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Just as businesses need to adapt to consumer habits, lifestyle changes and technological innovation to protect their revenue streams, so too do governments. Parliamentarians are, though, much less agile than most chief executives. Reforming the tax system without upsetting constituents is a tricky business. Take Britain’s fuel duty — a tax on petrol and diesel. In what has become something of a ritual, a scheduled annual inflation uprating has been cancelled for 13 years in a row, allowing the government to appease motorists, an important voter base. The problem is that soon there will be no fuel duty to collect at all.
The levy brings in about £25bn in receipts for the UK Treasury. The switch to electric vehicles — which are exempt from the tax — means fuel duty revenue has been falling. Last year, EVs accounted for around one in six car sales. Alongside the UK’s plans to ban the sale of new petrol and diesel cars from 2030, as part of its net zero goals, the revenue stream is set to disappear.
Fuel duty accounts for more than 2 per cent of UK government revenues. In the context of rising spending demands — which require commitments in the present — that is significant. While some are understandably averse to taxing expenditures that support the green transition, there is a case for carefully extending a levy to EVs over time.
Fuel duty exists in part as a charge for the broader societal costs of using a vehicle which are not reflected in the purchase price — particularly its greenhouse gas emissions. Even if EVs are not gas guzzlers, they still impose a cost. This includes road wear and tear, accidents and congestion.
The 115 hours UK commuters spend on average in gridlocked roads every year is estimated to cost about £7bn. Average road speeds are already below peer nations. And, traffic could increase by more than 20 per cent by 2060, according to forecasts by the Department for Transport. It also anticipates the use of EVs, which are cheaper to run than fossil fuel vehicles, to encourage more driving.
Getting Britain moving faster will support productivity growth. Yet, fuel duty, a flat per litre charge, is not well targeted to tackle congestion, which varies by time and place. This means a charge on EV use will be important to incentivise more efficient road use and to offset the lost revenues from fuel duty.
Britain should gradually adopt road pricing. A flat-rate per mile road use charge for EVs — with non-EVs continuing to face the fuel duty — is a sensible starting point. For measure, a six pence per mile charge, plus value added tax, would offset the fall in fuel duty revenues, according to the Resolution Foundation. EV telematics — onboard devices including GPS — could be used to collect the new charge. Eventually this system can be integrated into local urban congestion charge plans, with different per-mile charges, to target traffic hotspots more directly. Revenues could also be invested in improving public transport alternatives.
This must not discourage the transition to EVs. As the upfront cost of going electric is still high, the initial road pricing charge should kick-in with a delay and then be slowly raised as the EV sector matures. Initial free-miles allowances could play a role. Either way, announcing plans early would avoid the expectation that vehicle use will remain charge-free.
Procrastination may help avoid the immediate political costs of tax reform, but over time it can create a fiscal black hole. Dwindling fuel duty revenues need to be offset somehow. A road use charge offers an opportunity to raise money and cut the hours lost in traffic at the same time.
This is the third in a series of editorials on reforming the UK tax system. The first, on the need for reform, can be found here. The second on corporation tax, can be found here.