Reforming Fuel Duty

The Green Fiscal Commission was a policy think tank established in 2007 to investigate the case for reforming the UK taxation system to reflect a more green position. They published their final report late last year which included a host of useful policy recommendations to the UK government. These policy recommendations were closely linked to the requirement for the UK to reduce its carbon emissions in line with the target budgets outlined in the Climate Change Bill. The commission argued the case that the vast amount of these carbon reductions could be generated by reforming the taxation system to increase tax on polluting activities (public bads) whilst decreasing tax on public goods such as employment to ensure fiscal neutrality.

I enjoyed reading about their suggestions and I believe that the case they put forward is both valid and required. In order to alter consumer and industry behaviour to reflect the environmental damage these activity generates it is crucial that this damage is incorporated into the price of goods and services produced and consumed. The public and industry may state a high level of concern for the environment but in order to ensure this concern is translated into action one of the best methods is to increase the price of activities that create this environmental impact.

Currently taxation on vehicles in the UK generates the largest single contribution to the tax base. This contribution measured £45 billion in 2006 with fuel duty the largest part of this at £23.4 billion. This tax on fuel is charged at point of sale and is fully incorporated into the price paid by the consumer at the pump. This tax was not initially designed for the purpose of incorporating the environmental damage externality of fossil fuel combustion into the price but simply as a method for raising revenue. This tax, by changing the price of the good, does generate a reduction in demand and thus can be argued to have environmental benefits. The tax itself could also be reengineered to emphasize these benefits.

As customers pay this tax on an incremental basis each time they refuel their vehicles the economic impact (to the individual) can seem small. If this tax was instead condensed to one annual payment allowing the consumer to see just how much tax they are paying on the use of their vehicle then this could generate a behavioural change. This would be a fiscal shift so that the fuel duty is deducted from the fuel price paid by the consumer at the point of sale and instead is issued to the vehicle owner as an annual tax statement. This tax will be calculated on the quantity of fuel consumed by that vehicle and so an inventory of the fuel sales associated with a vehicle registration number will have to be established.

The principle behind this proposed fiscal shift is to allow the vehicle owner to fully realise the proportion of their income that is being taxed due to use of their vehicle. Consumers often use a high discount rate (upwards of 20% in some cases) when attempting to represent future expenditure. This has the effect of significantly reducing the costs of purchasing fuel in the future and can therefore diminish the demand induced behavioural change. A singular annual charge of all the fuel duty generated from vehicle operation could produce a more significant behavioural change as it will represent a large amount of expenditure coming due in a short period of time.

This is just a concept idea. In order to establish if my hypothesis is correct detailed research would have to be conducted with individuals to see if they would state a preference to change behaviour to driving fewer annual miles if put in this new fiscal situation. It is my belief that there is a good chance this would generate a reduction in total miles driven however, an investigation would also be necessary to determine if the general public would have a positive, negative or neutral stance on the proposed tax change. Also consideration must be given to the extent this measure will reduce the quantity of revenue generated from fuel duty as this shortfall will have to be levied on other tax channels.