RE-SETTING UK ENERGY POLICY: What role for Economic Instruments?

There is growing bewilderment practically everywhere about what the still relatively new UK Government is doing is respect of energy policy. The mantra since the election is that energy policy is to be re-set to achieve decarbonisation targets, to which the government says that it is still committed, in a more cost-effective way that will benefit the ‘hard-working families’ to which the government says that it is also committed. Unfortunately it is quite impossible to recognise this laudable objective in the policies that have so far been implemented, especially those which use those policies called economic instruments – basically taxes, charges and subsidies – which are the subject of this blog.

Firstly, relatively low subsidies for the cheapest low-carbon energy source, onshore wind, are to be removed early, and planning permission has been made more difficult to secure even for those plants that do not need subsidy. Secondly, subsidies for the second cheapest low-carbon energy source, solar PV, seem likely to be drastically cut, just when industry sources thought that they were only a few years from being able to be subsidy-free, but depended on continuing support to get there. Over 1,000 jobs in the solar industry have already gone, with more losses predicted if the subsidy cuts are followed through. These once hard-working families at least will find it difficult to discern the government’s concern for their welfare.

Of course, it is right that mature industries should be subsidy-free, and one might applaud the government for its aspirations, if not its timing, on this point, were it not for the fact that it is storming ahead with giving a very large subsidy to Hinkley Point C nuclear power station, including a price guarantee that will cost consumers an extra £4.4 bn to £20 bn, on the government’s own figures, with various credit guarantees, insurances and derisking subsidies on top. Yet nuclear power is a mature industry if ever there was one, and one whose costs, unlike those of renewables, resolutely refuse to fall and in this case will impact hard-working families and other energy consumers for 35 years from the date of first generation. It now looks almost certain that when power from Hinkley Point C finally comes on line, it will be substantially more expensive, and therefore more heavily subsidised, even than offshore wind, which was once thought to be unassailable as the most expensive low-carbon energy source. In short, the government’s subsidy policy is anything but cost-effective, and will maintain a burden on hard-working families for decades and everyone else, whilst eschewing energy sources that would seem only to need a few more years’ support. The credibility of the government’s repeated stated commitments to both cost-effectiveness and emissions reduction is fatally undermined by its removal of the specific tax incentives for energy efficiency and renewables, which score at the top of the range on both counts.

So to the tax side of economic instruments, concerning which there have been two major changes from the new government in its Summer Budget 2015. First, the exemption from the Climate Change Levy (the tax on the business use of energy) which was accorded to renewable electricity sources has been removed. This was announced in July and took effect from August 1^st, without any prior consultation, thereby depriving renewable generators of a source of revenue (currently £5.54/MWh) which they will certainly have factored into their business plans when these were created – and bidding competitively for government contracts. While perhaps not technically retrospective legislation, such a change is devastating for business confidence in the stability and predictability of government policy, something which this government, as others before it, claims to be committed to. For example, a recent government consultation paper relevant to this blog, ‘Reforming the business energy efficiency tax landscape’, states: “The government is committed to developing an effective framework that provides businesses with certainty and encourages business investment in energy efficiency and carbon saving” – an assurance that might be expected to attract the cynical riposte from renewable generators at least: “At least until the next Budget” – this change is expected to increase government revenues (if current investment plans still proceed with the corresponding added cost) by about £900 million by 2020.

The other energy-related tax adjustment in the Summer Budget was the abolition, apart from in the year of purchase, of the gradation of Vehicle Excise Duty according to the vehicle’s calculated carbon dioxide emissions per km travelled. Before the Summer Budget this ranged from £0 (for 0-100 gCO₂/km) to £505 (for over 255 gCO₂/km) per year. The Summer Budget changed this such that all new registrations from April 17 will pay a flat rate of £140 per year (with a £310 supplement for cars with a list price of more than £40,000), including vehicles with emissions of 1-50 gCO₂/km per year. The new first-year rates range from £0-2,000, compared to £0-1,100 under the current system. The change is expected to increase the tax take by about £1 billion per year by 2020, with the main losers the drivers of low-emission vehicles.

In sum, this is a very strange way for a government to proceed when it claims to be interested in business investment in energy efficiency and carbon saving, both of which require some confidence in the stability of government policy which this government’s actions over the last six months have done much to destroy. What does this say about the likely outcome of the consultation on the ‘business energy efficiency tax landscape’?

One tax from the last government that has so far survived the energy policy activism of this one is the carbon price support (CPS). This was originally intended to rise at a rate reflecting the Treasury’s estimated ‘social cost of carbon’, but in the face of political concern about energy bills this ‘escalator’ was halted in the 2015 budget, with the CPS at around £18/tCO₂ until 2020, . Apart from earning the Treasury around £2 billion a year, this tax plays a crucial role in reducing emissions from UK coal-fired power stations, with the removal of the CCL exemption for renewables the government seems to be drawing a distinction between taxes for climate policy, such as the CSP, and taxes for energy efficiency, such as the CCL and the other instruments mentioned in the consultation paper.

As far as these instruments are concerned, some simplification of the tax landscape can surely be expected. The main question is whether this will level up or down the effective rate of energy taxation. Even though these taxes will be denominated in energy, it would be desirable for their rates to be based on the energy’s carbon content. The government’s carbon price trajectory for firms outside the EU ETS suggests that this price should now be around £60/tCO₂, increasing to £76/tCO₂ by 2030. For electricity, the CPF, CCL and CRC (Carbon Reduction Commitment) together add up to about £55/tCO₂. For gas, the CCL and CRC add up to much less, only around £22/tCO₂. Taxing both these energy types at £60/tCO₂ (about £14/MWh for electricity and £11/MWh for gas) would therefore both simplify the tax rates and tie them explicitly into climate policy. The Climate Change Agreement rebates on the taxes for so-called energy-intensive sectors would probably need to be maintained for political reasons. Such an outcome to the consultation would do little to rectify the inconsistencies on the subsidy side of energy and climate highlighted above, but it would at least show that with tax policy the government was more committed to tax efficiency than its predecessor, without being less committed to emissions reduction, as it states.

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Prof Paul Ekins OBE is Director of the UCL Institute for Sustainable Resources and Professor of Resources and Environmental Policy