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IFS - Revenue from fuel duties down by nearly 1% of national income (£19bn) since 2000; £28bn still to be lost if we don’t act soon

Prime Minister Boris Johnson is said to be pressing for fuel duties to be cut by 2p per litre in the upcoming Budget. This would cost £1 billion a year in lost revenue on top of the £5.5 billion lost since 2010–11 arising from the failure to increase rates in line with CPI inflation.

Revenue from fuel duties now stands at £28 billion a year, which is 1.3% of national income. Revenue peaked at 2.2% of national income in 1999–2000. Had it remained at that level, the exchequer would currently be getting an extra £19 billion.

In any case, the government’s commitment to reaching zero net emissions by 2050 means that revenue from fuel duties will completely disappear over the next few decades. This is a huge long-run fiscal challenge for the government.

This also presents a further economic and social challenge. Taxes on motoring help to correct for the social costs generated by people’s driving. These include congestion, greenhouse gas emissions, local air pollution, noise, accidents and damage to infrastructure. By far the biggest of these – estimated by the government at around 80% of the total social cost – is congestion, a cost which will remain after the transition to electric cars.

We need to design new taxes which can gradually replace fuel duties. These should reflect at least distance driven, and ideally vary according to when and where journeys take place. Those driving in busy places would pay more, but the majority of journeys would be taxed less heavily than at present.

There is an advantage in acting quickly: it will be much harder politically to introduce such taxes only after revenue from fuel duties has fallen much further and many people are driving hybrid or electric cars in the expectation of paying little tax on them.

These are among key findings of a chapter from the IFS Green Budget, funded by the Nuffield Foundation and Citi and pre-released today. Other key findings include:

  • Fuel duties are not regressive as is often claimed. They take about the same fraction of the budget of low-, middle- and high-income households on average. However, looking only at households with a car, fuel duties take more of the budget of low-income drivers;
  • Fuel taxes account for more than 10% of the (non-housing) spending of about one household in 20. This is a heavy burden for those who have little choice over how much they drive;
  • The only justification for retaining the annual vehicle excise duty (VED) on car ownership is if the government rules out using fuel duties to raise revenue in its place. Similarly, company car tax should not be linked to emissions if the government can set fuel taxes and the VED ‘showroom tax’ appropriately.
  •  To effectively correct for the social costs of motoring – particularly as we move to more efficient and electric cars – we need to look beyond existing taxes. The ideal approach would be a system of road pricing with charges varying by time and location. Failing that – or, better, as a stepping stone towards it – there is a case for introducing a flat rate tax per mile driven to supplement reduced revenue from fuel duties and help correct for the social costs of driving.

Rebekah Stroud, co-author of the report and a Research Economist at the IFS, said:

“Cuts to fuel duties over the last two decades have contributed towards revenues’ being £19 billion a year lower than they would have been. Another 2p cut, as reportedly mooted by the Prime Minister, would cost a further £1 billion a year. The bigger challenge is that revenues are now set to disappear entirely over coming decades as we transition to electric cars. The government should set out its long-term plan for taxing driving, before it finds itself with virtually no revenues from driving and no way to correct for the costs – most importantly congestion – that driving imposes on others.”

A road map for motoring taxation

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