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GREEN TAXES WERE expected to form the centrepiece of the Pre-Budget Report and many commentators were disappointed with the lack of real content in the Chancellor's speech. We gathered together a group of practitioners with differing backgrounds and experience to discuss the issues.
The attendees were:
- Mike Truman, Taxation, chairing the discussion (MT)
- John Manning, PricewaterhouseCoopers LLP (JM)
- Alun Oliver, E3 Consulting (AO)
- Jaysson Palmer, Ernst & Young LLP (JP)
- Stephen Hockman Q.C. (SH)
- Maryanna Sharrock, Stephenson Harwood (MS)
- David Oxland, Cooper Parry (DO)
Which taxes?
MT — If we are going to discuss green taxes we first have to define them — what do you consider to be green taxes?
JM — I've been asking this myself, and I think there are three, or possibly four, groups. First you've got the clearly environmental taxes, such as landfill tax and the climate change levy. Then there are the 'quasi-green' taxes such as fuel duties and vehicle excise duties — taxes with a green tinge to them, even though they were never invented as environmental taxes. Third, you have the 'greening of the tax system' where the Government tries to incentivise green policy changes by using the existing tax system. And then finally you have the prospect of carbon pricing, which is effectively a green tax too.
DO — I'd want to throw R&D into the equation as well, particularly given the Prime Minister's comment that science will sort out the problems of the environment. The trouble is that the actual practice that HMRC adopts in an area like R&D relief doesn't always match up with the theory of how the tax relief is supposed to work.
MS — The other way to look at this is to divide by particular activities and the taxes that apply to them. When we looked at this we felt there were five separate areas where we felt green issues predominated;
- Power
- Pollution
- Waste
- Water
- Transport
AO — Thinking about Maryanna's split, I wondered whether construction should be treated as a separate category of its own. On the other hand, you could break it down in the same way — in terms of construction waste, the power it consumes and so on.
Regulation too
JP — What the taxes seek to do is to internalise the external environmental costs. But you can't look at green taxes in isolation, you also have to take into account regulatory issues. Tax isn't the only way of addressing the challenges of climate change; regulation and tax go hand in hand here.
SH — As a non-tax exert I'm interested to see that the debate here has already brought in regulation as well as tax, and that we are focusing on incentives and the wider regulatory and trading context. I think the balance of the way in which these tools are used is critical, particularly post-Stern Report.
DO — You don't just have to strike a balance, you also have to avoid the pitfall of overlapping incentives or disincentives. There is a big issue here of the consistency and coherence of government policy.
MS — I encountered an example of that looking at a scheme to improve energy efficiency in social housing. The idea was to give an exemption from SDLT if people insulated their houses — but the houses were mostly in disadvantaged areas and below the SDLT threshold anyway!
SH — The generic issue is how far adjusting levels of tax has affected behaviour. For example, when we had a married couple's allowance did that encourage people to get married?
DO — But there are some cases where taxation has changed behaviour. Increasing the tax on tobacco has significantly reduced smoking. Perhaps it is easier to affect behaviour by taxing something out of sight — tax incentives for good behaviour are more difficult.
MS — There is also the problem that some taxes such as aggregates levy and landfill taxes tend to be dealt with in the wrong place in the business. They are treated as an operating cost in the business. I have come across one company which was planning carefully for a £10 million corporation tax liability, but when we calculated their environmental taxes it came to £60 million. The environmental taxes had no behavioural effect because minimising them was "nobody's baby".
JP — In the past there has been a similar problem with VAT, but people are far more attuned to management and planning now. Responsibility for emissions trading also tends to sit in different places within different organisations, and there is a risk that people are missing opportunities to reduce their costs and emissions.
Effect and impact
MT — So which green taxes do we think have had the most impact on business so far, and is the effect different for small businesses compared to large ones?
JM — My perception is that landfill tax probably is working in the sense of being effective. There is a pretty clear reason for that, in that it has been a consistent coherent policy. Everybody knows that it was going to go on increasing, and it's now getting to a level where people say it is really expensive.
AO — But the actual cost of landfill is a tiny fraction of the total development costs. One of the barriers to selling our property taxation services to minimise liabilities is that businesses are not aware they are paying it, it is hidden in the total charge made to the contractor by a subcontractor for land clearance.
At £21 per tonne it's not viable to them to take action on some smaller projects. When they actually look at landfill tax, is it worth the time and cost and effort to get it right?
DO — We had a similar problem with 100% capital allowances on an energy saving air-conditioning unit. Despite the big fanfare of the announcement of the relief, we found that only two parts out of 100 in the system that qualify. It needs joined up thinking between the government and HMRC.
