Fuel duty losses in green transition may mean new taxes, Treasury warns

Department says falling income from levies that brought in £37bn last year could cause ‘significant and permanent fiscal pressure’

New taxes may be needed to replace billions of pounds in lost income from fuel duty on petrol and diesel cars, the Treasury has warned, revealing concerns at the heart of government over risks to the public finances from the green transition.

In documents released on Tuesday by Rishi Sunak’s department alongside the government’s net zero strategy, No 11 Downing Street said much of the £37bn raised last year from fuel duty and vehicle excise duty (VED) could be lost if drivers make the switch to electric cars, which have a low or zero tax rate to encourage take-up.

Unless taxes are raised on other areas of household and business activity, the Treasury will need to cut spending or increase borrowing to make up the difference.

Highlighting the difficulties for Whitehall officials as they navigate a route to a low-carbon economy, the Treasury said imposing heavier taxes on carbon users would only provide a sticking plaster if, as is likely, it accelerates the switch away from fossil fuels.

With only a week before the chancellor sets out his budget plans for the rest of the parliament and with the Cop26 summit due to begin in Glasgow later this month, the finance ministry said: “The largest impacts of the transition on the public finances will stem from permanent changes to behaviour that feed through to the tax system.

“Primary among these is the loss of significant amounts of tax revenue as the economy shifts away from the use of fossil fuels.”

The details come after confidential documents leaked to the Observer revealed a rift between Sunak and the prime minister, Boris Johnson, over the potential economic effects linked to the net zero transition.

While concluding that the costs of inaction on global heating would outweigh the costs of action – with benefits for the economy from cutting carbon emissions – the Treasury said failure to offset the fall in tax income from fossil fuels would put the public finances in an “unsustainable position”.

Back in July, the UK’s fiscal watchdog warned that the global climate crisis would add 21% of GDP to the national debt by 2050, or £469bn in today’s terms, but that cost will be lower if the government acts quickly.

According to the Treasury’s net zero review, higher taxes could discourage foreign companies from operating in the UK, lowering tax revenues further. Ministers need to consider “working collaboratively” on “effective international action” to protect British companies from being hit by taxes that other countries may avoid applying, it said.

UK fuel duty is currently 57.95p per litre for petrol and diesel, with the addition of a 20% VAT charge. It has been frozen over the last decade, costing the exchequer £50bn in a move that climate campaigners warn has added to carbon emissions.

Nevertheless, fuel duties brought in £37bn in 2019-20 – equivalent to 1.7% of GDP – leaving a large funding gap once electric and hydrogen vehicles become more mainstream.

The Treasury said that this would create “a significant and permanent fiscal pressure”, which may not be offset by the temporary revenues from making polluters pay more through expanded carbon pricing.

The report added: “Therefore, delivering net zero sustainably and consistently with the government’s fiscal strategy requires expanding carbon pricing and ensuring motoring taxes keep pace with these changes during the transition.”

It said extra borrowing would not provide the answer, and that the government would need to consider changes to existing taxes and new sources of revenue. No 11 said this could include expanding carbon pricing, and ensuring motor taxes keep pace with the transition to a green economy.

Currently, pure battery electric vehicles are exempt from VED, while plug-in hybrids attract a lower rate of tax. This means the move to electric cars is already hitting government revenues, which has prompted warnings that road taxes might be needed to fill the shortfall.

Contributors

Phillip Inman and Graeme Wearden

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