Fuel duty: the hidden costs

Fuel duty rose by 2p this week, the third increase in the last ten months. Governments tend to view petrol taxes as a convenient source of revenue when budget deficits are high. Indeed, the last Conservative government increased fuel duty dramatically in the mid-1990s, introducing a tax escalator at the tail end of the last recession.

The demand for fuel is relatively inelastic, meaning that higher prices do not lead to a big fall in consumption. The tax is also relatively cheap to collect, difficult to evade and can be justified rhetorically on environmental grounds.

But despite these political advantages, fuel duty has harmful hidden effects that politicians rarely discuss. One of these is the impact of higher travel costs on labour mobility.

Employment is not worthwhile when travel-to-work expenses are too high, particularly given the availability of welfare benefits to the unemployed. And subsidised public transport typically offers restricted access to workplaces – perhaps only to town centres and narrow route corridors. Opportunities may therefore be severely limited for job-seekers taxed and regulated out of car ownership or unable to afford inflated running costs. 

The result is not just additional unemployment. Businesses may also face higher labour costs as the pool of potential employees is reduced. In addition, transport taxes tend to decrease the number of potential customers by shrinking the area within which exchange is profitable. In wider economic terms, competition is stifled, economies of scale are lost and the deepening of the division of labour is suppressed – with the knock-on effect of lower productivity growth.

The tax receipts from higher fuel duty rates are therefore likely, in the long run, to be undermined by the general losses to the Treasury associated with the higher costs imposed on the production of wealth. In the context of Britain’s worst-ever peacetime fiscal crisis, and an apparent unwillingness to make significant cuts to public spending, the latest tax rise may be yet another example of short-term political expediency overriding the imperatives of longer-term economic efficiency.

All taxes are problematic, but I’m not sure I agree with your drift on this. I would sooner see taxes on fuel than payroll taxes or income tax, which are likely to have a more significant effect on employment. Lower public spending preferable to either.

Len – I agree that payroll taxes or income tax are particularly undesirable in terms of employment. However, the problem with fuel duty is that it taxes one particular economic activity at a punitive rate, close to 70%, which means its distorting effects are very pronounced. There is a strong argument for having low rates across the board rather than the huge variation we see now.

Of course, Richard Wellings doesn’t mention that many people are forced to travel long distances to work because stamp duty on house purchases is so high – people simply can’t afford to move closer to work, so find it very difficult to avoid or minimise fuel duty.Richard Wellings also doesn’t mention is that fuel tax isn’t just a tax like any other. There is a cost to using roads – those roads have to be provided, maintained and policed, so it’s right that there is a tax approximately proportional to their use (admittedly, road charging is another – though expensive to collect – solution). Is fuel tax is approximately in line with those costs, including a return on publicly owned assets.

HJ – It’s not just stamp duty. The planning system stops settlements adapting to changing economic conditions, leading to inflated house prices in boom areas, which in turn raise the costs of relocation.With regard to fuel duty, motoring taxes exceed road expenditure by a factor of about four. The ratio is rather worse for car drivers since heavy goods vehicles do far more damage to the roads. The situation regarding a return on assets is complicated as construction was funded through taxation and market prices are largely absent. Privatisation and pricing, at least of trunk roads and motorways, could help resolve this problem. See the final chapter of The Railways, the Market and the Government (which also deals with environmental costs).

Vehicle-fuel duty supposedly serves a dual purpose – partly revenue-raising, partly Pigovian internalization of social costs. It appears to be heavily over-priced for the latter purpose, compared to other activities with similar social costs. It is also not obvious why this particular form of energy-use should be targeted as a source of tax-revenues, so much more heavily than other forms. As Richard says, it distorts economic choices. Full road-pricing involves excessive intrusion and transaction costs, but moving some motoring costs to a Swiss-style vignette system on major roads, and re-balancing the externality-pricing mechanisms across all energy-consumption would be a big improvement.

Richard – I was well aware that HGVs proportionately do far more damage to the roads and cause more accidents than cars. Independent assessments have shown that, if anything, HGVs are undertaxed. Quite simply, we are subsidising companies to move things around. Perhaps the likes of Tesco would think twice about centralised sourcing and depots if they had to pay the full cost of their transport.Whether or not road construction was funded by taxation isn’t irrelevant. There is a publicly owned asset on which the government should be seeking a reasonable return from users so that general taxpayers can be taxed less in future.

HJ – There are enormous difficulties calculating whether or not HGVs are ‘undertaxed’ in the absence of market prices. Moreover, one should not forget that HGVs are heavily regulated, so very substantial additional costs are imposed by government on hauliers and their customers, such as statutory weight limits, vehicle emissions standards etc. Placing as many roads as possible in the private sector is surely the solution to the asset question. On restitution grounds, there may be a case for allocating shares to motorists and/or other taxpayers rather than conducting a conventional flotation. Moreover, the government would almost certainly squander the proceeds of a sell off.