JM — We have found in research that only 11% of businesses were even aware of 100% capital allowances for energy efficient equipment
MS — This is a problem when you are trying to put together finance to develop these things for sale, you do not know whether or not they are going to qualify once you are selling them so you cannot take the benefit into account..
Regulatory changes
SH — It seems to me that what we are saying is that a modest level of tax is not significant enough to make an impression of people's behaviour on its own. It needs to be linked with social or commercial factors. If you want to use tax on its own it has to be a very high rate.
JP — You find that landfill operators are aware of the landfill tax issue, but it doesn't hit the radar for commercial clients. There is more of a change in municipal authorities dealing with household waste — there has been a significant increase in recycling schemes.
AO — But recycling has been as much a reaction to regulatory impact as it has to taxation; local authorities know that they are losing their access to landfill, so they have to meet their recycling targets to avoid penatlies.
Tax problems
MT — We have already touched on some of this, but what do you think the major problems are with the current green taxes?
JM — This is a nitty gritty point — in every sense of the term — but the aggregates levy has had a contradictory outcome on the 'grit powder' business because of a perverse incentive. The small particles of grit and powder which are a by-product from quarrying used to be made into low-cost building materials. Because of the increased costs imposed by the aggregates levy, they are now simply dumped in a slag heap!
MS — There is also a problem with land remediation relief, because you can't get tax relief if you are the original polluter. So if, for example, you buy the company in which the land sits you cannot get relief for cleaning it up. We also find that land remediation relief is very difficult to qualify for.
AO — Our experience is not quite so bad at all, and it does seem to be on budget for HMRC so they are paying out what they expected to. Again, though, it is certainty which is the problem — are clients sure that they are going to get the relief? And then there is the problem of the developer acting as a partnership — why should they be not entitled to the tax relief because they choose to operate as a partnership rather than a limited company? It's the same pollution they clean up.
Post-legislative scrutiny
SH — There is an interesting general point which might be relevant here, something I became aware of last year. The Law Commission has become interested in 'post-legislative scrutiny', which as its name suggests is the opposite of pre-legislative scrutiny! They envisage an exercise to decide how effective a piece of legislation has been. So for example if a tax is supposed to deter behaviour, the more tax it actually raises, the less effective it will have been!
JP — Yes, these taxes are here to be 'avoided', but by reducing or finding alternatives to the behaviours they are intended to deter.
AO — There was a report in May on the effect of the Land Remediation Tax Relief, but it showed that there is a very low level of awareness. The Revenue released a figure of £170 million as the estimated cost of enhanced capital allowances in 2005/06; the figure for 2006/07 is forecast to be £130 million.
Decision drivers
MT – How much of this is down to the personality of this particular Chancellor? He sometimes seems to think that everyone sits down with a calculator and works out the tax consequences of all their actions, when we know that it doesn’t work that way.
JP – Anecdotally, most people still seem to make decisions based on the convenience factor rather than a tax cost.
DO – Increasing taxes on fuel does not seem to have driven people onto public transport, for example.
Research & development
MS – One of the things my clients struggle with is that R&D doesn’t fit nicely into the business information flow. It is not information that is naturally available from the records, you have to work hard to find it. That is particularly true of failed projects; failed R&D is always hidden somewhere, not on the balance sheet, and no-one wants to talk about a project which didn’t work!
AO – It’s a problem with the internal dialogue in the business, with those responsible for budgets being aware of tax. It needs to be put on the boardroom agenda. If businesses really understood the true costs, then there is a tipping point at which the tax will make their behaviour change, but if the awareness is not there then, whatever the tax regime, nothing will change.
Front of mind
JP – Businesses fail to see this as a tax liability, they see it as an inevitable cost, rather than one that can be reduced or managed by changes to behaviours. They don't see that they can manage it. Having said that, I would say that more firms are seeing it as something to manage – but there is still not enough is ‘front-of-mindness’ about it.
JM – But there are ethical considerations about avoiding green taxes. We don’t, as a profession, want to be saying to clients that ‘we can help you avoid environmental taxes so you can carry on polluting to your heart’s content’.
JP – ‘Avoidance’ here means reducing the tax by avoiding the behaviours, and the pollution – something that Government is seeking to encourage.
PBR
MT – So, if that was the green taxes landscape as the Chancellor delivered his Pre-Budget Report, what did you think of the content of it?
AO – It was a safe one, being his (allegedly) last budget – relatively uninspiring. There was the promise of zero stamp duty on zero carbon housing, but the costs involved are expected to be far higher than the SDLT saving. It was a damp squib really.
