Net zero and the tax system

With COP26 less than three weeks away, Rishi Sunak’s forthcoming budget must set out a coherent tax strategy to help the UK transition to a zero carbon economy. Failing to set out a clear and consistent approach to reaching net zero will raise the costs of the transition.

The chancellor has so far been silent on how the tax system could be used to support businesses and households to make the transition, and the Treasury’s net zero review – promised for spring 2020 – has still not been published. Current concerns over rising energy prices for both households and businesses, and fuel shortages may provide a further excuse for inaction. 

Even if the chancellor does not want to actively use the tax system to promote the transition to net zero, he cannot avoid the consequences of existing policies. The move to electric cars will, over time, eliminate the £27 billion a year the Exchequer raises from fuel duty. Without a plan to shift the burden to other motoring taxes, that hole in public finances could require hefty increases in income tax.

But there is a strong case for Rishi Sunak to demonstrate that he is prepared to deploy the full range of Treasury instruments to meet the government’s target. That means reviewing existing perverse incentives – like the minimal taxation of flying despite its significant carbon impact, and the reduced rate of VAT on new build, which incentivises demolition over retrofits – and at the scope for using the tax system positively to encourage businesses and households to move to net zero.

This report says the Treasury should:

• Publish its net zero review which set out estimates of the cost of the transition; who will bear the direct costs; how these will be shared between the taxpayer and consumers; to what extent the Treasury will look to borrowing to meet its aims.
• Commit to a net zero tax audit to ensure that the current tax system as a whole supports the transition. This should cover all taxes, not just the few that the Treasury defines as environmental taxes.
• Ensure that future tax changes are net zero proofed. Either the Office for Budget Responsibility or the Climate Change Committee should assess budget measures for compatibility with the net zero goals. 
• Ensure tax policy is properly integrated into departmental sectoral strategies. It makes no sense for the transport decarbonisation strategy to say nothing about future taxes on motorists.
• Change will be difficult for many households and businesses, and the chancellor needs both to engage with the public to make sure measures gain and retain public consent, and to work with colleagues to support those who are least able to bear the costs of change.