It's not easy being green: raising the share of environmental taxes in total receipts

The Coalition agreement reiterated the Conservative's manifesto pledge to "increase the proportion of tax revenue accounted for by environmental taxes". Past experience suggests that this is easier said than done. On coming to power in 1997, the previous Labour Government indicated a general ambition to shift taxation from 'goods' such as income to 'bads' such as pollution. Despite this, our Election Briefing Note showed that between 1997 and 2009 revenues from environmental taxes fell sharply as a share of total receipts.

In an earlier observation, we pointed out that in the absence of any significant increases in environmental taxes, their share of total tax revenue was likely to fall still further. This is for two main reasons. Firstly, as the economy recovers, growth in non-environmental revenues such as VAT, income tax and corporation tax is likely to outpace growth in environmental revenues such as fuel duty. Secondly, to the extent that environmental taxes encourage people to consume less of the taxed goods like energy and vehicle fuel, revenues will tend to be eroded over time.

Although the Coalition has not stated an explicit timetable over which the desire to increase the green tax share of total revenues should be judged, it seems that as a minimum we would expect the share to be at least as high at the end of the current Parliament (assumed to be 2014/15) as it was at end of the last one (2009/10). Using the most recent estimates for future receipts from the Office for Budget Responsibility following the June emergency Budget, green taxes are forecast to fall from 6.9% of total receipts in 2009/10 to 6.5% in 2014/15. As the chart below shows, simply to get the share in 2014/15 back to the 2009/10 estimate would require additional green tax revenues of £2.5 billion on top of the £45.8 billion forecast for 2014/15 (an increase of around 5%), assuming that those extra receipts were offset by cuts in non-environmental taxes. If the Coalition wanted to go further, perhaps raising the share of green taxes to 7.5% by 2014/15, they would need to raise an extra £6.7 billion, almost 15% more than currently forecast.

Source: Authors' calculations from OBR forecasts and historical data. Note: Bars show share of environmental taxes out of total revenue. Figures from 2009/10 are forecasts based on latest OBR data. Dashed line is 2009/10 share of 6.9%. Cash figures are the nominal amounts of additional green tax revenue needed each year from 2010/11 to maintain 2009/10 share, assuming offsetting reductions in non-environmental taxes. Environmental taxes include fuel duty, Vehicle Excise Duty, Air Passenger Duty, Landfill Tax, Climate Change Levy and Aggregates Levy. VAT charged on Fuel Duty, the Fossil Fuel Levy, Hydro Benefit and Gas Levy are not included in these figures.

This 'green tax gap' is essentially the same as was inherited from Labour based on forecasts at the time of Alistair Darling's last Budget in March. That so little has altered following George Osborne's first Budget simply reflects the lack of any new policy announcements on environmental taxes. Given the scale of the fiscal retrenchment required over the coming years, and the pledge made in the Coalition agreement, it is perhaps surprising that the Government did not take the opportunity to spell out any firm increases in green taxes in the Budget. They did however suggest there would be a consultation on reformulating Air Passenger Duty (APD) into a charge per-plane rather than per-passenger. A similar reform was consulted on by the previous Government, but was ultimately rejected in favour of reforming the APD system. In their manifesto, the Liberal Democrats proposed to go ahead with this reform, to raise an additional £3 billion per year. If this were to happen, this would raise just more than enough (based on current forecasts) by the end of the Parliament for the Government to meet the pledge to raise the share of green taxes in total revenues, but with little margin for error. Raising the share substantially above that which it inherited would require bolder action from the Coalition. If it wanted to raise much more revenue from the existing system of green taxes, it would be hard to do so without further increases in fuel duty over and above those already planned, since fuel duty makes up almost three-quarters of green tax receipts. Alternatives may include new taxes, perhaps on carbon emissions or congestion but as yet there is no concrete evidence that these will come soon.