Environmental tax measures Contents

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1The relationship between the tax system and the government’s environmental objectives

1.On the basis of a report by the Comptroller and Auditor General, we took evidence from HM Treasury and HM Revenue & Customs (HMRC).1

2.The government has ambitious environmental objectives. It has committed to bringing all greenhouse gas emissions to net zero by 2050 and to leave the natural environment “in a better state than we found it”.2 Tax measures are an important tool in implementing environmental policy. Taxes can be levied on goods or services which harm the environment and thus incentivise businesses and people to change their behaviour. Tax reliefs can also encourage taxpayers to use environmentally friendly products or services.3 Tax measures can be used alongside other policy tools such as regulation to achieve environmental objectives.4

3.Within government, the Department for Environment, Food & Rural Affairs (Defra) has lead responsibility for all environmental policy areas apart from climate change mitigation (including net zero emissions), on which the Department for Business, Energy & Industrial Strategy (BEIS) leads. Ministers decide on whether tax measures are used to support environmental goals. Where measures are used, HM Treasury and HMRC (the exchequer departments) are responsible for designing the measures to achieve objectives set by ministers, and for monitoring and evaluating their impact. HM Treasury is responsible for the strategic oversight of the tax system and HMRC is responsible for administering the system.5

4.HM Treasury and HMRC administer four taxes with explicit environmental objectives (referred to as environmental taxes throughout this report):

a)Climate Change Levy – a tax collected by energy suppliers and paid by businesses and the public sector to encourage them to become more energy-efficient and thereby reduce greenhouse gas emissions.

b)Carbon Price Support – aims to drive electricity generators to invest in low-carbon electricity by increasing the cost of the fossil fuels they use. The Climate Change Levy and Carbon Price Support raised £2.0 billion in 2019–20.

c)Landfill Tax – a tax on landfill operators to divert waste from landfill to other less harmful methods of waste management (raised £0.6 billion in 2019–20).

d)Aggregates Levy – a tax to encourage the use of recycled materials over the extraction of rock, sand and gravel which can damage the environment (raised £0.4 billion in 2019–20, including from quarry operators).

Other taxes, such as fuel duty (also known as hydrocarbon oils duty, £28 billion in 2019–20), have an impact on government’s environmental objectives but do not have specific environmental objectives.6

The role of tax in achieving net zero and other environmental objectives

5.In 2011 the Mirrlees review published by the Institute for Fiscal Studies described taxes as “among the most important economic instruments available to deal efficiently with pollution and thereby help protect the environment”. It also noted that “it remains a pity that no serious, comprehensive and public review and analysis of the potential options in this area have been undertaken”. In May 2020, the Climate Change Committee set out six principles for a resilient recovery to COVID-19, one of which was to “strengthen incentives to reduce emissions when considering tax changes”.7

6.We received written evidence from stakeholders in which they identified tax measures which they said were hindering rather than supporting environmental objectives, including net zero. The Association of Accounting Technicians said there had been several seemingly perverse tax decisions that discouraged the greening of the British economy while raising some revenue. It gave the example of VAT being increased from 5% to 20% on some low carbon items, including most solar panel installations and heat pumps, although VAT on coal to residential properties remained at 5%.8 The energy supplier, OVO Energy, was also critical of the 2019 VAT increase on some products. It said that environmental taxation needs to be implemented in a way that incentivises and rewards electric heat consumption rather than gas consumption.9 The Green Alliance argued that the current tax system is driving environmental perversities. It said there were three major areas - construction, household energy, and repair - where adjusting VAT could have clear environmental and social benefits, while helping the government to revive the economy.10

7.We asked HM Treasury why it had not undertaken the comprehensive public review of the options for environmental taxation that the Mirrlees Review had called for. HM Treasury said that in the past 10 years, it had done an enormous amount of internal analysis, as part of its policy advice to ministers, on environmental taxation and the environmental impacts of tax decisions, and on the role that tax can play in achieving environmental objectives.11

8.HM Treasury also said that two years ago it had been asked to prepare a report on the costs and benefits of transition to net zero.12 This report was due in autumn 2020 but has been delayed.13 An interim report was published in December 2020.14 HM Treasury said the interim report set out that tax is one of a range of levers, including regulation, legislation and public spending, the government has to support transition to next zero. HM Treasury now expects to publish the final report soon.15

9.HM Treasury told us that the final report will provide an analytical framework to consider the economic and fiscal costs of moving to net zero.16 HMRC said the final report would dovetail within a broader cross-government strategy on how to achieve net zero which BEIS is due to publish later in 2021.17 HM Treasury said that the particular contribution tax should make to net zero, alongside other tools, needs to be thought of in the context of this overall strategy. It also said that there was a need for a comprehensive strategy first and then government would work out the role that tax would play within that strategy.18

10.The UK is hosting the 26th UN Climate Change Conference of the Parties (COP26) in Glasgow in November 2021. COP26 provides the opportunity for the UK to work with all countries and join forces with civil society, companies and people to inspire climate action.19

