Energy and Environment

How the tax system distorts the travel industry

Off the radar, because it was announced eighteen months ago, April saw a major change in taxation of travel by air. For some years now passengers catching a flight from nearly all UK airports have been paying a tax on departure as an adjustment to the price of their airline ticket – a tax referred to as an Air Passenger Duty (APD), and one that has a professed environmental objective. APD applies to domestic as well as overseas flights, but bears most heavily on the latter. True to form, bureaucrats this year introduced further complexity to the tax with more categorisation, whilst ignoring glaring inconsistencies in the taxation of travel generally (to say nothing of the muddled mish-mash of regulations and imposts that seem to bedevil the British approach to environmental issues).

Travel is a derived demand, undertaken for benefits garnered at the journey’s end: from doing business, visiting friends and relatives, from studying or, most likely, taking a holiday break. But there are numerous options for procuring the same (or similar) benefits, alternatives which could involve varying amounts of travel or make use of different modes of travel. In other words, within most of these segments of the market economy, close substitutes are available so that the cross-price elasticities of demand are particularly high. As travel agents know well, customers are highly responsive to often small price differences, differences which APD accentuates in a way not necessarily intended.

For example, a growing segment of the market for long distance overseas holidays is cruising the oceans in giant floating hotels. The UK-sourced cruise liner business pre-covid was turning over about two billion pounds per annum (precise figures are hard to come by), shipping its two million annual clients far and wide, some to Antarctica, the Pacific and, when not circumnavigating the globe, reaching down to the Caribbean or Mediterranean. However, here lies a problem. Contrary to the instinct of many, this is a particularly “dirty” holiday, commonly acknowledged by the techy people to produce more, arguably far more, emissions than a broadly similar holiday making use of aviation.  And yet, there is no equivalent to APD to balance prices charged. Nor is cruise shipping, unlike aircraft, subject to the emissions trading scheme applying across the European Economic Area (EEA), or the post-Brexit parallel UK scheme. The result: there is a serious distortion of a (highly) competitive market, the price of a holiday by air is raised artificially, and not insubstantially, relative to that by sea; travellers are incentivised by a tax discrepancy (or the quasi-tax of the emissions trading scheme) to choose the environmentally dirtier holiday option, and many have been doing so.

The best way to tackle this and other distortions is to introduce a generally applied carbon tax, probably too difficult, too neutral, unfortunately, for politicians living in a world replete with lobbyists and vested interests to deal with. A fall-back would be to extend the tradable certificates of the ETS (albeit with its underlying arbitrarily, politically-set targets) to incorporate shipping. There have been suggestions for doing so in the UK but the Government’s consultation limited the suggestion to the domestic sector of the industry (another bitty add-on proposal) with no mention of cruise shipping. Of course, to gain parity on environmental taxes with the aviation industry, incorporation of not only the ETS but also something equivalent to APD is called for.

Equivalence between the two sectors might be achieved by introducing a ‘sea passenger duty’ (SPD) which could broadly follow the structure of APD: international scheduled air journeys from airports in Great Britain (Northern Ireland is exempt for long-haul flights because of recognised competition effects from Dublin in the Irish Republic) to countries with a capital city further than 5,500 miles from London currently pay the highest rate of duty, countries 2,000 miles away or less pay the lowest rate, with flights to the rest of the world paying an intermediate rate. Complexity is added by the chosen class of travel; thus, a business class flight to, say, Singapore is hit with £601 duty (to the Channel Islands ‘only’ £78). Under an SPD scheme, the cruise ship passenger would pay SPD according to class of cabin, distance sailed, and the relevant charging band.

Of course, such a suggestion too might prove politically toxic (forget competitive distortions or saving the planet) because sea ferry services tie the United Kingdom’s territorial extremities to the centre (although that unionist sentiment has not stopped APD from being applied to similar journeys by air, except those departing the Highlands and Islands of Scotland). So, maybe a CPD, a Cruise Ship Duty, is the most that economists, environmentalists (and a Treasury seeking revenues by adding a modest amount of duty to an average £1000 spend of a cruise passenger) can feasibly argue for, even if such a tax does introduce yet another ‘mish to the mash’ of environmental levies.



Prof David Starkie’s book, Airport Enterprises: an economic analysis, is to be published by the RPI, Oxford, in June.

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