UK Green Taxes
Fundamentals Update as at 3 December 2013 by Lorenzo Beriozza
The Chancellor’s Autumn Statement on 5 December comes at a time when things are falling into place. Growth is improving, inflation is falling back closer to target and government borrowing has fallen by more than expected. Hence the Autumn Statement will be an opportunity to boast that the Coalition’s plan is on track and has proven the opposition wrong. It will be an opportunity to update the fiscal and macro projections. However, there is likely to be a highly political element to the statement – not least with regards to the treatment of green taxes on utility bills. Despite the improvement in the outlook, the Chancellor will reaffirm the government’s commitment to the austerity programme and say that it is not appropriate to change course now that the outlook has brightened.
Green Taxes and the RPI
One of the most closely watched aspects of the Autumn statement will be green taxes within utility bills. Politically, the opposition leader, Ed Miliband, has thrown down the gauntlet to the coalition. Amid the latest round of near-10% utility bill increases, Miliband has pledged to freeze utility bills for two years if Labour wins the next election in 2015. Former Conservative Prime Minister John Major has also called for a windfall tax on energy profits. This provoked a kneejerk reaction from David Cameron who said that “we also need to roll back the green charges” but specific details have been held back until the Autumn Statement. Green taxes account for around £115 in an average £1320 per year utility bill. Within that, there are two elements that look likely to be scrapped or watered down in the Autumn Statement. These are:
- The ‘Warm Homes Discount’ which accounts for £7-£15 in the average bill. This is used to reduce bills for the poorest households in society; and
- The Energy Companies Obligation (ECO). This accounts for £47-£60 on the average bill and compel power suppliers to pay for insulation and energy saving measures for people in low income areas and on disability benefit.
Speculation is that these measures will be scrapped and paid for out of general taxation instead. Energy providers would be expected to pass on the reduced green taxes by cutting their tariffs accordingly. Reports suggest that this would represent a reduction of up to £75 on the average bill (around a 5% reduction). However, that is likely to be towards the aggressive end of the spectrum. The PM is trapped between a rock and a hard place. To do nothing in the face of sharply rising utility bills would be a big loss of face. The flipside is that the Government’s coalition partners, the Lib Dems, are reluctant to abandon their commitment to the environment. In addition, reports this week also show that more than 25 Conservative MPs are opposed to ditching green policies. The most recent reports on this issue have suggested that a more gradual drip feed of green tax cuts is likely to occur. More specifically, the cost of the ‘warm homes discount’ could be removed from utility bills.
In addition, the horizon over which the ECO is paid for could be extended to 2017 (currently the ECO is scheduled to run until 2015). That could mean that rather than a one-off drop in green taxes of a hefty £75, a string of smaller reductions could be implemented over the next year or so. Politically, it would probably pay dividends for the government to prolong the period over which the cuts take place. If the cuts all come in one big lump immediately, then households will probably have forgotten all about them by the time of the mid-2015 general election. Moreover, if the government uses up all of its ammunition now, what happens when it comes to next winter and the utility companies try to raise prices again? News that profits in the sector have risen fivefold since 2009 lends support to John Major’s call for a profits windfall tax. Clearly two cold winters have contributed to increased energy demand and flattered the profit numbers. Nonetheless, there is a growing political case for alleviating the squeeze on household incomes. A windfall tax would potentially have longer lasting effects than cutting green taxes and represents a credible threat. It would imply that if the providers raise prices year after year in order to boost profit margins, then the government will claw those profits back and channel the proceeds back to green causes or the like. The flipside is that a policy which discourages profitability would undermine the incentive to legitimately cut costs and waste. Furthermore, profits are necessary in order for the sector to invest in the future of the industry. There has been relatively little discussion of a windfall tax since John Major proposed it, so this is not looking like the most likely announcement.
Impact on the RPI
As things stand, the utility price hikes announced by the ‘Big Six’ energy providers represent an average increase of around 8%. That would increase the contribution to headline inflation to 0.4 % – up fractionally compared with the past 12 months. If the more extreme announcement becomes real, of a one-off £75 drop in green taxes effective immediately, that could see the contribution to headline inflation slip to just 0.15%. In terms of how the actual RPI inflation rate might look by February when the recent price hikes and potential green tax cuts are effective:
- If green taxes are cut by £75 immediately, the RPI forecast for February would be 3.1%YoY.
- If there is no cut in green taxes the RPI forecast for February would be 3.3% YoY.
- If there is a partial drop in the ECO portion of green taxed (bills cut by 3%) the RPI forecast for February would be 3.2% YoY.
Source: Scotiabank
