October 31, 2013 6:44 pm

Britain’s energy chaos reflects a long-term lack of focus

We have an alphabet soup of policies creating unnecessary complexity, writes Paul Johnson

The debate over energy pricing is throwing the built-in contradictions of UK energy policy into relief. For years, this government and its predecessor have been trying to achieve sometimes incompatible goals simultaneously through energy policy: securing supply; keeping prices “affordable” for households; and tackling climate change. The result has been an incredibly complex, often incoherent and unstable set of policies.

Today’s debate does not focus on what a principled policy should look like, considering that the main parties have signed up to a legally binding target to cut carbon emissions to 80 per cent below 1990 levels by 2050.

Meeting this target will require large-scale decarbonisation of the electricity sector and big reductions in household and industry emissions. Given that, you would expect some sort of consistent carbon price to be imposed on energy use. This would provide the clear signal required to help ensure emissions are reduced where it is least costly to do so.

Instead we have an alphabet soup of policies creating unnecessary complexity and taxing different forms of energy use very differently. There are at least eight policies affecting household electricity bills, and seven affecting businesses.

Despite the recent focus on rising household energy bills, business use is in fact taxed far more heavily. And electricity is taxed much more heavily than gas. Effective carbon taxes range from close to zero (for household gas consumption) to £70 per tonne of carbon dioxide equivalent (tCO2e) for electricity used by non-energy intensive medium-sized businesses.

Policies already announced will only exacerbate these undesirable differences, with the carbon price faced by businesses for electricity use set to rise beyond £120/tCO2e by 2020. The latter is almost double the government’s own stated view of the carbon price that is required to be consistent with meeting climate change commitments.

And all this ignores one of the economically most bizarre, if politically understandable, aspects of energy policy. By charging value added tax at only 5 per cent on most domestic energy use, as against the standard rate of 20 per cent, household energy use is, in effect, subsidised. Taking account of this, the effective carbon price on gas used by households is in fact significantly negative.

We all know the reason for these inconsistencies. Energy is a necessity. It makes up 16 per cent of spending of the poorest tenth of the population but only 3 per cent of the richest tenth – so taxes on household energy use are regressive.

It is quite appropriate to take account of this in designing policy. But current policy does so inconsistently, and is problematic in two respects. First, the distributional effects of present policies are neither trivial nor transparent. Taxes on business are not victimless; they affect households in the end. And the multitude of taxes and charges that have raised the price of energy for households have made the system less progressive.

Second, it is not the distributional effect of any single part of the tax and benefit system that matters, but the overall effect. It would be quite possible to make energy taxation more coherent and simpler while using the revenues raised to leave the overall tax and benefit system at least as redistributive as it is now. Energy taxes should be designed to tackle the market failures they are there to tackle. Redistribution can be done by bits of the system designed for redistribution, such as income tax and the social security system.

Nobody is pretending such a change would be easy. And the truth is you cannot compensate every low income household that loses from such a change. But before writing this off as a direction for reform, do not forget the following truths. The current VAT structure is a much bigger subsidy in cash terms to the rich than to the poor. The current energy tax structure has imposed significant extra costs on households, both directly and indirectly, without explicit financial compensation.

And finally, if as a society we are to sign up to ambitious decarbonisation targets, we will have to pay for it. Not having a consistent carbon price may look easier in the short run but, one way or another, it will increase the costs we all have to pay by more than is necessary.

The writer is director of Institute for Fiscal Studies, which co-publishes ‘Energy Use Policies and Carbon Pricing in the UK’ today

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