CIOT/IFS debate: What is the role of tax in getting to net zero?

A video recording is available - here

Chaired by IFS Director Paul Johnson, himself a member of the UK’s Climate Change Committee, the participants were:

Alex Bowen – Special Adviser to the Grantham Research Institute on Climate Change and the Environment at the London School of Economics.

Peter Levell – Associate Director, Institute for Fiscal Studies.

Femke Groothuis – Co-Founder and President of the Ex’tax Project, a Dutch think tank focused on a shift from taxing labour to taxing resource use and pollution.

Chris Morgan – Head of Global Responsible Tax Programme, KPMG International.

Carbon pricing can be a ‘major tool’ in our climate armoury

That was the view of Alex Bowen, who said that while its critics argue that it fails to reduce emissions, it had been shown to be effective in countries that had chosen to implement it.

There are many ways that a carbon price can be implemented. Bowen told the audience that his preference was for a carbon tax – which he said was simple to implement and would minimise bureaucracy – but that, in terms of global reach, an emissions trading scheme may be easier to integrate with global trading systems.

Citing a paper published by the Crawford School of Public Policy in Australia, Bowen highlighted the effects of carbon pricing, showing that the average annual growth rate of CO2 emissions from fuel combustion was lower in countries that had a carbon price compared to those without.

He added that carbon pricing is gaining traction as an important policy lever, with World Bank data published this year showing that 20 per cent of all greenhouse gas emissions are now covered by a carbon price.

This figure has doubled in less than a decade and is five times higher than the 4 per cent of emissions that were covered by a carbon price in 2004.

However, uncertainty remains about the level at which it should be set. Bowen said that meeting the commitments made at the Paris climate summit would require the price to be set between $40 and $80 (USD) per tonne in the 2020s (rising to between $50 and $100 per tonne by 2030) but that others have modelled prices of as much as $160 per tonne.

He said this variance could be explained by factors including the rate of technological development and wider economic responses to the decarbonisation agenda, with the price of oil an important indicator to track. The collapse in oil prices in the 2010s, he suggested, had ‘slowed down’ the development of low carbon technologies.

Bowen concluded his remarks by noting the competing pressures governments will face when deciding how to spend the revenue raised by a carbon price. According to a paper published by Bowen in 2015, carbon pricing has the potential to raise ‘considerable amounts of new revenue’ for governments, but choosing how to spend it will be more complicated. The important takeaway? Someone will be disappointed.

The UK needs a more consistent approach to carbon pricing

Peter Levell looked at the UK’s approach to carbon taxation and offered some recommendations for the future.

There is no single carbon tax in the UK. At present, the UK’s approach to carbon pricing is held together by an Emissions Trading Scheme (ETS) that covers around 29 per cent of carbon emissions, and by a patchwork of policies such as fuel duty, levies on energy supplies, landfill and aviation taxes.

This has led to an inconsistent approach to carbon taxation in the UK and to varying levels of emissions reductions across sectors. While waste management and electricity generation have reported marked carbon reductions (71 per cent and 63 per cent respectively), other sectors have seen theirs increase – aviation and shipping by 38 per cent.

Levell outlined the IFS’ work – as part of this year’s Green Budget – to consider the implicit value of carbon taxes across a range of different sectors. Among its findings:

• Energy intensive businesses are taxed less on their emissions in comparison to non-intensive ones – for fear that they will relocate rather than reduce their emissions.
• Business energy use is taxed more heavily than household use (due in part to the Climate Change Levy) while both within households and across energy use, gas is taxed less than electricity.
• Aviation taxes are priced to favour more expensive flights and long-haul flights are not taxed proportionately to the emissions they generate.

While government taxes to incentivise decarbonisation, Levell pointed out that it also subsidises. These subsidies tend to focus on emerging rather than established technologies. Of the examples Levell gave, support for fledgling technologies like wave and tidal power receive markedly more support than mature technologies such as onshore wind and landfill and sewage gas.

Looking to the future, Lewell argued that the upcoming budget provided the UK with an opportunity to reset its approach to carbon pricing. Among the recommendations put forward in the IFS Green Budget were; greater consistency in carbon pricing, subsidies to promote greener household heating for consumers and the development of a long-term strategy for road taxation and the transition to electric vehicles.

We need to rethink the way our tax systems handle environmental change

Femke Groothuis’ work with the Ex’tax project has recommended a shift from traditional forms of taxation on labour towards a regime that is focused on the taxation of resource use and the development of a circular economy.

Groothuis said that carbon pricing alone was an insufficient solution to the climate challenge and was critical of governments that had provided green subsidies to industries. She said this made no sense while the fundamental rules of the system continued to favour polluters.

She noted that, in the UK, nearly 40 per cent of revenue generated from taxation was based on payroll taxes like income tax and National Insurance with just 7 per cent of receipts generated from environmental taxes.

Groothuis argued that this incentivised businesses to minimise their labour input, which could prove problematic as many of the tools needed to manage our energy transition will require skills and people power.

What is needed, she argued, is a steady update of our tax systems so that they can adapt to the twin challenges of environmental and social change.

A study produced by the Ex’tax project with Cambridge Econometrics had found that reducing payroll taxes on workers and businesses through a programme of tax cuts and credits, together with the introduction of a ‘polluter pays’ principle to the taxation of pollution and resource use, had concluded that such a tax shift could deliver higher economic growth, create more jobs, and reduce pollution and import dependency.

