In an article for our website ahead of next month's UK Budget, Jason Collins, Chair of our Climate Change Working Group, reflects on a significant recent government report on the environment and outlines the challlenges with emissions trading schemes. Jason is also a partner at Pinsent Masons.
As we get closer to the Budget on 3 March, much attention has focused on which taxes could be increased to pay for the eye-watering cost to the Treasury of the COVID-19 pandemic and the measures the Chancellor will take to support the economy.
The House of Commons Environmental Audit Committee (EAC) has been considering the measures the Chancellor could announce which would help the UK to achieve its statutory commitment to net zero emissions by 2050 (and its target of a 68 per cent reduction by 2030). The recommendations in its recent report focus more on where spending should be directed to help the economy recover, indirectly boosting tax revenues, rather than on immediate changes to the system or tax rises.
The EAC says that the need to provide a stimulus to economic recovery should be treated as an opportunity to accelerate investment on nature recovery, climate adaptation and cutting emissions to net zero. It recommends investment in areas such energy efficiency, reuse and recycling of materials (the so called 'circular economy'), climate adaptation and nature recovery, which it says would provide a "green jobs boost" to counter unemployment.
It points out that the speed at which COVID-19 vaccines have been developed shows how rapidly scientific progress can be made when efforts are concentrated and the problem is urgent and stresses that this same level of urgency needs to be applied to developing solutions to the climate crisis. As the report says, "there will be no vaccine against runaway climate change".
In terms of taxation measures, now that the UK is freed from the constraints of the EU VAT system, the EAC wants the Chancellor to use the UK's VAT system to encourage behaviour which will benefit the environment.
Producing concrete and steel both involve huge amounts of CO2 emissions and so the refurbishment of existing buildings and the reuse of building materials can involve much lower emissions than demolishing an existing building and building a new one. However, the report points out that our VAT system can actually encourage behaviour that creates more emissions because building work on renovating a house is currently subject to 20 per cent VAT, while new build is zero-rated for VAT purposes.
The EAC does not go as far as suggesting that all home improvements should be zero rated, but recommends reducing VAT on green home upgrades to incentivise more people to install low-carbon technologies and improve the energy efficiency of existing homes.
It also recommends reducing the rate of VAT on repair services and products containing reused or recycled materials in order to increase the circularity of the UK economy. These sound sensible measures in terms of climate change reduction, but have the potential to add considerable complexity to the VAT system.
A more straightforward measure to introduce would be the EAC's recommendation to introduce further tax incentives to make ultra-low emission cars more affordable to encourage uptake. Even after the Government's £3000 subsidy for buying a new electric car, the initial outlay can still be over 20 per cent more than on a petrol or diesel car, although the running costs should be lower.
Whilst some of those interviewed by the committee favoured increasing taxes on the aviation sector, the EAC suggested "fine-tuning" environmental taxes such as air passenger duty (APD) to encourage investment in low emission technology. It described APD as a ‘blunt instrument’ as it takes no account of the emissions of the aircraft in question, so that it does not act as an incentive for the airlines to invest in cleaner technology.
Until the end of the Brexit transition period, the UK participated in the EU's emissions trading scheme (ETS), under which those covered by the scheme were required to obtain allowances or 'permits' to emit. The ETS only covers power generators and businesses operating in very energy-intensive industry sectors. including oil refineries, and cement, steel and chemical production, plus aviation involving flights within the EU. The UK is now introducing its own ETS which is expected largely to mirror the EU ETS, albeit with proportionately fewer allowances in play in an attempt to make carbon more expensive.
There are two structural issues with any system of carbon pricing, whether that is in the form of an ETS or a tax.
The first is that it does not cover all those who emit within a country. Taken together, those covered by the ETS are responsible for only around a third of the UK's emissions. Some of those interviewed by the EAC called for carbon pricing across the whole economy, possibly in the form of a carbon emissions tax rather than extending the ETS. This aspect was not covered in much detail in the EAC report, but the committee recommended that the Government begin scoping work on a carbon tax. There have been press reports suggesting that the Government is already doing this.
The second issue is that those countries that have a form of carbon pricing might make themselves less competitive than countries that do not. Carbon pricing in one country would simply lead to 'carbon leakage' if production moved into that lower cost country.
The ETS deals with the problem of carbon leakage by giving free credits to businesses which compete with businesses in countries not subject to carbon pricing. However, in terms of reducing emissions, this defeats the object of having a carbon price in the first place.
Accordingly the EU is intending to introduce a carbon border adjustment mechanism (CBAM) in 2023. A CBAM would apply a price to raw materials which have been extracted or produced outside the UK in order to ensure that domestic businesses are not unfairly beaten on price. There would be a credit or an exemption for materials originating in a country which applies a carbon price, thus providing a spur to ensure more countries introduce carbon pricing domestically. Over time, the EU would seek to extend the CBAM to cover finished goods where equivalent goods produced domestically are subject to domestic carbon pricing.
The EAC recommends that the Government investigates the merits of a CBAM for the UK, although it says that measures would be required to ensure that the policy did not adversely impact developing countries.
With the UK taking over presidency of the G7 this year and hosting a meeting of leaders in Cornwall in July, and hosting the UN Climate Change Conference of the Parties (COP26) in Glasgow in November, there is a clear view emerging from government that the UK should be a world leader in the race towards net-zero. We will have to wait until 3 March to see whether the Chancellor uses his Budget to announce tax and spend measures to help to give the UK a reasonable prospect of achieving its net zero commitments – and it would in our view be helpful if the Government set out a fiscal roadmap for how the tax system might evolve over the next 30 years, giving businesses and consumers the best chance to plan ahead.
Blog by Jason Collins, Chair of Chartered Institute of Taxation's Climate Change Working Group,