Net zero and UK tax policy

Update: The government has now responded to the report. For more information on the government’s response, see Responding to the Net Zero recommendations: tax.

On 13 January, Chris Skidmore MP published a report, Mission Zero: Independent Review of Net Zero. This report was commissioned by the government in September 2022 to consider how the net zero target might maximise economic growth whilst also increasing energy security and affordability for consumers and businesses. The Report contains a number of recommendations in relation to tax policy as well as highlighting a number of other areas where stakeholders made suggestions as to how tax changes might incentivise the move to net zero.

Background

In the lead up to COP26 in Glasgow, the government published a report on the likely impact of a move to a net zero carbon status by 2050. In the report, Net Zero Review, the government emphasised the likely costs to the public purse of the transition over the next 30 years, and the fact that these will need to be met either by higher taxation or reduced spending (or both). However, the report fell short of indicating any particular tax changes that may need to be introduced and, despite calls from a number of bodies, such as the Institute for Government, there has been little in the way of development of a tax strategy for a move to net zero. The 2023 Report by Chris Skidmore MP may be the first step towards such a strategy.

Tax policy recommendations

The Report stresses that tax policy to incentivise growth and decarbonisation is needed. The government should use a balanced approach of tax incentives and disincentives to encourage economic activity that meets the dual objective of growth and decarbonisation.

In this context, the Report notes that some tax measures are already in place to support decarbonisation, but these largely target the power sector via Carbon Price Support, broader business energy efficiency via the Climate Change Levy and Climate Change Agreement Joint Incentives and the waste sector via the Plastic Packaging Tax, Landfill Tax and Aggregates Levy. The Report recommends that a net zero tax audit should be undertaken to help to ensure that the taxes not defined as ‘environmental’ also support the transition.

The Report also notes that other countries have been utilising tax incentives to drive growth and decarbonisation. Most recently the USA has developed a tax credit policy offer for businesses in the 2022 Inflation Reduction Act, while the Canadian Government has offered a similar policy but in the form of a tax credit to lower the cost of capital in clean technologies and hydrogen production. This aims to encourage businesses to more actively participate in, and seek to directly financially benefit from, the transition to net zero and provide greater energy security. Clearly, the UK should be mindful of the policy choices made by other countries, as they are made within a political context.

Capital allowances

The Report includes as a main recommendation: “By Autumn 2023, HMT should review how policy incentivises investment in decarbonisation, including via the tax system and capital allowances.” The Report notes that the existence of the current super-deduction and additional first year allowances (until March 2023) are welcome, but specifically recommends that HM Treasury should, as part of a wider review, consider a successor to these schemes that focusses on increasing investment in low-carbon technologies.

It will be remembered that the then Chancellor, Rishi Sunak, launched a review of capital allowances back in May 2022, with the publication of a policy paper by HM Treasury, but the outcome of that review, if any, is still awaited. As such, that review offers the opportunity for the government to consider targeted measures.

However, the Report also recognises that not all businesses are likely to benefit from higher capital allowances at this time when cash is short and other expenses high. Many businesses pointed out that direct grants and/or loans would be a better way of incentivising (and enabling) capital expenditure on decarbonisation technologies. Accordingly, the Report recommends that as part of a wider review into the tax system to incentivise investment in decarbonisation, the government should explore the effectiveness of tax reliefs for businesses in encouraging investment, when energy costs are so high.

R&D incentives

The Report also recommends that: “By Autumn 2023, Government should review how to incentivise greater R&D for net zero, including considering the role of clarity on research priorities and government support, tax credits, greater ring-fencing of R&D spend, and enabling regulations.”

The timing of this recommendation is apposite, given that the government has just launched a review into merging the two existing R&D incentive schemes in the UK. That consultation does indeed raise the question whether, and if so how, R&D incentives might provide more targeted support for ‘green technology’. However, contributors to the Report suggested that the government should go further and offer similar style incentives going beyond R&D to incentivise the application of low carbon technologies that advance the net zero transition.

VAT

The Report highlights the fact that the UK has introduced a zero-rate of VAT for certain energy saving products and their installation until 2027. These include items such as heat pumps and solar panels. The Report recommends that this policy should be maintained permanently.

In addition, the Report highlights that repairing goods has a much lower carbon footprint than replacing products. However, repair can often be more expensive than replacement. One measure to make repairing products more affordable could be the introduction of a zero-rate of VAT on all repairs for individuals.

However, the only official recommendation is that the government should “equalise VAT on public and private electric vehicle charging in 2024”. Currently VAT is charged on domestic energy bills at 5%, but on public electric vehicle charging at the standard rate of 20%. Notably, however, the Report does not actually recommend a rate at which the two should be equalised.

Carbon leakage

In relation to the issue of carbon leakage (the displacement of production and associated emissions from one jurisdiction to another, due to different levels of climate action across jurisdictions including through carbon pricing measures), the Report recommends that the government “should progress with the consultation on carbon leakage measures and speed up decision-making to enable Government to implement effective carbon leakage mitigations from 2026”.

In particular, respondents to the Report were in favour of a Carbon Border Adjustment Mechanism (CBAM) similar in design to the EU’s as a policy to mitigate carbon leakage. A CBAM would apply the UK ETS price to imported goods, ensuring that UK producers and consumers play on a level playing field. Encouraging UK industry to decarbonise without applying similar standards and costs to imported materials and goods risks making the UK uncompetitive.

SDLT

The Review heard calls for an energy-adjusted Stamp Duty Land Tax, which would encourage owners to improve the energy performance of their homes, boosting the energy efficiency retrofit market.

Business rates

On business rates, the Report recommends that the government should continually assess the existing business rates incentives to ensure there are no further inadvertent disincentives for businesses to invest in net zero technologies. For example, up to 50% of business investment is potentially subject to business rates such as property improvements. Exemptions are needed for eligible green plant and machinery such as solar panels, wind turbines, battery storage used with renewables and electric vehicle charging points and low carbon heat networks.

Accordingly, HM Treasury should consider the balance between increasing business rates and the use of business rates in supporting business growth and decarbonisation.

Electric vehicles

The Report notes that though government grants for electric vehicles have ended, incentives remain in place to promote uptake, including exemptions from vehicle excise duty (until 2025).

Of course, as part of its identification of the fiscal challenges of the move to net zero, the 2021 Report highlighted the reduction in fuel duty as motorists move away from petrol to electric. Fuel and Vehicle Excise Duty (VED) contributes £37bn in tax revenues (in 2019/20) and the report noted that should the current tax system remain unchanged, then tax receipts from this source would gradually reduce towards zero by 2050. Given that VED currently amounts to some 1.7% of GDP, this would have an unsustainable impact on public finances.

However, apart from recommendations around balancing VAT on public and private charging and a general exhortation that the government “should maintain and deliver on planned regulations, funding, and incentives to accelerate electric vehicle uptake and avoid undermining progress”, there is no mention of the particular issues around replacement of VED in the 2023 Report.