FULL REPORT & ANALYSIS: The National Audit Office (NAO) – the government’s independent auditor – says that the Chancellor of the Exchequer’s departments of the Treasury, HM Revenue & Customs (HMRC) don’t know enough about the effects of environmental taxes.
It comes ahead of a Treasury review of how the transition to net-zero will be funded. A key part of this will be replacing the £32bn raised each year by fuel duty and air passenger duty.
The report shows that the four existing environmental tax measures, which raised £3.1bn last year, was dwarfed by the £16.8bn in ‘tax breaks’ designed to achieve economic goals, such as increasing investment, encourage public transport use and reduce fuel poverty.
The report says that “while there is some evidence of the positive impact that taxes can have on the environment, too little is known about their effect.”
“Taxes are one of the tools available to government in pursuing its ambitious environmental goals. HM Treasury’s review of how the transition to net zero will be funded is an important first step in this process.”
Gareth Davies, Head, National Audit Office
It adds that the Chancellor’s departments only “have a limited understanding of how far the tax system supports government’s environmental objectives.”
The effect of taxation and its use in the green agenda and route to net-zero can be a powerful tool and will be under increasing scrutiny and lobbying over the coming year.
Work closely together, call
In a comprehensive 64-page report published today (download below), the NAO says that the Treasury and HMRC should work closely with other departments to ensure that current and future taxes are compatible with the environmental strategies being developed across government.
The NAO audits the financial accounts of departments and other public bodies. It also examines and reports on the value for money of how public money has been spent.
Commenting on the report NAO Head Gareth Davies says: “Taxes are one of the tools available to government in pursuing its ambitious environmental goals.
“While there is some evidence of the positive impact that taxes can have on the environment, too little is known about their effect.
“HM Treasury’s review of how the transition to net zero will be funded is an important first step in this process.”
Limited understanding
Today’s report from the National Audit Office (NAO) has found that HM Treasury and HM Revenue & Customs (the exchequer departments) have a limited understanding of how far the tax system supports government’s environmental objectives.
Tax measures can be an important tool in implementing environmental policy, by taxing goods or services which harm the environment and incentivising businesses and citizens to change their behaviour.
The exchequer departments administer four taxes with explicit environmental objectives (environmental taxes) – Climate Change Levy; Carbon Price Support; Landfill Tax; and Aggregates Levy. These taxes raised £3.1 billion in 2019. The government plans to introduce a fifth – the Plastic Packaging Tax – from April 2022.
policy, by taxing goods or services which harm the environment and incentivising
businesses and people to change their behaviour
When designing environmental taxes, the exchequer departments carry out many important practices the NAO would expect, such as consulting with stakeholders and ensuring taxpayers get advance warning so they can prepare.
However, they “do not quantify all costs” and “rarely specify how they will measure environmental impact” to allow Parliament to assess if taxes are meeting their objectives.
The NAO has found that HMRC only has limited insight into the environmental impact of taxes.
Landfill Tax: Too many unknowns
HMRC has formally evaluated the impact of Landfill Tax but has not carried out any further evaluations of the impact of environmental taxes.
In 2020, HMRC developed a single strategy for reducing the risks that environmental taxes are not paid.
However, HMRC only has a partial understanding of the tax gap (the gap between tax due and collected) for three of the four environmental taxes.
Landfill Tax has reduced use of landfill sites significantly, but it has also incentivised more illegal disposal of waste.
Between 1998 and 2014 HM Treasury increased the standard rate of Landfill Tax by 700% in real terms, contributing to a 65% fall in total waste to landfill over the period.
However, HMRC estimates that the misclassification of waste at authorised landfill sites and waste disposed at unauthorised sites reduced Landfill Tax revenue by around £275 million (28% of tax due) in 2018-19.
This figure does not include any revenue lost from illegal exports of waste and fly-tipping.
HMRC has sought to reduce tax lost by increasing its compliance work and extending the scope of the tax to unauthorised sites.
In 2020, government established a waste crime unit, including HMRC, to tackle the illegal disposal of waste. This includes HMRC, the National Crime Agency, the Environment Agency and others.
Wrong measures? Revenue raised v environmental impact
In addition to the four environmental taxes, there are other taxes that have an impact on the environment, such as fuel duty and Air Passenger Duty, which do not have an explicit environmental objective.
The exchequer departments told the NAO that they measure the performance of these taxes primarily in terms of revenue raised.
“The fact that neither Treasury nor HMRC can say what impact environmental taxes are having on the environment speaks volumes”
Meg Hillier MP, Chair, Public Accounts Committee
However, they are increasingly considering their environmental impact, for example in the 2020 Budget it was announced that the government would restrict entitlement to the reduced rate of fuel duty on diesel used in off-road vehicles, specifically to improve air quality and reduce CO2 emissions.
