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Environmental taxes need to focus on impact, not revenue raised

16 February 2021: The NAO has said that environmental taxes are making a positive impact, but too little is known about their overall effect.

The National Audit Office (NAO) has issued a report on environmental tax measures, which states that HM Treasury and HMRC have only a limited understanding of the impact they have on the environment.

The NAO comments that: “The scale of government’s environmental ambitions, particularly on net zero, means government needs to consider every tool at its disposal if it is to succeed. The exchequer departments need to fully understand the relationship between existing taxes and these ambitions, to ensure the taxes contribute as intended, and to learn lessons for any future taxes which may support wider environmental strategies. HM Treasury’s review of how the transition to net zero will be funded is an important first step in this process.”

The report identifies four taxes with explicit environmental objectives that seek to tax goods or services that harm the environment and to incentivise businesses and citizens to change their behaviour, in addition to considering other taxes that have a positive or negative effect on the environment or which will help or hinder progress to net zero. 

The Climate Change Levy, Carbon Price Support, Landfill Tax and Aggregates Levy together raised £3.1bn in 2019, but it is not clear how big an impact they have had on encouraging “green” behaviours. For comparison, they raised a lot less money than Fuel Duty and Air Passenger Duty, which together generated £31.6bn in the same year and are likely to have a much larger impact on environmental behaviours.

In their report, the NAO looks at how HM Treasury and HMRC currently manage environmental tax measures and how they assess the economy, efficiency and effectiveness of administering and overseeing taxes by government departments. The challenge for HMRC and Treasury, as the NAO also found, is in how to demonstrate the environmental impact taxes have beyond the simple end of just raising money.

The NAO found that the government does not quantify all potential costs before recommending options when designing environmental taxes or tax policies. For example, no quantification had taken place of the likely administration costs business would incur from the proposed plastic packaging tax, as these are seen as inherently difficult to estimate.

The NAO recommends that more is done to assess the success of each environmental tax measure after implementation. There need to be clear objectives of the environmental impact it aims to achieve, be that reducing plastic packaging by x% or having a carbon saving of y tonnes. Otherwise, it is very difficult for Parliament to scrutinise the effectiveness of policy measures.

For example, while the Landfill Tax has been successful in reducing the use of landfill sites, it has also led to greater illegal waste disposal. Clearing up illegal waste has a cost, and together with the misclassification of waste at unauthorised sites amounts to an estimated £275m lost in landfill tax revenue each year.

Other taxes that have an impact on the environment such as Fuel Duty and Air Passenger Duty are not currently assessed for behavioural impact but are primarily looked at in terms of their revenue-raising capacity. However, there is an increasing recognition that ministers want to know the environmental impact taxes have if the government is to achieve its environmental and net-zero objectives. 

Tax reliefs can also have an environmental impact, such as the lower rate of VAT for the installation of energy-saving equipment, which has been costed at £70m for 2019-20. However, other similar reliefs have not been costed, leading to HMRC holding limited information on which to make evaluations.

A major finding of the report is that there is no central overview of how the tax system impacts on overall government environmental goals. Although HMRC and Treasury work with different government departments leading on environmental strategies they do not map out the role of the tax system in helping the government achieve its environmental objectives or set out the interaction between the tax system and other policy tools.

Key recommendations for HMRC and other tax-raising departments to address include the need to better:

  • identify and monitor existing tax measures with a significant environmental impact;
  • clarify and set down their approach to designing, administering and evaluating tax measures with environmental or other policy objectives;
  • develop clear criteria for prioritising which taxes with an impact on the environment to evaluate, taking into account risks to value for money and the costs of evaluation;
  • quantify and publish the expected environmental impact of changes to taxes, where significant;
  • work with other departments to make visible how existing tax measures affect environmental goals; and
  • monitor the long-term impact of the government’s environmental goals on tax revenue and ensure these are considered as part of risk management.

A positive message from the NAO is that these concerns are increasingly understood by the Government. HM Treasury is due to issue a report this year on incorporating climate considerations into fiscal events and spending reviews and work is underway to consider what policy levers are needed to meet net-zero. This includes adopting a more strategic approach in how the tax system can be used to help achieve environmental objectives.

Alison Ring, Director, Public Sector for ICAEW, commented: “Well-designed tax policies have the potential to play a key part in helping the government succeed in its ambitious environmental objectives, including the significant challenge it has set itself of delivering net-zero carbon emissions by 2050. 

“Not only does HMRC need to better understand the impact of environmental taxes themselves, but it also needs to consider how the tax system can be used more effectively to drive change in the way the economy and society operates to deliver a sustainable environment.”

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