UK

Can Green Tax Incentives Spur Sustainable Growth?

By City A.M - Aug 28, 2024

• The UK faces a £22 billion fiscal gap, and environmental taxes could play a role in addressing this challenge.
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• While green taxes can be effective in driving positive behaviors, they can also disproportionately impact lower-income households.
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• The UK needs to develop a targeted and coherent green tax strategy that offers long-term certainty to investors in an increasingly complex global landscape.

With net zero a key plank of the new government’s agenda, what can we expect on environmental taxes in the Budget? Asks Sharon Baynham

We have a £22bn black hole in the public finances.  Who knew!  Well, anyone who dared to look according to the Institute for Fiscal Studies. The blame game has already started and recollections are sure to differ.  But the bottom line is we can now expect a tax squeeze in the Chancellor’s first Budget on 30 October.

A  ‘summer of speculation’ is upon us that is, unsurprisingly, focussing on what will happen to personal taxes. But I think there is another area that merits some attention: where do environmental taxes go from here, especially as the energy transition is a key plank of Labour policy?

Whether it be charging fuel duties, air passenger duty, plastics taxes, landfill taxes or Carbon Border Adjustment Mechanisms, countries, including our own, are good at taxing us into good behaviour.    

Their use can be controversial, especially when the burden falls on lower income households.  But they are certainly lucrative.  In 2023 UK Environmental taxes raised £52.5bn, about 5.5 per cent of total tax revenues.

Governments can easily become dependent on such sources of income, but that raises ethical questions about the purpose of these behavioural taxes.  Is their function to raise revenues or to drive a wider public good?  Or do we sit in a confused intersection between the two?

Take fuel duty, for example, where annual increases have been on a 13-year hiatus and a 5p ‘temporary’ reduction introduced in 2022 has set up permanent residence in the system. From a net zero perspective this makes no sense.  

Fuel duty contributes almost half of the UK’s tax take from environmental taxes. Increasing it in the Budget will be tempting. It won’t be popular, but it aligns with net zero and it would be profitable. The polls have over four years to recover if the government makes this move.

The bigger problem is that, as the country becomes more environmentally responsible,  revenues like these will disappear. The country needs to be weaned off them. No wonder the treasury is agitating to move from a fuel duty to a pay-per-mile system. 

That’s environmental tax policy as a ‘stick’ – but what about using it as a ‘carrot’ to incentivise investment in the energy transition?

The UK has a reasonable clutch of tax breaks, but few are specifically targeted on the green agenda. The previous government did not seem too enamoured of the idea: but Labour’s energy transition plans are more ambitious – and recognise the role the private sector has to play as a co-investor. 

In 2020 the Climate Change Commission identified that the necessary increased investment could be offset by cost reductions by the late 2030s.  So, if the this is a temporary funding gap, should the UK get more serious about green tax breaks?

Over in the US, President Biden’s Inflation Reduction Act (IRA) disrupted the global environment for green tech investment by offering US$369bn of subsidies including tax credits to unlock private investment. 

It set a high bar but it’s not without its critics. It prioritises US products over more affordable imports and its success in getting projects off the ground has been hit by supply chain issues. The sheer size of the tax breaks offered will impact global trade, arguably making international co-operation on energy transition more difficult.  

The IRA also departs from free market outcomes, re-introducing government as a key market player.  With an election less than three months away, this highly interventionist approach raises questions about longevity under a Trump presidency – and that increases uncertainty for the investor.

The IRA has changed behaviours.  Reuters recently reported that the US has seen over $350bn in private investment expected to create 300,000 new jobs. The numbers are impressive, but it will be many years before a proper assessment can be made, one which addresses the impact on other nations, especially the global south.

In the meantime, the UK needs to think smarter on green taxes.  Put simply, nobody can afford to compete on the same scale as the US.  But a good place to start would be a cross-party approach towards a targeted and coherent strategy that would be a viable alternative to the US – one which offers longer term certainty to investors in an increasingly interventionist, politically fractious and protectionist world.

By City AM