Air Passenger Duty – damaging a major growth industry

UK aviation has been a major growth industry in recent years, with high gross value added – just the sort of industry you might imagine the government would wish to encourage. Yet recent changes to Air Passenger Duty (APD) mean that it is the most highly taxed aviation industry in the world and it is showing serious signs of fatigue.

The Chancellor, in his 2011 Budget, announced a consultation on re-structuring APD. This concluded in mid-June with a statement due in the autumn. Since its introduction in 1994, APD has grown like Topsy. It imposes a mish-mash of rules and regulations on the industry, the explanatory notes of which on the Treasury website run to twelve chapters and two appendices. At its core are eight charging bands (up from four prior to 2009) distinguishing between passenger class and flight distance, which the government now proposes to simplify (and to incorporate business jets into the net).

The consultation process has brought out the worst in the UK aviation industry as different airlines have sought modifications that would best suit their own purposes: Virgin, exclusively a long-haul airline, for example has suggested that long-haul rates of duty be reduced and short-haul rates increased. In a competitive industry one might expect such dog-eat-dog behaviour. Unfortunately, the industry has an abysmal record of uniting on public interest issues, climate change being a case in point. In the current APD context, the in-fighting of the airlines will no doubt lead the Treasury to divide and rule, which of course it is rather good at.

What the industry as a whole should be emphasising is that for large segments of its market, demand is probably highly price-elastic. I have heard it said that low-cost carriers, for example, use rule-of-thumb elasticities of 2 or even 3, which means that this market segment should not be subject to high consumption taxes if one is to promote efficiency and, importantly, economic growth. The current incidence of APD on low-cost carriers is no doubt one important explanation for the significant downturn in traffic at regional airports, which tend to focus on flights by these airlines.

At the other end of the scale, research has indicated that business air passengers are price-inelastic. Consequently, the current APD distinction between leisure and business traffic (using the proxy of cabin class) seems reasonable in principle, although it is yet another (input) tax bearing on business and not particularly desirable in the current economic circumstances.

As for the distinction in APD rates according to distance flown, which the Treasury proposes to simplify by reducing the number of current bands, here there is a certain method in the madness. The overwhelming majority of UK originating long-haul flights are out of Heathrow (especially) and Gatwick. These are congested airports and increasingly so but, because of airport price controls, the scarcity rents (substantial in the case of Heathrow) would, but for the presence of APD, flow entirely to the user airlines. Therefore, in large measure, long-haul APD is a tax on some of the rents and, arguably, efficient; the downside is that it also catches the few non-congested regional airports with long-haul services.

The foregoing implies that an efficient adjustment to APD would be to give more focus to the dispensation in the current rules for certain flights originating in specific regions. At present, flights originating in the north and west of Scotland are APD-free. Curiously, this applies to flights from Inverness to London, for example. (No doubt having a Scottish Chancellor of the Exchequer for so many years has helped here). The recent consultation did raise the prospect of extending regional exemptions but this was largely in the context of devolving to administrations in Scotland, Wales and Northern Ireland. But the economics suggest extending APD-free flights to specified airports in the English regions where air traffic is especially price sensitive and the economy far from buoyant or, taking a leaf out of the Scottish book, exempting flights between UK regional airports. The latter would have a tiny negative impact on overall APD revenues but would help considerably with business connectivity.

Member of the Advisory Committee

Prof David Starkie is a senior associate at Case Associates, London. His many publications include  Aviation Markets: studies in competition and regulatory reform (Ashgate, 2008). David has advised governments and legislatures across the world on transport policy issues. He was economic advisor to the European Commission’s delegation at ICAO-related proceedings on aviation and the environment, Montreal and Washington DC 1995-97, and was on the Civil Aviation Authority’s expert panel for NATS price cap review 2006 and airport competition framework assessments 2010-11. More recently he was on the Airports Commission’s expert advisory panel. David is the author of the book The Motorway Age: How post-war governments reacted to rapid traffic growth.