This would also lead to a more progressive tax system, with the study showing that all households would see an increase in their purchasing power, with more benefits in relative terms for lower income households.

Carbon pricing offers a global solution

Chris Morgan has served as a member of the United Nations Subcommittee on Environmental Taxation Issues and has been involved in the development of a new carbon tax handbook, which will be launched at the UN on 25 October.

Morgan told the audience that a global carbon price was an ideal solution, but one that would be fraught with political and economic problems.

He said he was ‘agnostic…not dogmatic’ about the idea of a uniform carbon tax but would like to see the development of a coherent climate policy, with pricing a piece of the jigsaw. This should be developed alongside regulation, clearly defined targets and a tax policy designed to incentivise low carbon development.

The UN committee had chosen to focus on carbon taxes – particularly for developing countries – because they were much simpler to implement compared with Emissions Trading Schemes, which he acknowledged could be “more focused and more efficient” and were already used by a number of countries, including the UK.

A global carbon price may be difficult to introduce because not all nations will see it as being to their advantage, just as many countries have chosen to forego appearing at COP26 (“(we) can’t be that optimistic that there will be global agreement”, Morgan said).

One suggestion that has been put forward is the creation of a ‘Carbon Club’ of high ambition nations. These countries need not sign up to a carbon price or ETS, but should have the same emission reduction trajectories and could use their tax and regulatory systems to drive change. It has been suggested that nations could be incentivised to be part of the initiative by applying tariffs on goods from nations who are not members, but Morgan hinted that this could raise ‘serious’ issues with the World Trade Organisation.

Will carbon leakage be a problem, as emitters relocate their operations to less ambitious nations? Morgan said that, at present, there is little empirical evidence to suggest that this is a problem, but that this could be attributed to the relative low levels carbon taxes are currently set at. Over time, as prices rise, it is expected that this could become ‘a real issue’ and, as Morgan noted, is one of the reasons that the European Union had adopted  a proposal for a Carbon Border Adjustment Mechanism (CBAM) earlier this year to the anger of some countries who accused the bloc of engaging in ‘green protectionism’. He said that the UK may look to follow the EU’s lead, but that there were other ways to deal with the problem of carbon leakage.

Questions

Some of the topics covered during the Q&A that followed included:

How can we replace fuel duty?

Peter Levell said governments needed to think about how they can tax in better ways. He said this could focus on areas like congestion charging, air pollution and road user charging, which would also mean taxation being extended to electric vehicles.

Femke Groothuis said that the time had come for governments to start thinking about how they can replace these types of revenues. She said that the Netherlands had developed the concept of the smart kilometre, where vehicles are charged based on different factors that can include vehicle type, fuel used, weight and distance travelled. The approach is holistic, with revenues generated reinvested to help improve public transport options. But she added that has not been without its challenges, with some voicing concerns around privacy and others about the ability of existing technologies to meet needs.

Paul Johnson noted the political challenges of widening road taxation to electric vehicles, at a time when the tax system has been used to incentivise their uptake. He said exempting electric vehicles from tax now would make it much harder politically to introduce taxes on them in the future.

Which countries have achieved a better balance between the taxation of polluting activities and labour?

Chris Morgan noted that in general, Scandinavian countries like Norway, Sweden and Denmark had done well to increase the share of tax revenue generated from polluting activities. Femke Groothuis said it was difficult to find any one nation that had achieved an ‘optimal’ balance, adding that it was ‘hard to put a price on something that was previously free’.

Can carbon pricing be implemented equitably?

Paul Johnson highlighted the challenges involved in the transition to low carbon heating for low income households. In general, carbon taxes are seen as regressive and therefore governments needed to look at how to offset their impact through the tax and benefits system.

What are the trade-offs involved in linking the UK’s Emission Trading Scheme with the EU’s?

Alex Bowen said that he favoured closer integration between trading systems to help prevent carbon leakage and encourage cross-border cooperation. He said this would be helped by a common carbon price.

Are businesses supporting carbon taxes because they know they are unachievable?

Following reports that some company executives have endorsed the principle of carbon taxation because they know that, ultimately, it will be unachievable, Femke Groothuis acknowledged the potential for some businesses to engage in ‘greenwashing’. But, in contrast, she added, many businesses were taking the issue of carbon pricing seriously and were already factoring their development into their corporate plans, which they know will come ‘sooner rather than later’.

Chris Morgan pointed out the different approaches taken to decarbonisation across the Atlantic. In America, he said the focus was on investment, rather than taxation, with the opposite holding true in Europe. This can impact how businesses perceive the likelihood of carbon taxes taking hold in the future.

Will carbon taxation impact the government’s levelling up agenda?

With the levelling up agenda focused on areas of the country typically defined by their dependence on carbon intensive industries, is it possible that the government’s agenda will be derailed? Peter Levell suggested that government should ensure that competing products made abroad are taxed to prevent the displacement of industries, but also warned of tougher choices ahead, such as investing in the transition away from heavy industry and providing training and upskilling opportunities for workers who are at risk of being displaced as a result of the transition. Ultimately, he said a balance would need to found between each of these.

Chris Young, CIOT External Relations team.