Should the taxman clean up?

The Government is committed by international treaty to deliver CO2 reductions. This objective is consistent with my industry’s duty to satisfy the world’s growing need for energy. I don’t disagree with the Government’s commitment, and I also accept that there is a limit to what firms will do voluntarily to help meet it. But I […]

The Government is committed by international treaty to deliver CO2 reductions. This objective is consistent with my industry’s duty to satisfy the world’s growing need for energy. I don’t disagree with the Government’s commitment, and I also accept that there is a limit to what firms will do voluntarily to help meet it. But I am far from convinced that there is a single solution to this challenge.

I think we need a range of responses. These could include taxes, but not necessarily. An energy tax could be a powerful instrument for changing behaviour. But it could also do more harm than good if badly designed. While taxes may have a role, there are better economic instruments available.

First, there is emissions trading, which would be less expensive than taxes, and unlike taxes would guarantee that energy emissions are reduced by a specific amount. Emissions trading is a system where low-level polluters relative to an industry benchmark can sell permits to allow higher-level polluters to exceed that benchmark. It offers the greatest potential for achieving emission reductions at least cost and minimum competitive disadvantage. Voluntary agreements hold out similar benefits. Where they score over alternatives is that their sole focus is on the problem at hand the need to cut total greenhouse emissions.

In contrast, a business energy tax as normally understood is much less effective. At best, it only reduces emissions indirectly through increasing energy costs. It concentrates on industry and commerce, to the exclusion of other sectors. It taxes energy use, rather than carbon dioxide emissions, and fails to address other greenhouse gases.

I am opposed to the concept that energy is something which deserves to be taxed for its own sake, or that people should be made to feel guilty for wanting the enormous benefits which energy provides. There are also grave risks to the competitiveness of British industry if this route is pursued.

But that does not mean all taxes are useless, so long as they are directed at the harmful consequences of the use of energy. When this is the objective, so-called energy taxes could be used to support emissions trading by providing incentives to increase energy efficiency. This approach assumes that individuals have a genuine choice between options. But so long as this condition is satisfied, taxes can help to change behaviour. For example, the Government could introduce a reduced rate of corporation tax for companies which reduce their emissions over an agreed baseline. Or tax only the quantum by which an agreed target is exceeded.

What this approach has in common with emissions trading is that it concentrates attention upon a specified target. A benefit would flow from exceeding this target; and under-performance would incur a cost. This is an approach which businesses understand, since it motivates individuals to come up with solutions. It will be through the ingenuity of individuals and through advances in technology that ultimately the challenge of climate change is met.

This is in stark contrast to the UK’s experience with petrol taxes, where energy use is taxed merely to produce revenue with little, if any, impact on consumer behaviour. Over 80% of the price of a gallon of petrol is now accounted for by taxes of one sort or another. As with tobacco taxes, one wonders how the Chancellor would cope if customers finally decided that enough is enough and stopped driving or smoking.

Advocates of an energy tax are always quick to point out that the intention is revenue neutrality. Even if this is accepted by the Treasury, it is easier said than done. For instance, some argue that an industrial energy tax should be compensated for by a reduction in Employers’ National Insurance contributions. But this would introduce a fiscal bias against investment and capital-intensive industries.

Firms with large numbers of people and low energy use would reap all the rewards from this strategy, while energy-intensive industries with fewer employees would pay much more, despite efficiency gains. You could end up by imposing the highest penalties on some of the UK’s best-performing companies.

So while there is no point in denying that taxes can change behaviour, we shouldn’t think solely in terms of higher taxes. If the objective truly is to reduce emissions rather than increase revenues, the Government should concentrate upon making a success of emissions trading and see tax incentives as underpinning this approach. Taxation of energy ought to be implemented as a last, not the first, resort.

Rodney Chase is deputy chief executive of BP Amoco