More widely, HMRC has not identified the tax reliefs which could impact on government’s environmental goals.
From published material, the NAO has identified eight tax reliefs with a specific environmental goal or purpose, including a lower rate of VAT for the installation of energy saving equipment (which cost around £70 million in 2019-20).
The NAO also identified that five of the largest 25 tax reliefs supporting government’s wider objectives could impact on the cost of producing or consuming products made from or using fossil fuels.
Each of the five reliefs cost between £2 billion and £5 billion in 2019-20.
The NAO recommends that the exchequer departments should identify and monitor existing tax measures with a significant environmental impact.
No central oversight
The exchequer departments “do not centrally oversee how the tax system impacts on government’s environmental goals.”
While the Department for Environment, Food & Rural Affairs (Defra) and the Department for Business, Energy & Industrial Strategy (BEIS) have overall responsibility for government’s environmental objectives, HM Treasury is responsible for strategic oversight of the tax system.
There are “good examples” where planned changes to tax measures were considered in environmental strategies developed by Defra and BEIS, but the “different routes for announcing tax and regulation and spending decisions” make government-wide approaches “challenging to develop.”
How to fund net zero?
In November 2019 HM Treasury began a review, which will conclude in 2021, into how the transition to net zero should be funded.
The review’s interim report highlights that tax, regulation and spending are all important tools to support government’s efforts to get to net zero.
The final report will look in more detail at how HM Treasury could incorporate climate considerations into spending reviews and fiscal events, and how to embed the principles of the review into policy making across government.
HM Treasury and HMRC have told the NAO the report will also look at the environmental impact of other tax measures which do not necessarily have the environment as a core objective.
Current and future taxes
HM Treasury and HMRC administer four taxes with explicit environmental objectives (referred to as environmental taxes).
- Climate Change Levy – a tax collected by energy suppliers and paid by businesses and the public sector to encourage them to become more energy-efficient and thereby reduce greenhouse gas emissions.
- Carbon Price Support – aims to drive electricity generators to invest in low-carbon electricity by increasing the cost of the fossil fuels they use. The Climate Change Levy and Carbon Price Support raised £2.1bn in 2019.
- Landfill Tax – a tax on landfill operators to divert waste from landfill to other less harmful methods of waste management (raised £600m in 2019).
- Aggregates Levy – a tax to encourage the use of recycled materials over the extraction of rock, sand and gravel which can damage the environment (raised £400m in 2019, including from quarry operators).
Other HMRC-administered tax measures can also affect the environment. In particular:
- Two taxes whose primary purpose is to raise revenue – fuel duty and Air Passenger Duty – may contribute to government’s commitment to reduce CO2 emissions and improve air quality;
- Some tax reliefs have an environmental purpose and reduce the amount of tax due on non-environmental taxes when taxpayers use some environmentally friendly products or services such as low-carbon vehicles and installation of energy-saving products
- Tax reliefs introduced for other purposes. For example, VAT is charged at a lower rate of 5% on domestic fuel and power.
Environmental taxes may have a larger role to play in the future in view of the government’s environmental goals, but this will depend on ministerial decisions.
The government is planning to introduce a fifth environmental tax – the Plastic Packaging Tax – in April 2022.
HM Treasury is conducting a review into how the UK’s transition to a net zero economy should be funded and is due to issue the final
report in 2021.
The terms of reference for the review set out that the government will
consider a full range of levers, including tax.
Call for ‘all levers to be pulled’
Commenting on the report, Meg Hillier MP, Chair of the Public Accounts Committee says: “Those holding the purse strings in government have a crucial role to play in tackling the climate crisis.
“The fact that neither Treasury nor HMRC can say what impact environmental taxes are having on the environment speaks volumes.
“Even more worrying is the possibility that these taxes are incentivising harmful behaviour – landfill tax has resulted in more illegal dumping of waste.
“Government must start effectively pulling all of its available levers if it’s to have any hope of achieving its environmental goals.”
About the NAO
The National Audit Office (NAO) scrutinises public spending for Parliament and is independent of government and the civil service.
It helps Parliament hold government to account and it use its insights to help people who manage and govern public bodies improve public services.
The Comptroller and Auditor General (C&AG), Gareth Davies, is an Officer of the House of Commons and leads the NAO.
The NAO audits the financial accounts of departments and other public bodies. It also examines and reports on the value for money of how public money has been spent.
In 2019, the NAO’s work led to a positive financial impact through reduced costs, improved service delivery, or other benefits to citizens, of £1.1 billion.
