The UK’s March 2020 Budget: Red Diesel and the Dawn of Carbon Taxation

The Chancellor’s Budget shows clear signs that the UK government is now moving towards general carbon taxation.

As a taste of things to come, government is increase fuel tax on diesel for parts of the construction industry, amongst others, by 400%, from the currently discounted level of 11.14 pence per litre to the standard 57.95 pence per litre, resulting in an increase in annual fuel costs to the UK of about £1.6 billion per year. Much of this burden will fall on local authorities and taxpayers through the costs of road maintenance Framework contractors with the construction industry. It is inevitable that there will be further impacts on the costs of national infrastructure projects such as HS2.

It is almost impossible for a modern Chancellor to approach the despatch box with a Budget that is anything other than ostensibly committed to the mitigation of climate change, and in spite of the extraordinary measures announced to buffer the economy against the effects of Covid-19, Rishi Sunak’s debut is no exception, the first page of his Budget telling us that

In the year that the UK hosts the COP26 UN climate summit, the Budget takes steps to decarbonise the economy and protect the UK’s natural habitats, ensuring that every part of the UK economy is ready for the challenges of decarbonisation, and ready to capitalise on the opportunities to become leaders in the green markets of the future. (Budget, p. 1)

So far so anodyne. But that doesn’t mean that the document is empty, and that the reader can safely ignore it. Green lobbyists may be just a little disappointed, but overall they will be satisfied that the ratchet has been turned a few clicks further on, in spite of the almost overwhelming distractions of a genuine crisis in public health.

Not only are the gestures green, but the few bigger ticket items in climate policy that are actually costed are indicative of the direction of travel, which is towards general carbon taxation. This has long been the preferred instrument of the Treasury, and they are now reaffirming extant promises and beginning to provide details. The Budget informs us that:

The UK will continue to apply an ambitious carbon price from 1 January 2021 to support progress towards reaching net zero. The government will legislate at Finance Bill 2020 to prepare for a UK Emissions Trading System (ETS), which could be linked to the EU ETS. The government will also legislate for a carbon emissions tax as an alternative carbon pricing policy and consult on the design of a tax in spring 2020. (para 2.219)

The possibility of synchronisation with the EU ETS will presumably be used as a bargaining chip in negotiations, but since this would put the UK behind the EU’s emerging carbon tariff barrier, a Customs Union in all but name, it seems unlikely that the UK will agree to it. The Chancellor’s decision to freeze Carbon Price Support at £18/tCO2e (para 2.218) is not only an entirely understandable relief for businesses when facing severe economic difficulties as the result of Covid-19, but a fairly clear hint that the UK is willing to dispense with emissions trading, whether synchronised with the EU or not, on the 1st of January 2021.

It therefore seems much more probable, though far from certain, that the eventual outcome will be the straightforward system of taxation indicated briefly but pregnantly above. The consultation on this Carbon Emissions Tax will tell us more, and we don’t have long to wait.

This is no bolt from the blue. In spite of its political hazards, carbon taxation is and probably always shas been the preference of the Treasury, purely on the grounds of economic efficiency. After all, they tried and failed in 2012 to make major cuts in income support subsidies to renewables, replacing them with the Carbon Price Floor. As it happens the turf war between George Osborne’s Treasury and Ed Davey’s Department of Energy ended up with Treasury conceding ground in order to preserve the Coalition, leaving the consumer saddled with the costs of both the Price Floor and the subsidies to wind farms. But the Treasury is single-minded and implacable, and they are back. The Carbon Price Floor was only a step towards carbon taxation, but they are now ready to go whole hog.

This doesn’t mean that subsidies and levies are quite absent in the current Budget. It is proposed, for example, to compel consumers to subsidise a Carbon Capture and Sequestration (CCS) Infrastructure Fund of “at least £800 million” to support the “construction” of two gas fired power stations with CCS, the first by the mid 2020s and a second by 2030 (para 2.103). The details of this, like many other key policies, is not fully stated, being left for determination at a later date, this particular endeavour being included in the Comprehensive Spending Review which will conclude in July in time for announcement at and around the COP26 climate meeting in Glasgow in November.

There is also a proposal, a foolish proposal in my view, to supplement the centrally funded Renewable Heat Incentive (RHI) with a specific levy on consumer heating fuels to support the further expansion of renewable biomethane (para 2.105). This was probably the result of lobbying from landed interests, and is unlikely to proceed except at a small scale, since the levy would fall on extremely vulnerable consumers creating the opportunity for political controversy. Indeed, the original proposals for the RHI involved just such a domestic fuel levy, but this idea was discarded because it would hit low income households living off the gas grid and using bottled gas or LPG. If the current bright idea went the same way no one would be surprised.

