The Case for Carbon Taxes in the UK

Britain now has a new Liberal-Conservative coalition government, determined to tackle the huge British government budget deficit (at 12% of GDP in 2009/10, the highest since the second world war). The new chancellor, George Osborne, and his deputy, David Laws, will set out their initial plans for spending cuts shortly, and will lay out a new budget by late June. This 'emergency budget' will presumably also include plans for taxation increases. Many commentators believe that a rise in Value Added Tax (VAT) is both justified and likely. An alternative to a VAT rise is to impose a Carbon Tax. A carbon tax sets a fixed price on fossil fuel use, based on the carbon content of the fuel, and therefore is proportional to the final emissions of carbon dioxide produced. Not only could such a tax raise significant amounts of revenue, it would provide the incentives needed to meet ambitious targets for reducing greenhouse gas emissions by 2020, set out in the manifestos of both governing parties. Furthermore, a carbon tax could both stimulate and re-balance the economy away from increasingly costly fossil fuel imports and towards immediate investment in energy efficiency and low-carbon energy infrastructure. It can be argued that carbon taxes are currently well suited to the circumstances faced by the UK and other similar countries.

Carbon taxes are arguably the most important part of a package of measures needed to finance the replacement of an energy system currently dominated by fossil fuels. During the global economic crisis, many called for a 'green new deal', financed by government deficit spending. After the recession, our priorities are rather different. Massive government deficits and growing national debt limit the capacity for discretionary government spending financed by borrowing. When faced with large indebtedness, maintaining economic growth seems essential to reduce the burden of that debt. How can we both stimulate the economy and cut the deficit?

Maybe we need a stimulus promoted not by government spending, but rather encouraged by the government's ability to provide security and stability for investment in vital infrastructure. In the energy sector, the government can provide the stability that investors will achieve an adequate return on their investment in new low carbon electricity generation infrastructure, for example. This means that the government should provide confidence that the carbon price will be maintained.

What specific types of carbon taxes could be imposed? This depends in part on what is there already. As can be seen from the following table, there are a bewildering variety of different taxes in different sectors, managed by different departments, and at different tax rates. However, a few general statements can be made. Taxation on energy is highest in the road transport sector (when taxes amount to equivalent of over £500/tCO2) and lowest on air transport, domestic heating, and net-imports, where carbon or energy taxes are minimal. Amongst the other sectors, there is already a small carbon tax of £20/tCO2, once the european emissions trading scheme is added to the climate change levy and other fees and charges existing at the national level.>

Deciding on an approach for all sectors requires the application of a number of principles, some of which will be outlined here. Firstly, we need to determine the target carbon price. I would argue for a carbon price of around £100/tCO2, since this is the approximately the price needed to stimulate large-scale alternatives to fossil fuel. Secondly, the carbon tax should simplify the existing taxation system. Thirdly, the tax should where possible leave British industry in an equivalent, or more competitive position. Fourthly, the change should in the short term make consumers no worse off, and in the medium term, it should protect the most needy

From these principles we could suggest a number of possible alternatives. The first is a single, across-the-board carbon tax. This is the simplest and most clear. The main concern for this tax would be an impact on competitiveness on energy-intensive sectors. Such impacts are surprisingly limited, as in Britain's case the sectors that are most energy-intensive are not those that are particularly export-intensive. Energy is a surprisingly small proportion of costs for most businesses. However, there would remain some effects in the coal & steel and chemicals sectors, for example. Special measures, such as refunds, could be imposed in these sectors. A more elegant solution would be a system of border tax adjustments, which would probably have to be imposed at the EU level. A ubiquitous, cross-sectoral, carbon tax could be safely introduced at a low level of around £10-20/tCO2, across all sectors apart from imports , and replacing the climate change levy. Other less-ambitious approaches could include replacing and rationalizing the climate change levy, and/or a residential carbon tax, refunded initially according to historical usage, with the refund being taken away over time, although retained for the elderly.

Instead of a VAT rise, the government should consider imposing a carbon tax in one, many, or all of the energy-consuming sectors of the UK economy, and guarantee that this rate will be at least maintained for the lifetime of new infrastructure.


Problems Solved

  • Reduce budget deficit (12% of GDP in 2009/10).
  • Reach the challenging emissions targets for 2020 (34% by 2020 (Conservative) or 40% by 2020 (Liberal Democrats)).
  • Reform and simplify the tax system, including the climate change levy.
  • Provide a level playing field for low carbon investments by putting a minimum price on carbon. Let the market decide, rather than the government 'picking winners'.
  • Provide an economic stimulus by encouraging economic agents to bring forward expenditure on energy service, substituting current investment spending on energy efficiency for future spending on fuel use, creating real assets, and increasing net national wealth.
  • Rebalance the UK economy to reduce imports and improve balance of trade.

Existing Measures By Sector

No. Sector                 Schemes            C-Price  Emissions-as-%-of-uk
1 Electricity/Domestic ets red-vat fit ro £10/tCO2 (15%)
2 Electricity/Commercial ets ccl ro £20 (15%)
3 Electricity/Industrial ets ccl ro £20 (10%)
4 Gas/Domestic red-vat £0 (10%)
5 Gas/Commercial cert £10 (5%)
6 Gas/Industrial ets £10 (5%)
7 Oil/Road Transport rtd roadtax £500* (20%)
8 Oil/Air Transport lc £20 (5%)
9 Oil-Coal/Commercial ccl £10 (trace)
10 Oil-Coal/Industry ets ccl £20 (5%)
11 Oil-Coal/Domestic duty £? (trace)
12 Agriculure & Waste - (10%)
13 Embodied carbon in Imports - (additional ~+70%)
14 UK contribution to intl air transport (additional ~+5%)
15 UK contribution to intl shipping (additional ~+5%)

Possible Sectoral Approaches

  • Domestic refunded carbon tax 1&4 red_vat increaser neutral
  • Small industrial/commercial carbon tax (ccl levy replacement) 2 3 5 6 9 10
  • Large Industrial/commmercial Electricity carbon tax refunded in energy terms. (R.O. replacement) 1 2 3 neutral
  • Carbon Import tarriff (eu level)