Well yes the ideal response to global warming should be a carbon tax, but this doesnt seem to be happening, and at least a tax on petrol is targetting one significant contributor. It is also a tax that relatively speaking can be imposed unilaterally without a big competitive impact on the national economy. So I dont really understand why in the current employment environment we are not reducing NI and putting even more onto petrol. Obviously the transport lobby will create a fuss because it will impact the business but if you want to address this particular environmental issue you are not going to be able to get around that.

All taxes are problematic, but I’m not sure I agree with your drift on this. I would sooner see taxes on fuel than payroll taxes or income tax, which are likely to have a more significant effect on employment. Lower public spending preferable to either.

Len – I agree that payroll taxes or income tax are particularly undesirable in terms of employment. However, the problem with fuel duty is that it taxes one particular economic activity at a punitive rate, close to 70%, which means its distorting effects are very pronounced. There is a strong argument for having low rates across the board rather than the huge variation we see now.

Of course, Richard Wellings doesn’t mention that many people are forced to travel long distances to work because stamp duty on house purchases is so high – people simply can’t afford to move closer to work, so find it very difficult to avoid or minimise fuel duty.Richard Wellings also doesn’t mention is that fuel tax isn’t just a tax like any other. There is a cost to using roads – those roads have to be provided, maintained and policed, so it’s right that there is a tax approximately proportional to their use (admittedly, road charging is another – though expensive to collect – solution). Is fuel tax is approximately in line with those costs, including a return on publicly owned assets.

HJ – It’s not just stamp duty. The planning system stops settlements adapting to changing economic conditions, leading to inflated house prices in boom areas, which in turn raise the costs of relocation.With regard to fuel duty, motoring taxes exceed road expenditure by a factor of about four. The ratio is rather worse for car drivers since heavy goods vehicles do far more damage to the roads. The situation regarding a return on assets is complicated as construction was funded through taxation and market prices are largely absent. Privatisation and pricing, at least of trunk roads and motorways, could help resolve this problem. See the final chapter of The Railways, the Market and the Government (which also deals with environmental costs).

Vehicle-fuel duty supposedly serves a dual purpose – partly revenue-raising, partly Pigovian internalization of social costs. It appears to be heavily over-priced for the latter purpose, compared to other activities with similar social costs. It is also not obvious why this particular form of energy-use should be targeted as a source of tax-revenues, so much more heavily than other forms. As Richard says, it distorts economic choices. Full road-pricing involves excessive intrusion and transaction costs, but moving some motoring costs to a Swiss-style vignette system on major roads, and re-balancing the externality-pricing mechanisms across all energy-consumption would be a big improvement.

Richard – I was well aware that HGVs proportionately do far more damage to the roads and cause more accidents than cars. Independent assessments have shown that, if anything, HGVs are undertaxed. Quite simply, we are subsidising companies to move things around. Perhaps the likes of Tesco would think twice about centralised sourcing and depots if they had to pay the full cost of their transport.Whether or not road construction was funded by taxation isn’t irrelevant. There is a publicly owned asset on which the government should be seeking a reasonable return from users so that general taxpayers can be taxed less in future.

HJ – There are enormous difficulties calculating whether or not HGVs are ‘undertaxed’ in the absence of market prices. Moreover, one should not forget that HGVs are heavily regulated, so very substantial additional costs are imposed by government on hauliers and their customers, such as statutory weight limits, vehicle emissions standards etc. Placing as many roads as possible in the private sector is surely the solution to the asset question. On restitution grounds, there may be a case for allocating shares to motorists and/or other taxpayers rather than conducting a conventional flotation. Moreover, the government would almost certainly squander the proceeds of a sell off.

Well yes the ideal response to global warming should be a carbon tax, but this doesnt seem to be happening, and at least a tax on petrol is targetting one significant contributor. It is also a tax that relatively speaking can be imposed unilaterally without a big competitive impact on the national economy. So I dont really understand why in the current employment environment we are not reducing NI and putting even more onto petrol. Obviously the transport lobby will create a fuss because it will impact the business but if you want to address this particular environmental issue you are not going to be able to get around that.

Post new comment

The content of this field is kept private and will not be shown publicly.
Type the characters you see in this picture. (verify using audio)
Type the characters you see in the picture above; if you can't read them, submit the form and a new image will be generated. Not case sensitive.

Invest in the IEA. We are the catalyst for changing consensus and influencing public debate.

Donate now

Thank you for
your support

Subscribe to
publications

Subscribe

eNEWSLETTER