Fiscal responsibility: why leadership hopefuls need to green the tax system

What amount of money is ‘too much’ to save the planet?

This was the question that many were left asking after the Financial Times reported on a letter that Chancellor of the Exchequer Philip Hammond had written to Theresa May. He claimed that the cost of the UK getting to ‘net zero’ greenhouse gas (GHG) emissions by 2050, as May proposes, would be over £1 trillion. This, he said, was too high and would lead to reduced spending on schools, hospitals and the police force, as well as industries becoming uncompetitive without government subsidies.

Hammond’s points, as they were reported, seemed slightly confused: was he suggesting that the cost of the transition would be paid for entirely by the public sector? Or did he believe the tax take would plummet as a result of reduced economic activity? Either way, it didn’t seem clear that he’d considered how to get his own house order first, not least in terms of how the tax system could support a transition to net zero.

His letter came shortly after he had rebuked those in the Conservative leadership contest for unfunded pledges on public spending and tax cuts. These are coming thick and fast, with Boris Johnson looking to reduce taxes paid by those who are reasonably comfortably off, and other contenders outlining their spending and tax cutting priorities, without setting out a fully coherent fiscal position. Hammond could have made reference to alternative sources of revenue that could help fund such promises, and at the same time, help address a range of environmental problems.

Revenue recognition

The UK’s fiscal system, like those of many other countries, generates most of its tax revenue from a small number of taxes for which the tax base is large. Of the so-called National Accounts taxes, 71% of the £700bn of revenue collected in 2017-18 came from just four taxes: Income Tax, National Insurance Contributions (NICs), VAT and Corporation Tax. The first three account for 63% of revenues.

Cutting up the tax pie. Image: Dominic Hogg.

The tax system influences the efficiency with which the economy functions. There are many things that we might not want to tax – the things which we might want more of. These include the very things which are the source of the majority of the revenue: income tax takes away income that employees have worked to earn; NICs are effectively taxes on employment; VAT taxes value added, which in many sectors is closely related to labour; and corporation tax revenue comes from taxing profits.

Some taxes come from things whose consumption we are seeking to reduce: examples are duties on alcohol and tobacco, which together raise 3% of revenues from National Accounts taxes.

Taxes of evil

But what’s especially interesting is how little tax revenue comes from things we really would like to see less of, notably, pollution. At a time of environmental crisis, only 6.6% of tax revenues come from taxes that have some environmental component. The majority of this came from fuel duty, a tax which has been frozen, and eroded by inflation, for many years now, following years when an automatic escalator was in place. Successive chancellors have presented the freezing of fuel duty as good news for ‘white van man’, never mind that ‘white vans’ are one of the fastest growing source of air pollution in UK cities, fuelled by diesel, and our desire for convenience for on-line shopping. Vehicle Excise Duty comes in next, and accounts for 0.9% of tax revenues. A range of environmental levies, including those on landfill and aggregates, accounted for a further 0.9%. A miniscule 0.3% of tax revenues came from the climate change levy (including the carbon price floor) and the auctioning of allowances under the EU Emissions Trading Scheme.

Incredibly, those air pollutants that we know cause harm to human health completely escape taxation.

The flip side of taxes, on the fiscal side, is the offer of subsidies. It has been a source of considerable frustration on the part of (environmental) economists, and those seeking to ensure that fiscal systems are aligned with basic principles of economic efficiency, that subsidies for environmentally damaging activities, notably, those related to fossil fuel extraction, have endured for so long. The first time (of many since) that the G20 nations made a commitment to remove fossil fuels was in 2009 at the G20 summit in Pittsburgh, where the parties committed to ‘phase out and rationalize over the medium term inefficient fossil fuel subsidies’. Little action has, however, been taken.

According to one study, the UK offered an average of £5.9bn worth of subsidies each year to fossil-fuel industries in 2013 and 2014, most of it in the form of tax breaks to help boost declining North Sea production. In addition, the UK introduced a new North Sea tax break in 2015 which Government estimated would be worth £1.7bn over the ensuing five years.

Beating the system

It’s fairly obvious that the UK’s tax system is not well adapted to deal with the challenges that now confront it: Hammond’s name can be added to a lengthening list of Chancellors who have failed to get rid of fossil fuel subsidies. If we want to improve the efficiency of the economy, and send signals to business regarding the changes that need to be made in future, then we need to increase – in the short term – the share of tax derived from environmentally damaging activities, and shift the burden of taxation away from the things we shouldn’t be taxing at all (like labour).

Potential sources for tax revenue would be:

• Air pollutants from stationary sources
• Additional banding of vehicle excise duty to reflect the emissions of NOx and particulate matter;
• Re-introducing a fuel duty escalator;
• Tyres, recognising their contribution to deteriorating air quality and microplastic pollution;
• Incineration, based on the emissions of CO2 and other air pollutants (particularly NOx where not already covered by the tax on stationary sources mentioned above);
• Levies on primary material use (beyond those already within the scope of the aggregates tax);
• Use of pesticides (banded by the potential of the specific chemical to cause environmental harm) and synthetic fertilisers;
• Meat (especially beef) consumption; and
• Greenhouse gases: the 2018 Budget indicated that if the UK left the EU without a deal, a tax on carbon dioxide of £16 per tonne would be implemented. The £16 per tonne figure is too low to generate change of the nature required (the current traded price for EU allowances in the EU ETS is already closer to £20 per tonne of CO₂). Such a tax should move, over a period of 5 years or so, to a level around £60 per tonne, potentially going beyond in future years. This would drive innovation, and considerable change in the use of fossil fuels.

In addition, we should finally do the blindingly obvious thing that all politicians will say they support, but none has had the courage to do: remove each and every form of subsidy for the fossil fuel industry.

It’s clear from the above that there is plenty of scope for generating additional tax revenues from environmental taxes in the UK. These revenues could be used to support a transition to the net zero position which Philip Hammond felt would draw funds away from other public services: a supportive fiscal policy could reduce any requirement for public support (by incentivising the necessary change) whilst also generating revenue. That could be used to reduce other taxes on, for example, labour or income – or to reduce any regressive effects of environmental taxes.

Given the growing public concern regarding environmental issues, the leadership hopefuls in both the Conservative and Liberal Democrat parties should consider using these approaches as a means to fund their own promises of tax cuts. The UK needs to gear up for the change that is necessary to avoid catastrophic climate change, and to lead the world in this respect. We can’t afford another Chancellor who believes, like King Canute’s courtiers, that the tide will be turned by the waft of a hand. We do need someone who understands that actions taken now can help constrain the depth of the crisis confronting us.

Featured image: Aron Urb (CC-BY 2.0), via Flickr.