Let’s green the tax regime

With just weeks to go until the Chancellor makes his Autumn Statement, industry expert Tom Lowe believes it will be an opportunity for the government to introduce tax reforms to assist the UK’s drive to net zero. Writing for Utility Week, Lowe explains how the country can green its tax regime.

On 22 November, the Chancellor is set to deliver the Autumn Statement. He faces the difficult challenge of supporting people and businesses with high energy costs from a relatively weak fiscal position. As well as continuing to support people through the current gas crisis, the Chancellor has to support people and businesses to switch away from inefficient fossil fuels to cleaner alternatives for transport and heat. A mixture of carrots and sticks are needed to support the upfront investment required for this switch.

The Autumn Statement is likely to be the penultimate fiscal opportunity of this Parliament for the Chancellor to adjust the tax system to support the transition to net zero. This is a chance to reduce carbon emissions, lower bills and encourage investment into the UK. The Chancellor can take long-term decisions by presenting a positive set of green changes to the tax system.

This would build on what the UK government has already achieved. The tax system has helped facilitate the transition to electric vehicles (EVs) over the last decade. We have seen the positive impact of using direct grants and preferential tax rates to improve range and lower upfront costs, ultimately removing the need for subsidy. There are now 900,000 EVs on the road in Britain.

Similar incentives are already on offer to facilitate heat decarbonisation, one of the most complex challenges in the net zero transition. The UK government zero-rated VAT for heat pumps from 2022 to 2027, a flexibility provided by Britain leaving the EU. It recently increased the Boiler Upgrade Scheme grant for air-source heat pumps from £5,000 to £7,500, meaning the UK government now matches the size of the Home Energy Scotland grant available from the Scottish Government.

As well as using the tax system to increase consumer uptake, the UK government is supporting manufacturers to invest in low carbon heating solutions to reshore manufacturing and reduce costs. Grants of up to £15 million are available through the heat pump investment accelerator competition, while the Clean Heat Market Mechanism encourages boiler manufacturers to diversify. Full expensing is available from March 2023 to March 2026, allowing businesses to claim 100% capital allowances on qualifying plant and machinery investments.

The costs of the various carrots and sticks outlined above pale in comparison to the £40 billion spent subsidising energy bills for people and businesses when gas prices rose rapidly during 2021 and 2022. They are also small in comparison to the costs that are coming. For instance, as EVs replace petrol and diesel consumption, fuel duty revenues will fall. This could eventually leave a hole of £25 billion in government finances.

The UK government will likely need to explore deeper reform of the tax system as the transition accelerates. This includes the costs of decommissioning at least parts of the gas grid, financing the expansion of the electricity network and supporting business models for both hydrogen and carbon capture, utilisation and storage (CCUS). These are long-term and expensive infrastructure projects. Investment in the electricity transmission and distribution network alone is expected to cost between £40 billion and £110 billion extra over the next 25 years. Much of this cost is slated to fall on energy bills.

Others have looked at the issue of tax already, with Green Alliance’s TransformTax project outlining the need to green the tax system. In simple terms, the question is how much of the transition is funded through taxes, energy bills or borrowing. The freezing of income tax thresholds from 2021 to 2028 means that more households are already paying more tax. There is likely a role for borrowing to invest in the transition. The UK government is already expected to run a budget deficit of over £100 billion in 2023-24, essentially borrowing to fund current spending. Labour’s plan to invest up to £28 billion per year during the next Parliament could involve some additional borrowing.

There is more that the UK government can do to support people through adjusting taxes, starting with the Autumn Statement. HM Revenue and Customs and HM Treasury consulted over the summer on modernising the list of Energy Saving Materials eligible for VAT zero-rating. A joint letter coordinated by Thermal Storage UK in May 2023 called for zero-rating to extend to heat batteries, electro-chemical batteries and EV chargers. This letter was co-signed by a diverse group of organisations, including EON, EDF, Ovo, UK Power Networks, Citizens Advice, the Energy Saving Trust, Nesta, Sunamp, tepeo, Caldera and Powervault.

Extending the VAT relief to flexible assets supports decarbonisation of the power system. More flexibility on the demand-side means better use of renewables and lower network investment to manage peak demand. For heat, extending the relief to heat batteries would allow people to choose the right technology for their property. While heat pumps have an important role in decarbonising heat in millions of buildings, other buildings will need alternatives. Extending the relief would also maintain consistency with the government’s work on Energy Smart Appliances, which covers heat pumps and heat batteries.

The Chancellor could also use the Autumn Statement to provide an update on the commitment to rebalance electricity and gas prices over time to incentivise switching to EVs and electric heating. Electricity costs around four times as much per unit as gas (28p / kWh versus 7p / kWh in the current price cap). This is partly explained by green and social levies sitting on electricity bills rather than gas, making up around 10% of the electricity bill. As electric heating and transport is more efficient than burning fossil fuels, even relatively minor reductions in electricity prices could make the operating costs for fuel switching economically appealing.

Organisations across the sector are making important proposals for further reform. The Sustainable Energy Association is looking for policies to be more technology agnostic, and for schemes, like the Boiler Upgrade Scheme, to expand to cover a wider range of low-carbon technologies (including smart thermal stores). E3G has proposed a discounted unit rate for electricity used in heating, following the lead of Denmark. The campaign group FairCharge is calling for VAT on public chargers to fall from 20% to 5% to align with the VAT treatment of home electric charging.

It is no surprise that there are upfront costs to the transition to net zero. We are rebuilding much of the foundational infrastructure of the economy. Building an energy system that no longer burns fossil fuels in homes, vehicles, industry or power generation will deliver long-term benefits, including improved air quality, enhanced efficiency and lower emissions.

The Office for Budget Responsibility and the Climate Change Committee both estimate that acting early on net zero is the best way of keeping costs down. This is why HM Treasury will come under increasing pressure to publish a tax roadmap for net zero. This roadmap will need to reflect changes in tax revenues, people switching to low carbon options and the upfront costs of the transition. A transition to net zero that is pragmatic, proportionate and realistic – as the Prime Minister wants – will need to tackle the tax system. The forthcoming Autumn Statement is a good place to start.