Budget 2011 and Environmental Taxes

Written evidence submitted by the Institute of Directors

Thank you for giving the Institute of Directors (IoD) the opportunity to comment on your enquiry, published in April 2011. Issues surrounding environmental and taxation policy are of considerable interest to the IoD and its membership.

About the IoD

Founded in 1903, and granted a Royal charter in 1906, the IoD is an independent, non-party political organisation of 40,000 individual members. Its aim is to serve, support, represent and set standards for directors to enable them to fulfil their leadership responsibilities in creating wealth for the benefit of business and society as a whole. The membership is drawn from right across the business spectrum. 92% of FTSE 100 companies have IoD members on their boards, but the majority of members, some 70%, comprise directors of small and medium-sized enterprises, ranging from long-established businesses to start-up companies.

General Comments

The Institute of Directors (IoD) supports the Government’s aim of addressing climate change. However, the IoD believes that the Government should allow the market to function effectively in order to enable market forces to achieve these goals. Thus, the IoD has desigined a set of principles that can be used as a guide for environmental taxation and regulation.

Britain’s energy market is over regulated. UK governments have designed detailed programmes and schemes controlling the market to an extent that disables it. On the subsidies front, the Government fragmented the renewables market by creating a technology based subsidy - the Renewable Obligations (RO) and the Feed in Tarrifs (FIT) are a prime example for this. On the regulations front, the market is also over regulated; there is extensive domestic regulation surrounding gas and nuclear generation, Emission Performance Standards (EPS), the Climate Change Levy, on top of extensive European regulation in this area. All these different schemes and programmes lead to a high level of uncertainty and confusion within the market. This also undermines markets and impedes investment decisions. [1] Instead investors and entrepreneurs wait for the Government to make decisions on which technologies it favors. The final outcome is that regulatory and political uncertainty not only increases costs in the market, but also encourges market investors to ‘wait and see’. This undermines the innovation and investments that are critical for developing an effective energy market. With regards to taxation, there is a case for some environmental taxation. It makes polluters pay for the burdens that they impose on others. But environmental taxes, like all other taxes, impose burdens. Any developments in environmental taxation should therefore observe the following principles.

Revenue neutrality

Any increases in revenue raised should be matched by reductions in the revenue raised from other taxes. Environmental taxes must not become a tool to increase the size of the overall tax burden. The adverse economic effects of high overall levels of taxation are well-documented in the economic literature.

It is particularly important to emphasise revenue neutrality because environmental taxes are hard to design perfectly. They can easily fail to achieve their goals, either because the wrong activities are taxed or because taxes are set at the wrong levels. The double dividend that is sometimes attributed to environmental taxes can all too easily turn into a double loss, when a tax does not achieve its intended goals but still imposes the burden that any tax imposes. A constraint of revenue neutrality at least limits the damage that can be done.

The burden of a tax will in part be suffered by persons other than the immediate payers of the tax, including customers, suppliers, employees and shareholders (including shareholders on whom many people depend, such as pension funds). One of the worst policy mistakes to make would be to think that because environmental taxes are intended to address worthy ends, they are cost-free, or even positively desirable in themselves (as opposed to being desirable for the results that they may achieve). All taxes are burdens on individuals, one way or another, even if the route is indirect, and the costs of taxation must never be neglected.

Equal application to business and private consumers

Environmental taxes should apply equally to businesses and to private consumers, even if they are only collected from businesses, and the amounts due should appear prominently on bills or tickets that are sent to private consumers.

A tax on businesses can easily go unnoticed by private individuals, even though they are in fact paying it, one way or another. And where a tax on private consumers is collected via businesses (for example as part of the cost of a flight ticket), the amount should be drawn to the attention of the consumers. That will help the consumers to decide on their behaviour, and it will also help them to form their political views on whether given taxes are justified.

Where private individuals engage in activity that is sufficiently environmentally damaging for businesses to be taxed, private individuals should also be taxed. For example, whatever the case for discouraging carbon dioxide emissions may be, it applies equally to emissions by businesses and to emissions by private individuals. If, for example, the climate change levy makes environmental sense, the exemption of domestic energy consumption from the levy makes no environmental sense.

Simplicity

Environmental taxes should be simple in design and straightforward in their application. They must also be introduced with ample warning and with advance publication of detailed guidance on what needs to be done.