JM – So close after the Stern report, it is surprising that more wasn’t made of it. The measures talked about were small in scale, and seemed to have had more to do with raising revenue than environmental issues.
MS – He kept saying things like ‘It’s my ambition to …’. Everything was for the future, it wasn’t immediate.
Regulatory reform
SH: Is this an acknowledgement that the balance is shifting, and that fiscal measures are not seen as the way to achieve the green agenda? Are we looking more at regulation in future?
JM – Emissions trading is being seen as the principal carbon pricing tool used by the Government, and that is by definition not a tax.I think there is a kind of jumping on the carbon trading bandwagon. It’s more acceptable – it doesn’t contain the word tax and does not fall directly on the consumer.
AO – The sheer scale of tax that is needed to change behaviour is unpalatable to the marketplace politically. Housebuilders are estimating that a zero carbon house would increase costs by between 10% and 15%. And in any case that has no impact on older housing stock. Most of the housing stock of the country is old, and it is just sitting there oozing out heat and energy wastefully. It’s the combination of tax and regulation which will have the quickest impact.
MS – The problem with the old housing stock is that much of it is tenanted, and the landlord cannot afford to do the work because the tenant won’t pay more rent for it.
AO – Yes, there are proposals to extend the landlord energy saving scheme for corporate landlords, but again they are still currently awaiting approval.
Guessing reactions
JM – The challenge for Government here is that it is effectively guessing at consumer reaction. In economic terms it is all to do with elasticity analysis.
My sense is that fuel duty and air passenger duty will make little difference. They get a lot of publicity, and people jumping up and down, but ultimately it isn’t enough to change behaviours.
AO – It’s the greening of taxation rather than environmental taxes. Taxes are badged differently rather than saying ‘actually we are raising taxes and getting more money in the pot’.
DO – And for smaller businesses that may well put up costs but prices don’t necessarily follow, so margins will suffer.
MS – It may also be the tipping point for moving some manufacturing outside the UK, to China for example.
JM – We are competing with other countries who may not be as green as us.
JP – You can’t make changes in a vacuum; the thorny issues around environmental change have to be dealt with multilaterally. Individually it is also important for everyone to be doing their own bit for the environment. It’s very easy for the public to say that individually they can each only contribute a small amount. My behaviours have changed a little but I wouldn’t say it is strictly taxation that has caused the changes; it’s as much the ethics of it.
JM – We as individuals and consumers respond to something being cheaper – for example the duty differential between leaded and unleaded fuel moved people quickly to unleaded. So, for example, why isn’t there a reduced rate of VAT on low-energy light bulbs? In the UK we respond to incentives like that.
MS – It’s effectively tax PR. For example, there is a subsidy for bio-diesel, which sounds good, but it’s not quite enough to create a real incentive.
DO – So we strip the rainforest to grow biofuel plants. Is that a good idea?
MT – George Monbiot said that biofuel is the worst environmental decision that could ever be made for that very reason.
The tax that wasn’t?
SH – Is there a tax that wasn’t introduced which could have made a difference?
AO – There was certainly nothing to whet the appetite in this report. It would have taken something that captured the domestic housing market to have a real impact.
DO – It was suggested that there would be a significant charge on four wheel drive ‘Chelsea tractors’, but he seems to have left that to local government.
AO – I know a number of people who have gone for the hybrid vehicles in London because they are exempt from the congestion charge. Tax does have an impact in some areas. The problem is that whilst those who drive cheaper cars will recognise the saving, someone buying a £60,000 car won’t notice the impact because it is too small.
No absolutes
JM – There are no absolutes in the environmental debate. In terms of policy, we will experience every instrument that is available to Government and rightly so.
AO – It is the comparative costs that are important, that will help people shift from one to the other. When you are looking at aviation as opposed to any other way of getting to a destination, is there a true comparative cost inclusive of taxes? You are not comparing apples with apples.
Energy sources
DO – But you can compare the costs and environmental impact of energy sources, wind power and nuclear energy, for example.
JM – I haven’t yet heard an environmentalist saying that nuclear is good, which always surprises me. Wind is the one that has more potential, but some people think that it has problems of visual and ecological intrusion.
AO – Gasifying woodchips is another technology which is being looked at again, but the sheer volume of the harvest that is needed to make a viable power crop is massive
JP – The question we have to answer is which basket of measures will produce the best changes, because they will all have some impact. I can go down to a DIY superstore and buy a wind turbine and get tax free income from microgeneration, but it’s going to take a very long time for me to see the financial benefit.
DO – And it’s a bit like buying a digital TV – next year it will be half the price and twice as efficient.
