Conservatives' green tax pledge unlikely to be met

The Conservatives have pledged in their manifesto to "increase the proportion of tax revenues accounted for by environmental taxes, ensuring that any additional revenues from new green taxes that are principally designed as an environmental measure to change behaviour are used to reduce the burden of taxation elsewhere". In a briefing note released today we analyse this pledge, along with other environmental policy proposals put forward by each of the main UK political parties.

The idea of shifting taxation from 'goods' to 'bads' in this way is not new. Indeed, the Labour Party indicated similar intentions upon coming to office in 1997. The Liberal Democrats also talked of a 'green switch' in the tax system in 2006 (although no mention is made of this in their 2010 manifesto).

Recent history suggests that this is, however, a difficult ambition to achieve in practice. Since 1997 revenues from environmental taxes have in fact decreased both as a proportion of total revenue (from 9.5% in 1997 to 7.9% in 2009) and as a proportion of national income (from 3.3% to 2.8% over the same period).

There is also of course the question of whether using the share of revenues from environmental taxes as a measure of a government's "greenness" is sensible. We address this in our briefing note on Environmental Policy Since 1997. Effective environmental taxes will reduce the prevalence of the activities being taxed, and thus potentially reduce tax revenues. Despite these problems, it seems to be a popular ambition.

The reason it has proved a difficult ambition to fulfil is straightforward. Over 90% of the revenue from taxes that are considered "environmental" is raised from motorists in the form of fuel duty, the VAT paid on that duty and Vehicle Excise Duty (VED). And revenue from these taxes has barely budged in real terms since 1997. (Revenues from the other green taxes haven't increased much either.)

The real level of fuel duty has in fact risen by 10% since 1997 - mostly as a result of big increases before 2000, and despite a failure even to increase duty in line with inflation for most of the period between 2000 and 2008. But real revenues have not increased, in spite of an increase in total miles driven, because of a general improvement in the fuel efficiency of the UK's vehicle stock -implying lower revenues per vehicle mile. In part this reflects the long term effectiveness of fuel duties as a spur to reducing consumption through greater efficiency. This trend towards more fuel efficient cars is likely to continue, meaning that government has to run to stand still in terms of increasing duties to maintain revenue. Indeed in the medium term government climate change objectives are predicated on a wholesale move to the use of vehicles that don't use petrol at all.

Meanwhile the average payment of VED - the annual tax paid by car owners - has actually fallen on average in real terms since 1997. VED has been restructured so that levels relate to the fuel efficiency of cars, but the overall effect of changes has been to make owning a car cheaper.

In the absence of any new green taxes, or increases in other existing taxes, meeting the Conservative pledge to increase environmental taxes as a proportion of the total will be largely dependent on what happens to taxes on motorists. The Conservatives do propose changes to existing green taxes - including a reform of the climate change levy, and a "fair fuel stabiliser" for fuel duty - but both of these are supposed to be revenue neutral.

Even with the current fuel duty escalator intended to raise duties by 1 pence per litre per year in real terms until at least 2014-15, the most recent budget forecast is for environmental taxes to fall further as a proportion of all taxes - from 7% to 6.6% between 2009-10 and 2014-15.This in part reflects the fact that other revenue sources such as VAT, income tax and corporation tax are likely to bounce back more strongly as a result of economic growth. As a matter of arithmetic this will depress the proportion of total revenue accounted for by environmental taxes. So just to maintain the share of revenues from green taxes, the next government will have to raise an additional £2.5 billion from environmental sources in 2014-15. This would be, for instance, equivalent to roughly a 7% increase in revenues from fuel duty above what is currently forecast (that is, on top of the government's current fuel escalator).

Currently fuel duty is set a rate of 57.19p per litre and this is scheduled to increase to 61.57p (in 2010 prices) by September 2014. In order to raise revenues from fuel duty by 7% (assuming no changes in fuel efficiency or in total miles driven), the duty would need to be over 65p a litre by that date. With continued increases in vehicle efficiency even this is unlikely to be enough to meet the pledge.

There are other ways of ensuring that environmental taxes as a whole rise. The fact that VAT is imposed at a reduced rate on domestic energy is an effective subsidy to energy consumption - not the greenest of tax policies. Imposing VAT at the full rate on domestic energy would raise £3 billion annually - more than enough to meet the Conservative environmental tax pledge. But despite the environmental rhetoric no party seems to be willing to grasp this particular nettle. Which is perhaps one indication of why it is so much easier to say that environmental taxes will rise than it is to deliver on that pledge.

Read more in our election briefing note no. 14, Environmental Policy Proposals