Royal Commission on Environmental Pollution

Instead of introducing a tax on energy, the government should tax the emissions of carbon dioxide from burning of fossil fuels that are giving rise to dangers of climate change.

The Royal Commission on Environmental Pollution has warned the Chancellor of the Exchequer that what was presented in the Budget as a 'climate change levy' will not be effective in reducing carbon dioxide emissions. It believes the practical difficulty of the alternative approach of levying tax on the carbon content of fuels has been much overstated, and the beneficial effects such an approach would have on choice of fuel have been understated.

The Royal Commission makes suggestions for preventing any problem arising in the bulk chemicals and metallurgical sectors over double taxation of carbon content. It considers it right in principle that a tax on the carbon content of fuels should affect the prices households, as well as industrial and commercial users, pay for energy. It advocates safeguards to prevent hardship and allow the phasing in of additional supplies of electricity from renewable sources which would not be taxed.

Attached is the full text of the letter to the Chancellor of the Exchequer from Sir Tom Blundell, the Chairman of the Royal Commission. Sir Tom welcomes other environmental measures in this year's Budget, and gives strong support to the government's aim of shifting the overall burden towards green taxes.

The Royal Commission on Environmental Pollution is an independent standing body. Its terms of reference are to advise on matters, both national and international, concerning the pollution of the environment; the adequacy of research in this field; and the future possibilities of danger to the environment. The Chairman and Members of the Commission are appointed by Her Majesty The Queen on the advice of the Prime Minister, and serve part time.

The Royal Commission is at present carrying out a major study of Energy and the Environment. The aim is to identify the actions required in the years immediately ahead in order to develop a sustainable long-term strategy for energy provision and use. It hopes to publish its report by early next year.

Further information about the Royal Commission's study of Energy and the Environment, is available on its web site at:

http://www.rcep.org.uk/energy.html

The contact for enquiries is:

David Lewis (telephone 0171 273 6644, fax 0171 273 6640)

9 June 1999

The Rt Hon Gordon Brown MP
Chancellor of the Exchequer
HM Treasury
Parliament Street
London SW1P 3AG

The Royal Commission on Environmental Pollution strongly supports your intent to use the tax system to deliver environmental objectives, so achieving a shift in the overall tax burden from 'goods' to 'bads'. We are glad to note the further move in that direction represented by your Budget statement on 9 March.

The production and use of energy has various adverse impacts on the environment, which have to be countered by an appropriate combination of statutory regulation and other approaches. One area in which economic instruments have a crucial role to play is bringing about reductions in carbon dioxide emissions in order to counter the dangers of climate change. The escalator for motor fuel duty is an important recognition of that. We welcome your proposals in this year's Budget for modifying the tax treatment of company cars and reducing vehicle excise duty for smaller cars, and the decision no longer to tax employer-run or subsidised schemes for environmentally friendly travel to work.

We are concerned however that a key proposal in the Budget, which you justified in terms of reducing carbon dioxide emissions, and which is being referred to misleadingly as 'the climate change levy', will not be effective in achieving its stated aim.

In his report to you in November last year Lord Marshall discussed whether it would be preferable to levy a carbon tax or an energy tax. While there are some arguments for taxing energy as such, on the ground that there are significant impacts from energy production and use other than emissions from the burning of fossil fuels, Lord Marshall recorded that the vast majority of the responses to a consultation paper had favoured a tax on carbon content. He expressed the view that 'there is a good case for trying to reflect, at least in broad terms, the carbon content of different fuels' in order to maximise the impact of a tax in reducing carbon dioxide emissions.

The case for preferring a tax on energy content, according to the consultation paper issued by HM Customs and Excise, relate to a supposed difficulty in applying a tax based on carbon content to electricity and the government's concern to maintain the quantities of coal used in electricity generation. That concern however is incompatible with the stated aim of this tax, which is to achieve an environmental benefit by countering global warming.

The practical difficulty of relating a tax to the carbon content of the fuels used has been much overstated, and the effect such a tax would have on choice of fuel understated. In the case of a fuel used for electricity generation the generator would pay an amount in tax determined by reference to its carbon content and would pass the tax on to distributors and end users through the price charged for the electrical energy. The carbon in biotic fuels, such as biomass, is part of the renewable carbon cycle, and those fuels would therefore be exempt from tax. There would not be any tax on carbon-free sources such as wind or hydro power. Thus the tax would give all users of fuels and electricity an incentive to ensure that carbon dioxide emissions were reduced. In a liberalised, and increasingly differentiated and decentralised market for electricity, a carbon tax would provide an incentive for consumers to switch to suppliers who obtain electricity from generators using low-carbon fuels or renewable sources. Arrangements will be needed for verifying that supplies are genuinely obtained from such sources, and such arrangements are desirable in any case in view of the proliferation of green tariffs. The detailed rules for application of the tax would have to be designed in such a way as to stimulate development of new capacity for generation from renewable sources, rather than reallocations of existing capacity, and prevent the operation of EC law giving an inappropriate preference to imported supplies.

Lord Marshall drew attention to possible problems in some industries, under a downstream carbon tax, over double taxation of carbon-containing intermediates used as inputs to other industrial processes. Double taxation can be avoided by levying the tax on the difference between the carbon content of a company's inputs and the carbon content of its products. This arrangement would apply primarily to the bulk chemicals and metallurgical sectors. To take the example of an oil refinery, the tax would be applied to the carbon dioxide emitted from the refinery, calculated by comparing the inputs of crude oil and the outputs of refined chemicals or fuels. The fuels produced by the refinery would be liable to tax only at the point at which they are sold as prepared fuels to end users and burned. Under this approach, cost increases resulting from the tax would accumulate along a supply chain, thereby encouraging reductions in carbon dioxide emissions throughout all stages of an industry.

Levying tax on the carbon content of fuels, including fuels used for electricity generation, will affect the prices paid by households, as well as by industrial and commercial users. We believe that is desirable in principle; a study by Cambridge Econometrics has shown that the importance of households in giving rise to carbon dioxide emissions from electricity generation has been underestimated. Suitable adjustments need to be made to other taxes and to benefits in order to produce an outcome that will be broadly revenue-neutral for the household sector, and as far as possible for different income bands; and need to be complemented by an intensification of other measures to alleviate fuel poverty. In a fully liberalised market individual consumers have the choice of obtaining electricity generated from renewable sources. Insofar as it affects households, application of a carbon tax will have to be phased in over a period to allow additional supplies of electricity from renewable sources to become available.

I am copying this letter to the Deputy Prime Minister and to the Secretary of State for Trade and Industry.

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