Can Green Tax Incentives Boost Sustainable Growth?

With net zero a key element of the new government’s agenda, what can we expect from environmental taxes in the budget? asks Sharon Baynham

We have a £22 billion black hole in the public finances. Who knew! Well, anyone dared to look according to the Institute for Fiscal Studies. The blame game has already started and the memories will definitely be different. But the bottom line is that we can now expect a tax hike of the chancellor the first budget on October 30.

A “summer of speculation” awaits us, which unsurprisingly centers on what will happen to personal taxes. But I think there’s another area that deserves attention: where are environmental taxes going from here, especially as the energy transition is a key element of Labour’s policy?

Whether it’s fuel taxes, air passenger taxes, plastic taxes, landfill taxes or carbon border adjustment mechanisms, countries, including ours, are good at forcing us to behave.

Their use can be controversial, especially when the burden falls on lower-income households. But they are definitely profitable. In 2023, UK environmental taxes raised £52.5 billion, around 5.5% of total tax revenue.

Governments can easily become dependent on such sources of revenue, but this raises ethical questions about the purpose of these behavioral taxes. Is their function to raise revenue or to drive a larger public good? Or do we stand at a confusing intersection between the two?

Take fuel duty, for example, where annual increases have been on hiatus for 13 years and a “temporary” 5p cut introduced in 2022 has settled permanently into the system. From a net zero this perspective makes no sense.

Fuel duty contributes almost half of the UK’s environmental taxes. Increasing it in the Budget will be tempting. It won’t be popular, but it aligns with net zero and would be profitable. The polls have over four years to recover if the government makes this move.

The bigger problem is that as the country becomes more environmentally responsible, revenues like these will disappear. The country must be weaned from them. No wonder the Treasury is scrambling to move from a fuel tax to a pay-per-mile system.

This is environmental fiscal policy as a ‘stick’ – but what about using it as a ‘carrot’ to stimulate investment in the energy transition?

The UK has a reasonable number of tax breaks, but few are specifically targeted by the green agenda. The previous government didn’t seem too keen on the idea: but Labour’s energy transition plans are more ambitious – and recognize the role the private sector needs to play as a co-investor.

In 2020, the Climate Change Commission identified that the increased investment needed could be offset by cost reductions by the end of the 2030s. So if this is a temporary funding gap, the UK should get more serious about cutting environmental taxes?

In the US, of President Biden Inflation Reduction Act (IRA) disrupted the global environment for investment in green technologies by providing $369 billion in subsidies, including tax credits, to unlock private investment.

It has set a high bar, but it is not without its critics. He prioritizes American products over more affordable imports, and his success in getting projects off the ground has been hampered by supply chain issues. The sheer size of the tax cuts offered will impact global trade, likely making international cooperation on the energy transition more difficult.

The IRA also moves away from free market outcomes, reintroducing government as a key market player. With an election less than three months away, this highly interventionist approach raises questions about the longevity of a Trump presidency — and that adds to investor uncertainty.

The IRA changed its behaviour. Reuters recently reported that the US has seen more than $350 billion in private investment that is expected to create 300,000 new jobs. The numbers are impressive, but it will be many years before a proper assessment can be made, one that addresses the impact on other nations, particularly the Global South.

Meanwhile, the UK needs to think smarter about green taxes. Simply put, no one can afford to compete on the same scale as the US. But a good place to start would be a cross-party approach to a targeted and coherent strategy that would be a viable alternative to the US – one that offers longer-term certainty to investors in an increasingly interventionist world, strained by from a political and protectionist point of view.

After AM city

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