UK government freezes fuel duty again, establishes Roads Fund and fiddles with Vehicle Excise Duty

Since 1936, when the previous Road Fund was wound up, the UK Treasury has been vehemently opposed to any form of tax hypothecation (dedication of revenue for one purpose).  The primary argument against it is that it reduces the flexibility of government in the use of its revenue, and can result in the hypothecated fund having too much money, and so spending on that purpose ends up being wasted.  

It would appear that all of that has been pushed to one side with yesterday's budget by Chancellor of the Exchequer, George Osborne, who announced three measures relevant to the charging and management of roads:

- Reform of Vehicle Excise Duty for cars (the tax on owning cars);

- Establishment of a hypothecated Roads Fund in England with the revenue generated in England from VED;

- Another year of freezing fuel duty.

No, it doesn't mean that there is any move to road pricing soon.  However, the setting up of a Roads Fund in particular will establish a closer relationship between what is paid by motorists (for owning a vehicle if not using it) and what is spent on roads.

Vehicle Excise Duty reform

Vehicle Excise Duty (VED) is similar to registration or licencing fees or taxes in other countries, and is essentially a tax on owning a vehicle that licences it to be operated on public roads.  The tax rates are based on two factors, vehicle size and CO2 emissions.  Most recently, VED was reduced significantly on trucks 12 tonnes and over, as the HGV road user levy (a vignette system of prepaying for access to roads based on time) was introduced to charge those vehicles. 

VED on existing registered vehicles and vehicle registered before 1 April 2017 is not to change, but from 1 April 2017 new cars registered will face only three bands of duty.  The primary reason for this is the loss of revenue due to the bands based on CO2 emissions, as the vehicle fleet moves towards lower emission vehicles.  When the existing bands were set up in 2003, the average new car emissions were at 173g/CO2/km, now it is 125g/CO2/km.  

The intention of the reform is to focus rewarding zero emission vehicles (which will continue to pay no VED at all), and to reward new vehicles in their first year if their emission levels are below 100g/CO2/km.  However, after that first year all vehicles will pay a flat rate of £140 (US$215) per annum.

For vehicles with emissions higher than 110g/CO2/km the first year of VED will be punitive, at a rate of between £160 (US$246) and £2000 (US$3077).  This is specifically intended to discourage purchases of new higher emission vehicles.  However, after the first year the rate for these vehicles will drop to the flat £140 per annum.  It would appear this is designed to treat the environmental component as relevant in the first year of ownership, but not beyond that point except for zero emission vehicles.

A premium VED is also imposed on cars with a list retail price of over £40,000 (US$61537) with an additional £310 (US$477) per annum added to VED for the first five years.

The existing, full VED price schedule is here (PDF - it is far too complex to just show an image). It includes a zero rate for many lower emission vehicles in the first year.

The new schedule, for cars is below:

UK new Vehicle Excise Duty rates for cars from 2017

The fiscal impacts of the new rates are outlined in the table below:

Additional revenue raised from changes to VED

My view

As a tax on owning a car, the economic justification for VED is that it is akin to an "access charge" in that it can be said as being a way of recovering some of the fixed costs of the road network.  Some economic and engineering assessments of the causes of road network deterioration indicate that around half of the costs of road maintenance can be attributed to the environment (sun, rain, earth movement) not road vehicle usage.  In other words, theoretically if there was no road traffic, the network would still deteriorate but at around half the rate it does with traffic.  Charging all road vehicles a fixed charge for accessing the network, to reflect these costs, can be considered to be economically efficient and equitable (as long as the variable costs are also charges efficiently, as most of the "wear and tear" costs are attributable to heavy vehicles, not light vehicles).

Simplifying VED in the way proposed appears to lend itself towards all cars eventually being charged such a flat rate to access public roads, notwithstanding free access for zero emission vehicles (recognising the benefit from eliminating emissions from road vehicles).  Beyond that there is effectively a luxury tax on more expensive cars (which appears purely to be a redistribution based idea), and a clear sliding scale of environmental incentive/disincentive around the first year of a new vehicle purchase (which is more likely to be the time when the VED rate influences purchase decisions).

The bigger question is whether it may be more efficient to shift more of the revenue raising from VED to charging by use, but there is no sign of interest in that from the Government for now.

