The Treasury has finally shared its assessment of the economic implications of net zero. While it signalled an acceptance of the benefits of action to tackle climate change, and was positive about some of the co-benefits, it lacked detail on who will pay, failed to spell out how it will fill the hole in the public finances left by the switch to electric vehicles, and offered only vague hints about a tax strategy to support the transition to net zero. While the short-term politics of this cautious approach are clear, it brings long-term risks.

The net zero review pours some cold water on prime ministerial boosterism

The review echoed the prime minister’s positive messages about investment and jobs, but with an added pouring of cold water. It pointed out that while some green investments would boost productivity, with positive multipliers, those benefits were likely to decrease over time as diminishing returns set in, and some investments, in carbon capture for example, would do nothing for productivity. Moreover it pointed out that the boost to jobs from new investment only came if there was surplus capacity in the economy.

The review did not answer question of who pays

In terms of the profile of costs, the Treasury used the estimates from the Business, Energy and Industrial Strategy department, which were very similar to those produced by the Climate Change Committee. In its assessment of potential revenues, the Treasury assumed a lower carbon price than that used by the OBR in its recently published fiscal risks scenario. 

Anyone hoping for a detailed distributional analysis will have been left disappointed. The Treasury argued there was too much technological uncertainty – and too much variation among households with similar incomes to be definitive about the costs they would face. But what they did make clear was that, because of those very uneven effects, help would come in the form of targeted grants rather than more general tax and benefit changes.  

The Treasury is reluctant to burden future generations with the costs of transition

The most eye-catching economic judgment made in the report is that the Treasury sees no case for a “green carve out” from its fiscal rules for the net zero transition. So the government does not intend to borrow more to pay for the one-off costs needed to get to net zero, but if fiscal rules allow (for example) 3% of GDP investment per year, then net zero investment can be included within that amount (potentially at the expense of other capital projects).

The Treasury provides a range of justifications – from the polluter pays principle to inevitable future fiscal pressures. But this hard line on additionality should give investors in their much vaunted “green gilts” pause for thought: it underlines the fact that the Treasury is using this to fund conventional government borrowing a bit more cheaply by tapping into green sentiment.

How much to fund the transition through public spending and borrowing is likely to be a big dividing line, not just between government and opposition, but within the government itself. This Treasury hard line shows every sign at having been drawn to rein in Rishi Sunak’s neighbour in No.10.

Additional costs would be met through revenues from expanded emissions trading

One source of funding for support through the transition would be revenues generated by an expanded emissions trading scheme. It makes sense to use these sort of temporary revenues to cover one-off costs.

The Treasury makes it clear that the government prefers this route to a rising carbon tax, which would probably be the first choice of the purist economist. That may be a recognition, based on experience, that it is easier to see carbon prices rise as a result of tightening emissions caps, than expecting chancellors to stick with annual tax increases. The lengthy freeze on fuel duty has shown that good economics can be impossible politics.

The report acknowledges that a rising carbon price could damage UK competitiveness. But the Treasury is much less keen on a carbon border adjustment mechanism – to protect domestic industry – than its counterparts in the EU or Canada, who are considering it. It says the way forward is international agreement. But absent that agreement, this could prove a real constraint on how high the domestic carbon price could go.

There are hints on how the tax system might adjust to net zero

The government has also indicated that over time it will seek to address the fact that high carbon gas is taxed much less heavily than lower carbon electricity. But not yet. Instead it has launched a “Fairness and Affordability” call for evidence.

But ministers are reluctant to say what might fill the gaping hole in the public finances that will be left by the switch to electric vehicles. That was absent from the summer transport decarbonisation strategy, and yet again they have been deaf to calls to start rolling the pitch for a move to road pricing or another alternative. What is filling that gap now are lurid headlines about higher taxes to come – rather than a shift within the same overall tax burden. The longer the future is left unclear, the more drivers of electric vehicles become used to less-heavily taxed motoring and the harder it is to make any move.

There is no commitment to a comprehensive review of net zero and the tax system

The government’s net zero strategy contained a hint that the current review of tax credits for research and development might lead to some changes to support net zero. But beyond that there was no hint in either the Treasury review or the wider strategy of any broader look at the tax system and net zero of the sort we proposed. The chapter on embedding net zero in government said there would be a net zero test for public spending – but yet again the Treasury has exempted its fiefdom of tax policy from that burden.

The Treasury will see this review as putting down some useful markers and drawing some lines within government. But it is a missed opportunity to spark an honest public debate about the scale and nature of the changes required.

Original source – The Institute for Government

Comments closed