Energy and Environment

Should liberals welcome green VAT discounts as a tax cut, or bemoan them as a tax distortion?


Markets and Morality
Tax and Fiscal Policy
In the Spring Statement, around half the policy costs of measures issued related to the energy crisis. One of the smaller measures was to temporarily reduce VAT on residential energy saving measures (and their installation) from 5% to 0% for 5 years, to encourage greater private investment in energy efficiency. A measure estimated to cost £280m in reduced VAT over the period, but in practice less than that, as we might expect a reasonable boost to other taxes from increased activity related to the pump-priming of the market. Literal pump-priming in this case, as the measure targeted include insulation, biomass boilers, controls, solar panels, mini-turbines, and heat pumps.

This sort of measure divides classical liberals. I take the rather naïve view, ‘hurrah a tax cut, take the win’. Others worry about tax complication and unintended consequences from privileging one group of products over another. They worry about distributional impacts, because although anyone can benefit, and there are specific programmes targeting social and hard-to-treat housing, the principal beneficiaries of most green discounts are those well-off and organised enough to invest in green goods, and those selling them.

On simplification there is an immediate win. Attempts to reduce the VAT rate on energy-saving measures previously collided in the 2010s with the European Court of Justice deciding that the measure breached the VAT Directive. Specifically that the UK

“cannot apply, with respect to all housing, a reduced rate of VAT to the supply and installation of energy-saving materials, since that rate is reserved solely to transactions relating to social housing.”

There followed in 2019 a revision to VAT notice 708/6, that reduced the availability of the 2014 measure and introduced a bizarre 60% test on top an existing social benefit test. One that meant that if the cost of materials installed was more than 60% of the cost of the installation work, the reduced then 5% rate would only apply to the labour but not the materials, then charged at 20%. This effectively barred more expensive energy-saving products from being discounted, regardless as to whether they were more effective and a better investment.

That’s gone, along with reference to the EU as an authority on UK VAT. It’s not full simplification, there is still a question of ‘principal supply’. If for example you put installation in your roof, that job is now zero-rated. However if you leave the insulation upgrade until when you do your full roof project, it and the labour will be charged at 20%, as the roof is considered the principal supply and the efficiency work ancillary. There are then still two rates of VAT for the same products and services in the same building using the same contractors, dependent on how and when those products and services are packaged and delivered. This will cause some confusion and complication for both customers and traders, and will require some gaming, such as splitting projects in two. It is unclear why rules do not simply allow apportionment, but that is the joy of tax rules, and why classical liberals worry about these wrinkles.

In respect of distortion there is a wider problem. What happens behind the scenes of tax and standards battles based on product codes are lobbying battles. Producers of marginal goods, for example solar batteries, will attempt to get their goods on the list. Whilst their rivals will attempt to exclude them. These battles are rarely seen by the public, taking place between regulatory affairs lobbyists, trade bodies, quangos, and civil servants, but can have a profound impact on their choices. One of the reasons James Dyson became such a staunch Brexiteer was losing such a battle within the EU to German competition. Another argument then for tax consistency is to disempower these debates and ensure all are treated fairly, rather than ranked by their presumed social worth, which in fact boils down to the judgement of who more effectively influences decision makers. When environmental activists complain about corporatism, believing it only to apply to ‘bad things’ like fossil fuels and finance, anyone with a passing knowledge of how green policies are developed smiles politely.

A further argument against this change now is that energy prices are high, ranging from 5-10 times higher for gas, and 4-7 times higher for oil than two years ago. Were the Government to do absolutely nothing we would expect to see a sharp increase in private investment in energy saving measures and related trades. The danger of pump priming at such a time is further inflation. Supply chains adapt to market forces. Higher demand induces higher prices, induces higher supply, reducing prices. But supply chains are sticky. There is no magic heat pump tree, these things take time, and attempts to accelerate markets with tax cuts can see some or most of the benefit swallowed up in price rises for no benefit to productivity.

Against which, and back in the real world of the political economy, where politicians feel that they must do something (as our former A&R Director Lord Kamall was fond of pointing out), of the list of problems the Government could create this is at the lower end of concern. So in summary, ‘a tax cut, hurrah!’. A measure that may help achieve some decarbonisation objectives less expensively, hurrah!

But for the now ever longer tax code and need for builders to play the system for their customers, boo! These decisions will never be clean and easy.


Andy Mayer is Chief Operating Officer at the IEA. Andy worked as Head of Public Affairs, UK & Ireland at BASF plc for seven years. He has over 20 years of experience in strategic communications and the operations that support them in the business and think tank worlds.

1 thought on “Should liberals welcome green VAT discounts as a tax cut, or bemoan them as a tax distortion?”

  1. Posted 03/04/2022 at 10:11 | Permalink

    “These decisions will never be clean and easy.” Certainly not. I have another concern. No one stops to think about the net effect of various so-called green investments. Take solar panels for example. How much carbon is released in their manufacture, transportation (usually from China) and installation? And how many years does it take to offset this initial carbon release and on-going maintenance. Indeed is an offset achieved at all before the panels have to be replaced/ modified? Given the UK climate and the fact that the issue is a global problem, would it not be more effective to install these things not here but in, say, Portugal, Australia etc. The same issue applies to many other measures. It all needs very careful consideration rather than jumping to seductive conclusions.

Leave a Reply

Your email address will not be published.