According to the BBC, the Society of Motor Manufacturers and Traders is unhappy with a flat rate beyond the first year for lower emission vehicles, concerned that it will discourage purchase of such vehicles.  I'm not so sure, as the discount remains in the first year when the price of the vehicle is at its highest, beyond that prices for second hand vehicles vary widely according to condition and usage. The RAC Foundation is not pleased that there will be in effect, increases on average in VED, but notes that actual new vehicle prices have been dropping in real terms in any case.

Roads Fund

Hailing from a country (New Zealand) that has had a rather successful hypothecated roads (and public transport funding) fund for some years now, it has always seemed rather strange that the UK has resisted such a move.  Particularly since I was closely involved with those who managed the NZ fund, and in developing policy for the raising of revenue for it and expenditure from it.  The reasons to oppose setting up such a fund can be addressed by looking at what rules are placed around its management, and how the revenue sources for it are specified and reviewed, rather than the concept itself.  Roads are not like health, education or welfare spending, which are based on purchasing of social services based on equity and demand, but are rather economic infrastructure that government has purchased largely because efficient means to charge for all road use have been difficult because of technological limitations.  Today, it is not too difficult to conceive of an entire road network that charges users directly and uses that revenue to maintain and develop the network.  Treating social spending by government in the same way raises equity and access issues that are much more complex and profoundly difficult.

It isn't difficult to create a hypothecated roads fund that could be mismanaged, but equally the New Zealand example is one which seems to have stood the test of time and changes in government.

Key to making such a fund work is:

- Identifying a revenue source linked closely to what the fund is to be used for;

- Regular reviews of the rates set for the revenue source and linking that to how the fund is used, so that the fund does not grow beyond what is an appropriate level of spending;

- Establishing an independent board to determine how to allocate the funds raised on a transparent, economically efficient and objectives driven way.

The announcement yesterday was that all revenues from VED in England will be placed into a Roads Fund which will be used to fund road expenditure in England from 2020.  However, the announcement does raise many questions:

1. Will Wales, Scotland and Northern Ireland devolved administrations be allocated the same revenue by proportion (presumably according to revenue raised by address of vehicle owners)?

2. Presuming that it is all VED revenue that will be hypothecated, will the HGV road user levy revenue also be hypothecated into this fund, given that UK lorry owners pay this with their VED?

3. How will the Road Fund revenues be allocated between Highways England and local authorities?  Will it continue to be by the existing political/bureaucratic processes or will be a board be set up to manage it?

4. Given VED raises just short of £6 billion per annum and expenditure on roads is over £7.5 billion, will the new fund be used to provide core spending on maintenance and renewals or also be used for new capital spending?

5. Will spending over the revenue raised from VED be treated differently, or will the Roads Fund be "topped up" by general revenues to enable a higher level of road spending?

6. Will the Roads Fund be available for funding cycling and pedestrian infrastructure associated with roads?

7. Is it intended that a portion of Fuel Duty be allocated to the Roads Fund in due course?

8. Will the Roads Fund be able to guarantee spending on maintenance to local authorities for 6-7 year funding periods like Highways England, so that more efficient longer term contracting arrangements for maintenance can be more widely established?

New Zealand's path to its hypothecated roads fund was done in steps before legally designating all motoring specific taxes (registration/licensing, fuel and weight/distance road user charges) to that fund, and reviewing those taxes against a cost allocation model so that charges corresponded to road users benefiting the most from future expenditure (including cost the system the most in terms of maintenance).  The UK government could learn a bit from this staged approach.

The more important point, is that setting up a Roads Fund is a necessary step before further reforms are implemented to link paying to use the road with money spent on the road.   It will enable an option to be offered whereby instead of paying VED, motorists might choose to pay directly to use the roads based on distance (except, of course, zero emissions vehicles).  In other words, if road pricing is ever to be implemented on a wide scale, a Roads Fund will be necessary to ringfence the tradeoff in revenue sources between VED and road pricing.  This is likely to be more attractive if a portion of fuel duty is also hypothecated to the Roads Fund, given that VED advantages those who use their vehicles the most.  So those who believe that the future lies with charging for road use directly, should welcome the creation of a Roads Fund.  It is a step forward.

