November 16th, 2018

Regression test: must environmental taxes hit the poorest?

7 minute read

by Peter Jones

 

Political enthusiasm for environmental taxes seems to be at a low ebb in the UK. In the run up to Budget 2018, there was indications that things might change, but talk of a new tax on plastics turned into a consultation, while taxes on incineration and single-use cups were mooted and rejected, and signals were given of a possible future decrease in carbon pricing.

Since David Cameron started railing against the costs that “green crap” added to energy bills, the main argument against environmental taxes has been their impact on poorer people – that they are “regressive”. But if the concern about environmental taxes is their impact on the wellbeing of poorer people, we need to look at both sides of the scale. In many cases, poorer people are also those who benefit most from the environmental impacts such taxes have.

This article examines whether, on balance, environmental taxes are regressive, and if so, what this means for the case for adopting them. While all environmental taxes have their own distinct features that nuance their distributional effects, for the purposes of this blog I will focus on fuel duty, which shows up a lot of the relevant features. If you want a longer list of interesting tax options, my colleague Dominic Hogg recently blogged a good run-down of possible measures.

 

May fair?

The latest Budget saw fuel duty frozen for the ninth successive year. The decision was announced in the Budget, but had been trailed by the Prime Minister at her Conservative Party conference speech, where she picked up the long-running theme of the financial impacts of green taxes. According to the Guardian’s reporting:

The prime minister said the government was showing families they were “on their side” and that to have a “little bit of money left to put away at the end of the month” is not “measured in pounds and pence”.

“It’s the joy and precious memories that a week’s holiday with the family brings. It’s the peace of mind that comes with having some savings,” she said.

Mrs May might not have been measuring the pounds and pence, but Philip Hammond was. He reported to Parliament that the long freeze had saved the average car driver just over £1,000 – or a little more than £100 a year. It might not pay for much of a holiday, but it’s a sum that will matter more to someone with very little disposable income than to those with a great deal.

However, looking just at the immediate effects of a tax on those that are subject to it (in this case, the “average car driver”) overstates the financially regressive tendencies of environmental taxes. To understand how the poorest are affected, we need also to understand how car drivers are distributed within the population, and how behaviour will respond to the change in prices.

 

Fuelling inequality

Looking at fuel tax, Department for Transport data says that amongst the poorest 20% of households (those with incomes up to ~£17,500) 56% own a car; amongst the top 40% (with incomes over ~£31,500), the figure is 86%. So, a lot of poor households wouldn’t face any additional direct costs if fuel duty increased.

How would people respond to higher fuel prices? Rather than carrying on regardless, we would expect people to be deterred from taking some car journeys, leading them to prefer public transport or active travel. Of course, people on lower incomes will be more sensitive to prices, and therefore more likely to change their behaviour – what might be called getting “priced off the road” – while richer people might choose to absorb the extra fuel costs rather than reduce their car use. Amongst drivers, then, those in the poorest quartile would be most affected – if not financially, then in their ability to afford a car at all.

 

Robin Hood

Can environmental taxes avoid taking from the poor? Picture: public domain, via Wikimedia Commons.

 

Rather than driving less, people might start to select more fuel-efficient cars, so that they can maintain their mobility without increasing their fuel costs. That would provide an incentive to car manufacturers to cater for this preference by focusing technological developments on increasing miles per gallon. Amongst new cars, a more fuel efficient one is not necessarily more expensive (quite the opposite); but people on lower incomes will tend to have less access to capital or finance to purchase a new car, so are more likely to be buying older second-hand vehicles.

Likewise, the fuel-efficiency of used cars varies, and we might assume that cost-conscious buyers will already prefer cars with smaller engines. However, if new technologies reduce fuel consumption more radically, these will take a long time to work their way through to the cheaper end of the second-hand market, leaving poorer people choosing from less fuel-efficient options for many years.

It seems that even after price response effects are taken into account the least well off may still be the ones worst affected by fuel duty, while those with more resources are better able to make changes to avoid additional costs. In that case, maybe environmental taxes are a bad idea from the point of view of social justice?

 

Income distribution

I don’t think that’s quite right, because it tells barely half the story. Whatever their distributional impacts, environmental taxes do appear to be effective in driving change and reducing pollution. The impacts of pollution are also unequally distributed. Take air pollution – numerous studies have found that those who suffer the greatest exposure to it are those on low incomes; so while they might take the biggest financial hit from fuel duty, they gain most from cleaner air if tax increases have the desired effect on emissions from cars.

That’s certainly a progressive result, which might be considered to offset (partially) the financially regressive impact. However, access to cleaner air is of little comfort if you’ve had to tighten your belt so far you can hardly breathe. Some sort of solution is still needed to mitigate the unequal financial impacts.

Conceptually, how money is raised through taxes is a separate issue from what government should spend it on. If a tax that is designed to act as incentive has unwelcome distributional impacts, these could be tackled through spending decisions that give money back to those who can least afford the costs.

One option would be to cut other taxes. Income Tax wouldn’t be a good choice – the poorest in society already pay very little – but cutting to VAT, another regressive tax, would tend to benefit those on low incomes. However, there would be no guarantee that the beneficiaries of a VAT cut would be the same people made worse off by a fuel duty increase.

 

Duty calls

Alternatively, government could use the additional tax take to directly support those on low incomes, through measures such as increases in benefits and tax credits. Or it could put money into active travel or public transport to increase its convenience or reduce its cost, which (outside London, at least) would tend to favour the less well off. That would provide an alternative for those incentivised by fuel duty not to drive – and also encourage those less affected by the price of fuel to use public transport instead. Clearly, then, a great deal could be done to make sure that poorer people aren’t unfairly affected by an increase in fuel duty.

Using market instruments such as taxes to achieve environmental goals ought to be relatively palatable to conservatives. Indeed, it was a conservative government that first implemented the fuel duty escalator. For those less wedded to using markets to drive environmental change, more direct and less regressive approaches are available. Government could set more stringent emissions standards for vehicles than those required by the EU. It could reverse its planned increases in roadbuilding and give more road space to public transport, bikes and pedestrians. It could ban cars from city centres. Or it could bring forward the proposed date for phasing out internal combustion engines. But these options seem far from their thinking.

The financially regressive impact of green taxes must be acknowledged by their advocates; if they’re to gain popularity, it’s important to argue that they are adopted alongside suitable mitigation. But when a government that favours many other economically regressive policies purports to be concerned about the impact of fuel duty increases on the less well off, one might detect an odour of rodents. It’s hard to see this rationale as more than a pretext to avoid taking action, especially when the readily available mitigating measures are ignored.

If one’s main concern is to help the least well off, there are many better ways to achieve this than allowing pollution to go untaxed.

 

Peter Jones

 

 

 

 

 

 

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Phillip Ward
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There is a political dimension to this which you have overlooked. The rural vote. Rural populations are now more dependent on cars than urban ones. Public transport is sparse – indeed it has disappeared where I live and distances are greater. so the impact of fuel increases is greater for both rich and poor and rural areas provide the government’s core vote. That is not to say that economic arguments do not play a part. Back when I was involved in this, economists recognised both short and long term elasticities around fuel prices. In the short term higher prices led… Read more »