Tax and Fiscal Policy

UK energy policy – when the left hand doesn’t know what the far left hand is doing

It has long been one of my personal gripes that the UK spends a large amount of money on energy market interventions to reduce carbon emissions whilst simultaneously providing domestic consumers with an effective (approximately) 15 per cent subsidy by exempting energy from the full rate of VAT. It is a bit like a group of cabinet ministers trying to push a boulder uphill whilst the prime minister has quietly sent another group of ministers to the top of the boulder to push the other way. Whilst the EU is often blamed for being interventionist – including in the field of energy policy and especially climate change – criticism is not always justified. Member states are often the main problem in relation to promoting interventionist energy policies and particular member states, such as the UK, have been at the forefront of encouraging EU intervention.

Indeed, a report commissioned by the European Commission, to its credit, shines a bright light on the problem of energy market interventions. It should be noted that the sort of figures that the Commission has come up with must have quite a large margin of error. However, some of the bigger numbers are quite easy to calculate.

The total cost of energy market interventions (effectively subsidies, implicit or explicit) by all member states is over €120 billion. Most of this relates to ongoing interventions, though some relates to historical interventions (for example, capital subsidies) that still have an effect on production costs. This figure excludes interventions in the transport market: many forms of transport are also free of value added tax or are subsidised implicitly or explicitly. Not surprisingly, the Commission argues that energy has high external social costs and this, of course, is a reason for not subsidising energy though readers of this blog might differ on whether it is a justification for taxing energy use further.

Subsidies for renewables

A considerable portion of energy interventions within the EU (just under 40 per cent) are in the form of subsidies for renewables. Astonishingly, around 10 per cent of the value of interventions involves support for coal – a fuel that is discouraged by EU regulation. Of course, green groups normally support renewable subsidies because they increase demand for renewables compared with carbon-intensive energy production. However, this approach is mistaken. Renewables do not have a ‘negative social cost’ (or positive social benefit) that would justify a subsidy. At best, they have a zero social benefit or cost. The neutral position is not to tax or subsidise them any more than any other product or service is taxed or subsidised (that is, value added tax at the standard rate should be charged). Some would argue that renewables may have lower social costs than carbon-intensive energy forms but that is an argument for taxing carbon intensive energy forms and not for subsidising renewables.

Subsidies for carbon-intensive energy

But, of course, governments being governments are inclined towards sub-optimal policies. Governments subsidise the consumption of those forms of energy that they believe will lead to the greatest ‘market’ failure of all time (man-made climate change). And the interventions in the UK market are greater than the interventions in any other market in the EU other than Germany. The total value of our government’s support for energy consumption is over £13 billion. The UK and Germany together account for nearly 40 per cent of the value of energy market interventions in the EU.

Most of the UK interventions (about 60 per cent) come in the form of support for energy demand. This will be made up largely of the exemption of domestic energy consumption from value added tax.

Thus we have interventions to support renewables that are simply designed to undo the work of other interventions which promote the consumption of carbon-intensive energy forms. Basically, we take various forms of fuel the consumption which, it is widely believed, lead to huge social costs and boost demand for them by reducing their price through exemption from value added tax. As a result, we then believe we have to boost the demand for less damaging forms of energy through both a value added tax exemption and other subsidies.

Why are we subsidising through tax exemptions the use of something of which we are trying to reduce consumption? Does the left hand of government know what the far left hand is doing? One reason we subsidise renewables is that we are encouraging the use of fossil fuels through their implicit subsidisation. If the implicit subsidy on domestic fuel were removed, all the support for renewables could be removed too. The cost of production of energy would be dramatically reduced, though the cost of energy to the consumer would increase. However, the government would also have up to £13 billion for tax cuts. That would be enough to abolish inheritance tax and capital gains tax and make a lot of other tax cuts too.

Academic and Research Director, IEA

Philip Booth is Senior Academic Fellow at the Institute of Economic Affairs. He is also Director of the Vinson Centre and Professor of Economics at the University of Buckingham and Professor of Finance, Public Policy and Ethics at St. Mary’s University, Twickenham. He also holds the position of (interim) Director of Catholic Mission at St. Mary’s having previously been Director of Research and Public Engagement and Dean of the Faculty of Education, Humanities and Social Sciences. From 2002-2016, Philip was Academic and Research Director (previously, Editorial and Programme Director) at the IEA. From 2002-2015 he was Professor of Insurance and Risk Management at Cass Business School. He is a Senior Research Fellow in the Centre for Federal Studies at the University of Kent and Adjunct Professor in the School of Law, University of Notre Dame, Australia. Previously, Philip Booth worked for the Bank of England as an adviser on financial stability issues and he was also Associate Dean of Cass Business School and held various other academic positions at City University. He has written widely, including a number of books, on investment, finance, social insurance and pensions as well as on the relationship between Catholic social teaching and economics. He is Deputy Editor of Economic Affairs. Philip is a Fellow of the Royal Statistical Society, a Fellow of the Institute of Actuaries and an honorary member of the Society of Actuaries of Poland. He has previously worked in the investment department of Axa Equity and Law and was been involved in a number of projects to help develop actuarial professions and actuarial, finance and investment professional teaching programmes in Central and Eastern Europe. Philip has a BA in Economics from the University of Durham and a PhD from City University.

6 thoughts on “UK energy policy – when the left hand doesn’t know what the far left hand is doing”

  1. Posted 12/11/2014 at 11:41 | Permalink

    How would this help pensioners in fuel poverty?

  2. Posted 12/11/2014 at 23:24 | Permalink

    Some pensioners, like some working individuals, may be poor according to some appropriate criterion. But they are not ‘fuel poor’ or ‘food poor’ or ‘iPad poor’ for that matter: they are poor. This may justify cash benefits, but it does not justify fuel subsidies, just as it does not justify food subsidies or iPad subsidies.

  3. Posted 12/11/2014 at 23:37 | Permalink

    “However, the government would also have up to £13 billion for tax cuts. That would be enough to abolish inheritance tax and capital gains tax and make a lot of other tax cuts too.”

    Abolish two of the least economically taxes we have, paid for by loading the burden on the poorest? Doesn’t sound like the best idea to me. An across the board VAT cut would, however be very sensible.

  4. Posted 13/11/2014 at 11:17 | Permalink

    It seems to me not necessarily useless to classify poverty according to cause, in this case rising fuel prices. The winter fuel payment for pensioners is staying at £200 – why not tie it to fuel prices?

  5. Posted 13/11/2014 at 12:34 | Permalink

    Rising fuel prices aren’t really a ’cause’ of poverty in isolation. Individual circumstances vary enormously. And in any case the winter fuel payment currently goes to rich and poor alike. Less than 20% of UK pensioners are now classed as at risk of poverty according to the European Commission’s definition, yet all UK pensioners – even those passing the winter in the south of Spain – are entitled to this benefit.
    Without attempts to think rationally about how we help poorer people, we waste huge amounts of public money.

  6. Posted 13/11/2014 at 14:33 | Permalink

    Means-test the winter fuel payment, then. Obviously in a different society things would be done differently.

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