So subsidies and levies survive, but these are clearly now exceptions. From this time onward the central core of British climate policy will be driven by carbon taxation, flanked by many other indirect coercions nudging consumers, particularly corporate and public sector consumers, towards private contracts with expensive energy sources. This “tax and nudge” strategy will mean that climate policy costs will be buried deep within the costs of all goods and services.

For example, Mrs May’s Plastic Packaging Tax, which dates back to 2018, is now firmly slated by this Budget for April 2022. Small businesses, those generating under 10 tonnes of plastic waste per year are excepted, but others will pay £200 per tonne for plastic waste that contains less than 30% recycled material. Government expects this to cost the economy £240m a year in 2022/3 and approximately the same in the two subsequent years. It will be interesting to see if businesses can find any way to avoid this tax without losing the benefits of high grade, unrecycled plastics, in sterile packaging for example. Time will tell.

The Budget also increases the Climate Change Levy (CCL) on natural gas used by commercial users, a reannouncement that has its roots in the promise in the Budget of 2016 to equalize the levies on gas and electricity. Treasury estimates that this will increase costs to the economy by £130 million in 2022/3, £260 million in 2023/4, and £270m in 2024/5 (p. 67), though they hope that the extension of the Climate Change Agreement discounts to CCL offered to consumers adopting energy efficiency measures will offset these additional costs by £5 million in the first year and £190 million in each of the two succeeding years. Whether this is realistic is anyone’s guess.

But the most significant, and immediately costly act of carbon taxation is the removal from April 2022 of the permission for several large classes of consumers to use diesel taxed at a lower rate and stained red to distinguish it, hence the name “Red Diesel” (para. 1.247).

The tax differential is large, standard diesel being taxed at 57.95 pence per litre, while Red Diesel is taxed at only 11.14 pence per litre.

This discount on fuel tax is currently permitted on about 15% of UK diesel sales and amounts to approximately £2.4 billion in foregone revenue for the Treasury.

Restricting the exemption will, according to the Treasury’s own calculations, reduce this foregone revenue to £800,000 a year and so add approximately £1.575 billion per year to the UK’s fuel costs in 2022/3, rising to £1.645 billion in 2024/5. These monies will pass to the Exchequer.

The Budget is, unsurprisingly, not specific about who will pay for this dramatic increase in fuel taxation, describing only those who will retain permission to use Red Diesel, namely agriculture, horticulture forestry, pisciculture, rail and non-domestic heating (including domestic heating) (para 2.231).

However, Her Majesty’s Revenue and Customs (HMRC) provides clear descriptions of the current exemption, from which we can infer that unless they fall into the categories still exempted by Mr Sunak above, the new higher rate of taxation on diesel will affect consumers using the following currently Excepted Vehicles:

• Unlicensed vehicles not on public roads

• Mowing machines

• Snow Clearing Vehicles

• Gritters

• Mobile Cranes

• Mobile Pumping Vehicles

• Digging Machines

• Works Trucks

• Road Rollers

• Road surfacing machines

• Tar Sprayers

As will be immediately apparent from this list the removal of the red diesel discount is focused generally on the construction industry, who are already warning that the cost of house building will rise by £5,000 a house, and rather also specifically on the road repair and maintenance sector.

Many of these road-related vehicles, snow clearers, gritters, road surfacing machines, are used by local authorities and other governmental agents or their contractors. The Treasury itself admits in the supplementary Budget 2020: Policy Costings document that about £150 million a year will have to be added to the “resource Departmental Expenditure Limit” (RDEL) because of an increase in the tax on diesel (Policy Costings, p. 20).

However, the Treasury analysis does not appear to take into account the full impact on Local Authorities, will now find not only their  direct expenditure on diesel rising, but will also see an increase in the cost of "Framework" contractors, such as Balfour Beatty, employed for road maintenance and construction, or for gritting and snow clearing. The impact on other infrastructure projects, major and minor, flood defences for example or HS2, will also clearly be significant.

There will consequently be a pressure to either increase local authority revenue from council tax and central government grant funding, or to cut back on infrastructure development and maintenance. Neither of these options will be popular, but that is is the character of carbon taxation. It brings out and identifies the full cost of climate policies. Everything becomes visibly more expensive. The Treasury’s preference is certainly likely to be more economically efficient, but it may not be good politics.

Dr John Constable, GWPF Energy Editor