspondence with Mr Huhne, and with the Institute of Fiscal Studies, which at roughly the same time had published a study [2] citing an omnibus elasticity study as evidence that aviation-related taxes could reduce emissions, GBD decided to initiate a study of the likely effectiveness of economic/fiscal instruments in influencing the sector’s environmental performance.

4. The project has gone through four stages:

· Desk research on elasticities, which following an examination of 128 studies, some frequently relied upon as the basis for subsequent elasticity calculations, found significant methodological flaws in most of them, with material omissions in others.

· Interviews with a range of full service, No Frills and charter carriers.

· Observation of UK, European and US airline and passenger market responses to a full economic cycle.

· A Round Table last Autumn, with representatives from DfT, CAA, DECC, airlines, academics, and aviation consultants convened to test methodological assumptions.

5. Further analytical work is required [3] . However, in connection with EASC’s examination of Budget issues such as the freeze in APD rates and of whether stronger fiscal stimuli should be adopted, provisional guidance for policymakers can be offered in the following paragraphs with a reasonable degree of certainty.

6. We took as a starting premise the assumption that for taxes or charges to be considered effective they must

· Stimulate a reduction in capacity or flight numbers

· Encourage an overall reduction in fuel burn

· Stimulate fleet replacement with more efficient models (if available)

· Stimulate accelerated commercialisation by airframe and engine manufacturers of more efficient technologies

7. On the methodological basis for the claimed effectiveness of taxes/charges, we found that only CAA (2005), DfT (2007) and possibly the MARKAL-ED and Dutch Aero models came close to producing elasticities based on reliable assumptions, but the Round Table concluded that even these may have overlooked important factors:

· The difficulty of measuring price sensitivity independent of all the other variables in the demand function. For example, because of surcharges and other fare increases, the flight component of overall holiday costs has increased, but the current models do not properly take account of the ability of travellers to reduce their overall holiday spend without changing the air travel element. In other words, forecast pressure on carriers to reduce capacity might not materialise.

· The fuzzy relationship between cost/price, demand and emissions (for example, a 30% cost increase or a 10% demand fall may not reduce emissions at all – it depends on the stage of the economic cycle, Me Too pressure, fear of losing valuable slots [4] and whether carriers are still profitable).

· Non-global instruments can be offset through service and passenger migration (carriers moving bases and routes to more fiscally advantageous regimes and sectors and passengers minimising their exposure by travelling via another country) and offsetting activity (such as cuts in Spanish landing fees) elsewhere – so-called Carbon Leakage.

· Instruments intended to incentivise fleet replacement and accelerated commercialisation of next generation technologies depend on whether those technologies are available.

· Those advocates of green aviation taxes/charges that we have studied do not appear to have taken account of opportunity costs (for example, the availability of low cost leases for older aircraft and curtailing the planned lifecycle of current production models in order to commercialise more efficient Blended Wing Bodies).

· Nor are behavioural factors, such as the desire to operate marginal services in order to retain slots rather than see them go to competitors or the influence of "Me Too" behaviour on the ability to absorb or pass on costs (airlines have shown a reluctance to raise prices through, for example, fuel surcharges out of line with their competitors) captured. The models Government has used to project the environmental impact of APD are not intended to take into account strategic behaviour on the part of firms or governments.

8. The view from airlines was that even before the recession, demand was reduced, but it was impossible to disaggregate the impact of fuel surcharges from other stimuli. They felt that APD will have reduced emissions, but the effect will have been very marginal. It has not affected scheduling (ie the number of flights). It is perhaps noteworthy that nowhere in the Budget 2011 consultation document on reform of APD [5] is any mention made of the impact to date of APD on emissions. It is not structured in a way that directly targets fuel burn/emissions and provides no incentive to replace fleets with more efficient/more economical (appropriately sized) aircraft as the same tax is payable irrespective of the efficiency of the aircraft. Furthermore, because almost no other country has followed suit (several have introduced and then rescinded APD-type instruments) passengers can limit their tax exposure by travelling longer distances via a third country (for example, London to Dubai via Amsterdam), increasing emissions. However, the Treasury has been advised that its attempt to make APD more reflective of environmental impact would be illegal. Claims that APD is an environmental tax have been replaced by statements emphasising its role in ensuring that aviation contributes to deficit reduction [6] . This may at least in part be due to an acceptance of the methodological uncertainties surrounding the relationship between taxation and fuel burn in this sector.

9. The industry’s resilience to the intended stimulus of economic instruments may, at least in the short to medium term, have been eroded by cost and capacity-trimming induced by a combination of a rise in fuel price and recession, but on the basis of observed responses to those factors it is still likely to be the case that aviation-related economic instruments are only likely to achieve material improvements in environmental performance if they exert pressure close to that experienced between 2008-10. In other words, for instruments to make a significant difference, they would need to induce the equivalent of at least replicating, on at least a medium-term basis, the recession of the past three years. Regulatory signals such as tighter emission limits, on the other hand, are likely to be more effective regardless of the economic cycle.

10. Market abatement curves produced by IATA and OMEGA show that the stimulus required for early retirement of aircraft is significant – up to $500/tonne of carbon. However, the establishment of a floor price for carbon [7] and/or using instruments to stimulate biofuel commercialisation could be effective fiscal options.

11. Although models take a long term view, from the point of view of effectiveness within typical political horizons, when economic stimuli are introduced is at least as important as their level. At times of economic optimism, carriers and passengers are less sensitive to such stimuli.

7 April 2011

[1] Ninth Report of 2002-03,   Budget 2003 and Aviation,   HC672 ; Third Report of 2003-04,   Pre-Budget Report 2003: Aviation follow-up , HC 233 ; Seventh Report of 2003-04,   Aviation: Sustainability and the Government Response , HC 623 and reports on the Budget and PBR in most years.

[2] http://www.ifs.org.uk/publications/3773

[3] We have identified the following issues:

[3] how the industry absorbed/adapted to cost increases and demand reductions;

[3] the extent to which it did so rather than react directly to APD/fuel price/economic downturn;

[3] the “new” industry/market model and its sensitivity; differences in likely airline/passenger responses to passenger taxes, incorporation of aviation into the EU Emission Trading Scheme, carbon pricing and fuel taxation;

[3] and the market conditions/signals that economic instruments must seek to replicate

[4] The offsetting impact of factors that do not feature in economic models of “logical” market behaviour – for example, the desire to operate marginal services in order to retain slots rather than see them go to competitors; or the influence of “Me Too” behaviour on the ability to impose surcharges (some US surcharges imposed by carriers individually or in small groups in response to cost increases were withdrawn after a few days because the market did not follow suit) – should not be overlooked.

[5] http://cdn.hm-treasury.gov.uk/2011budget_airpassenger.pdf

[6] Budget 2011 , 1.153

[7] ICAO conclud ed through use of the AERO model that a tax would have to be about 23 times more expensive than emission trading (c. $600/tonne fuel) to be as effective as trading .