Of course what it will mean is a return to motorists complaining that they "paid their road tax, but look at the potholes", which of course will be fair enough to some extent.  It is exactly this sort of relationship between consumer (motorist) and producer (council or Highways England) that should promote better accountability for the use of motoring specific taxation.  Hopefully, it will be matched by reform of local authority management of roads, so that the fund can be used to give priority to fixing the appalling standards of some local roads across the UK.

Fuel Duty

This is rather simple, fuel duty of £0.5795/l (US$0.89/l or US$3.37 per US gallon) on petrol and diesel (and some other rates for variations) has not changed since 2011 (when it was cut by £0.01 p/l).  This is to continue for one year, meaning that fuel tax in the UK has not increased since 2010. It appears clear that, despite a budget deficit of around £80 billion this year that the government wants to cut and move into surplus by 2019,  that the easy option - raising the non-hypothecated tax on fuel - is not attractive to this government.  Of course, none of the revenue raised from fuel duty (around £25 billion (US$38 billion) is dedicated to road expenditure, and is simply treated as general revenue (which is used for road expenditure).  Not only the politics around raising fuel duty are still seen as negative, but it appears that philosophically speaking - the newly elected Conservative majority government does not support increasing this taxation, which largely falls on road users (and is many times in excess of spending on roads).

What this means is that net revenue from fuel duty continues to be eroded by inflation (albeit inflation is barely above zero) and the increased fuel efficiency of the fleet.  A report from three years ago by the Institute for Fiscal Studies and the RAC Foundation indicated that this is a growing problem.  For a government keen on progressively reducing the size of the state, it fits into its philosophy, especially when fuel duty so vastly exceeds spending on roads, particularly when taxation on owning a vehicle (VED) is seen as the core source of revenue for this.  What the IFS report indicated was that total taxed fuel consumption would, year on year, decline by an average of around 1% per annum through to 2030, even though actual road use would increase by over 20% (reflecting increased population and incomes).  The lower emission levels seen in VED are being replicated in lower fuel consumption and lower fuel duty revenues.

Although an alternative view which looks at externalities (albeit many of these are monetised and not a "cost" for the government) may indicate that fuel duty is too low for some (high emitting vehicles on congested roads in built up areas) and too high for others (rural road users).  Fuel duty is really only an efficient externality tax on CO2 emissions as it is directly related to them,  it bears little relationship to congestion or exposure to noxious emissions.  

Furthermore, if tax on emissions was to be considered, it is worth noting that there is no fuel duty on domestic heating fuels, and a reduced level of VAT (it is 20% on petrol and diesel, 7.5% for domestic fuels), even though 25% of CO2 emissions come from domestic heating, but 19% come from road use.  It would appear those most concerned about climate change see road use as being less essential than domestic heating, which in many cases is debatable (particularly for freight).

(Source: 3  Committee on Climate Change (2012). The 2050 target – achieving an 80% reduction including emissions from international aviation and shipping. Retrieved 13 April 2012 from

http://hmccc.s3.amazonaws.com/IA&S/CCC_IAS_Tech-Rep_2050Target_April2012.pdf  )

Conclusion

The UK Government has tinkered with its tax on owning cars, largely to address a fiscal gap arising from the success of its programme to encourage car owners to buy lower emitting vehicles.  Now, it is retuning its approach to retain this incentive for the first year of ownership only, unless vehicles are zero emission rated.  It continues to freeze fuel duty, showing no interest in recovering more revenue from the use of the road, compared to owning vehicles.  However, the creation of a Roads Fund indicates a philosophical shift (I suggest over the "dead bodies" of some in HM Treasury) towards treating road users as "customers" who pay for the right to access the roads, and that revenue is used to pay for much of the cost of maintaining the roads.   Combined with the recent establishment of Highways England as a limited liability company with its shares held by the Crown, it indicates positive steps forward towards an institutional framework that could support moving towards more direct user charging.  However, it is important to emphasise that no indication at all has been given of political interest in moving to that step.  At some point, the question will be, can fuel duty be increased, can it sustainably be frozen indefinitely, and can the UK public be led, gently, down the path of an option to pay directly for road use rather than through taxes on ownership of vehicles (or fuel)?