There is some tension between simplicity and the precise achievement of policy objectives. But in the environmental field, uncertainties about what needs to be done mean that precision in policy objectives is meaningless anyway, as soon as one moves beyond high-level objectives such as target ranges for environmental variables. Complexity can of course also spring from a desire to achieve some extraneous political objective, but that is hardly a justification for complexity.

An important element in making the application of taxes straightforward is to give ample warning of their introduction and to publish detailed guidance in good time. There should be no repetition of what happened with the climate change levy when it was introduced. Draft guidance was made available in good time, but the finalised guidance was not published until after implementation of the levy.

Effective design

Environmental taxes should be designed to do their job properly. The level of a tax should match the cost of the environmental damage. The onus must be on the Government to demonstrate the amount of that cost. And there is no point in imposing a tax if the taxed behaviour will simply relocate to another country and continue to do the same damage.

If, for example, a tax is intended to reduce carbon dioxide emissions, there is no point in applying it to nuclear power. If nuclear power has other environmentally damaging effects, they should be dealt with using other measures, which may or may not include taxation. And if an activity has adverse environmental effects which justify taxing the activity, it should be taxed whether it is carried out by businesses or by private individuals.

The general uncertainties of environmental science make it hard to design taxes to achieve precise objectives. But that is not an excuse for giving up and introducing new taxes without adequate evidence to support their introduction. The onus must be on the Government to justify its proposals in detail. All of the analyses that officials carry out in relation to any proposal should be published in their raw form, with no selectivity or presentational gloss, before proposals are debated in Parliament. That level of openness will maximise the chances of making the correct decisions.

Competitveness

Environmental taxes hold a risk of undermining businesses competitvness by imposing additional costs on domestic businesses . Therefore the environmental tax system should be designed as part of an international or regional agreement, in order to maintain a level playing field. A tax system that will undermine British businesses competitvness, will not effectivlly address global warming, and will undermine growth and export, which are vital for the British economy. A tax system that ignores overseas competitition will undermine growth in the UK. It is therefore essential to design a tax system that is taking into consideration the boarder economic goals [2] .

Price volatility

Lately, we are witnessing high volatility in commodity prices. Higher energy costs impose a significent burden on households and businesses. Households are already experiencing an income squeeze due to higher inflation, higher VAT rates and a lack of wage growth. Businesses struggle to achieve growth due to diminishing demand and flat or deminishing export performance. Environmental taxation must be adjusted to this economic reality, and not impose high additional costs on struggeling businesses and households. Moreover, environmental taxes should be designed to adjust to volatile energy prices without inflicting additional costs on businesses and households.

Feed in Tarrif (FIT) and Carbon Price

The IoD believes that the current framework of subsidies hinders the market from delivering the results we aspire to see. It hinders the carbon price and reduces incentives for both the supply and the demand side. In the long-term FIT discriminates between technologies when its core aim is to provide investors with certainty about the level of support. These schemes, although well intentioned, have a combined effect that distorts the market. The IoD believes that the different models of FIT will distort the market and will undermine investment. It is our view that the market is being sliced and divided into too many sections. The IoD believes that market forces and market structure should be used in order to generate investment and ensure a functioning electricity market. A stable carbon price is the best, most effective framework for achieving this goal. As well as creating distortion within the market, FIT and other schemes undermine the development of a stable electricity market. The IoD is in favour of the Carbon price support, and believe that this along with a carbon tax would be an effective policy to encourage decarbonising the economy. Nevertheless, the IoD objects to FIT and other schemes that generate complexity and artificially discriminate between technologies.

Changing modes of transport

It might be thought that taxes could be used to ensure that the great majority of journeys by private car were replaced by journeys by bus, coach and rail, that the great majority of long-distance freight transport by road was transferred to transport by rail, and that most short-haul journeys by air were replaced by rail journeys.

While very high taxes probably would achieve these results, it is not at all clear that such results would be desirable. Certain methods of transport may have negative externalities associated with them. Even if they do, it does not follow that the use of those methods should be reduced to a very low level. The advantages of using a given method, such as convenience and speed, may be worth so much that they outweigh the externalities. The right approach is to measure the externalities, price them into people’s decisions by the imposition of matching taxes, and then let market forces determine the extent to which they are used. The IoD contends that a comprensive cost-benefit analysis should be used to design an effective tax system. Morevoer, additional considerations should be incorporated, such as international competition, macro-economic conditions etc. The environmental aim should be viewed as part of a greater economic and social goal.

Thank you once again for inviting the IoD to take part in this consultation. We hope you find our comments useful. If we can provide further detail on any of the points raised, please do not hesitate to contact us.

20 April 2011