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.