11.We asked whether by the time we get to COP 26 everybody will have a good idea of exactly how the government is going to meet its net carbon target by 2050. HM Treasury told us this was really a matter for BEIS. It explained that net zero would require an “immensely complicated” programme of work over nearly 30 years, and which will depend on things that are unknowable today, for example future technological change. While HM Treasury was clear that current and future governments would need to change the strategy, for example, as new evidence comes along, it acknowledged that it was critical for businesses and households to have “the best idea that they can have of the future” to reduce the whole economy cost. HM Treasury told us that the cross-government strategy was intended to set “out a very clear direction, next steps, plans and strategies, sector by sector, then an overall framework to try to pull all of those together.”20 It also told us that the government accepted that further action, beyond the current range of tax, regulation and other instruments, would be needed to hit the 2050 net zero target.21

The impact of environmental policies on tax revenue

12.HM Treasury’s December 2020 interim report on net zero said that “the transition to net zero and consequent structural changes in the economy will also have implications for the UK’s public finances and fiscal sustainability. As some sectors grow and others shrink, the mix of tax revenues will change.” The report also said that much of the current tax revenue that is wholly dependent on individuals’ and businesses’ consumption of fossil fuels or emission of greenhouse gases is likely to be eroded during the transition to a net zero economy. In 2019–20, £37 billion of revenue came from taxes on fossil fuels and greenhouse gases. Around £28 billion of this comes from fuel duty: the equivalent of around 6p on the basic rate of Income Tax.22 The remaining £9 billion came from Vehicle Excise Duty, Landfill Tax, emissions trading scheme receipts, and Carbon Price Support.23

13.The transition to cleaner vehicles in the UK will reduce the demand for petrol and diesel and thus affect the amount of fuel duty raised. In November 2020, government announced its ambition to stop the sale of new cars that are powered solely by petrol or diesel by 2030.24 The government also said that as the UK transitions to electric vehicles the government needed to ensure that revenue from motoring taxes keeps pace with the change, to ensure it could continue to fund public services and infrastructure.25

14.We asked what planning HM Treasury had undertaken to counteract the reduction in revenue from taxes on fossil fuels and greenhouse gases. It said that the government did not have a plan, but the reduction in revenue had been flagged and under review for several years, with ministers advised on long-term tax options. HM Treasury also said that the new regulation banning sales of new petrol and diesel cars would not take effect for another nine years in 2030.26

15.We pointed out that the ban on new petrol and diesel cars from 2030 is likely to have an impact on both the type of vehicles and volume of fuel purchased well before then.27 Under the lead of the Department for Transport, the government is using a range of levers to incentivise consumers to move to electric vehicles now. The levers include: the plug-in car grant scheme; support for home, destination and on route charging; lower rates of Vehicle Excise Duty and Company Car Tax for cleaner vehicles; and raising consumer awareness. The cross-government Office for Zero Emission Vehicles, which ultimately reports to the Secretary of State for Transport, spent a total of £1.1 billion between April 2010 and March 2020 on funding the plug-in car grant, charging infrastructure schemes and other schemes. The government’s intention to stop the sale of new petrol and diesel cars by 2030 will require a rapid growth in the number of zero-emission cars over the next decade.28

16.It may also take time for government to introduce tax changes needed to make-up for the reduction of fuel duty. The government normally consults on tax changes as it has recognised the importance of engaging with individuals, businesses and other organisations on possible tax measures.29 Tax changes are often announced two years or more before they are introduced. For example, the new Plastic Packaging Tax being introduced in April 2022 was first announced in the October 2018 Budget.30

17.We raised the potential impacts of changes to taxes, to address the reduction in revenue from fuel duty, on small and medium-sized businesses, on different regions and on the levelling-up agenda. HM Treasury said decisions on taxes, such as fuel duty, include consideration of distributional impacts and the impacts on the competitiveness of the economy. It also said that, in their Budget speeches, Chancellors have covered the impact of changes to fuel duty on incomes and on small businesses.31

Environmental tax measures and the Budget

18.The March 2021 Budget took place the week before our session with HM Treasury and HMRC on environmental tax measures. The Budget did not include any particular announcements on green taxes. It did however freeze fuel duty rates for the eleventh year. The Budget said the freeze would support hard-working people across the UK, particularly in more rural communities. The Budget also signalled that fuel duty rates for future years would be considered in the context of the UK’s commitment to reach net zero emissions by 2050.32 The previous Budget in March 2020 had also said that fuel duty rates will be considered alongside measures that are needed to help meet the UK’s net zero commitment.33 The government’s decisions on fuel duty rates highlights a key tension. There is a need for long-term planning, but Budgets are annual and led by day-to-day politics and issues.34

19.When we asked HM Treasury whether the tax system would have a role to play in achieving net zero, it said the role of tax would evolve over time from Budget to Budget.35 However, HM Treasury also recognises that as net zero is a 30-year programme, it needs to think about interventions over a long timeframe and not simply year by year.36

20.In September 2020, the Institute for Government called for HM Treasury to publish a tax roadmap to net zero, showing taxpayers how and when taxes might change.37 More recently, in February 2021, the House of Commons Treasury Committee recommended that the government should draw up a tax strategy for consultation that contains principles including for meeting climate change goals for net zero and other environmental objectives whilst giving consideration to those who are on lower incomes.38

21.Against this background, we asked HM Treasury whether it would publish its plans so that taxpayers may prepare for how and when taxes might need to change in order to achieve net zero. HM Treasury said that it was sure that in setting out its plans the government will be very conscious of the need to give households and businesses proper time to understand the nature of the transition and where the likely costs might fall, so that they can plan accordingly.39