AO – It’s a good headline grabber, but how much does it really contribute? And what about planning issues – how easily can you put up a microgenerator wind turbine? We looked at solar power about seven years ago and the pay back period was seven to ten years. We were going to move before that, so we wouldn’t have seen the benefit.
MS – If you are putting a new roof on you can just about justify building solar panels in, but fitting them afterwards just isn’t cost effective.
SH – For nuclear power, the problem is also planning issues – where to site the stations and how to dispose of the waste.
MT – But nuclear waste could be equated with carbon dioxide waste; we have been bunging CO2 into the atmosphere knowing it is extremely damaging. At least with nuclear waste you can bury it away. I have never heard that debate expressed in that way. I know there are concerns with safety, but I would have thought that perhaps nuclear would be the obvious one to look at.
Further changes
MT – What further changes to green taxes, if any, are you expecting in the future?
SH – There seems to be more and more explicit talk about carbon rationing, where everyone would have some form of personal credit card. Each individual would have his own carbon allocation, with the allocations being tradeable between individuals.
DO – There is a big difference between what should happen and what will happen.For example, because there is the greener alternative of travelling by train, domestic flights should be taxed out of existence but it won’t happen. The same is true of holiday flights, to limit the number that people take.
MS – The problem is that this is regressive taxation – rich people can afford to pay for trees to be planted and presumably get a carbon credit to offset the carbon cost of their flights.
JM – One of the challenges facing the Government is that the climate change levy isn’t really a carbon tax – you pay it on nuclear energy as well. If the principle is that the polluter pays, we have to link it specifically to the carbon emissions. Some commentators think that tax shoud be used to establish a baseline, and then use a carbon trading scheme on top of that, where more choice is introduced; in other words the option to trade or not to trade.
JP – My view is this must be driven by what science says. There are still some areas for which the debate needs to be played out before we are clear exactly how much they contribute to emissions and climate change. Then we need to make sure the right horse is backed. Taxing something that may not be the significant contributor may not succeed in driving down emissions.
AO – Looking at the traditional tax system, would it be acceptable to increase corporation tax, but then to say that we’ll give that money to industry in R&D allowances for those who are brave enough and willing enough to take the issues on? In other words, do we hypothecate a tranche of increased tax for R&D into green technologies?
Inconsistent messages
JM – There is inconsistency in the Government messages. The fuel poverty debate has led to the subsidising of energy through a reduced rate of VAT. Does that sound like climate change being the key to Government policy? Arguably you would say no. Could fuel poverty be dealt with through the benefits system, in particular the winter allowance? This is just one example of what could be explored.
MS – The poorest people tend to live in the worst insulated properties, and can’t afford to pay for repairs so energy is bleeding out from them. Very small landlords react differently from commercial landlords, because a small landlord is entirely cash-focussed so tends to avoid the capital expenditure on insulation. One of the hopes of the Real Estate Investment Trusts was to get these landlords to pool their properties together into a REIT, but it is not happening, and it isn’t likely to.
AO – It’s a long way off from getting to that sort of stage.
R&D incentives
SH – Is there scope for giving really strong incentives for greater investment in technology research – would that be possible?
AO – They have significantly raised the game for R&D, and have aimed it particularly at SMEs. The impact still isn’t entirely clear, but it is still only costing the Government about half a billion pounds. Will these levels really drive the UK forward economically?
DO – The minimum level to qualify for extra relief doesn’t encourage SMEs to do R&D.
MS – There is also the problem of being sure that you are going to qualify – it would be really helpful to have a ruling system in advance so that you could then borrow against the known future cash receipt of R&D credits from HMRC.
Revenue neutral
MT – If there are going to be further green tax increases, should they be revenue neutral? And if so, should we look at giving the tax back in green incentives or have we got to look at reducing other taxes on businesses?
AO – If you add too much of a burden you will just see people fleeing to lower tax jurisdictions. Without a pan-European or even wider approach people will decide this isn’t where they want to be. Many firms can pick and choose.
JP – The main challenge for taxation is encouraging R&D to help provide alternatives, incentivising them to invest and avoid, rather than to simply offshore their pollution.
AO – But the current regimes have too much uncertainty. You are only going to modify behaviour at the outset if there is greater certainty. Because that isn’t present in the current system, the reliefs are seen as nothing more than just icing on the cake.
MT – Thanks very much to everyone for a very interesting debate. To sum up, it seems that we are saying there are some real doubts about whether the existing tax measures have been effective, or indeed whether anything other than punitive rates can change behaviour on their own. Instead, regulation and tax have to work hand in hand. If they do, it may well be true that there is scope for tax incentives to modify behaviours, but in order to do so we think that there has to be much greater clarity and consistency in Government policy. The effectiveness of a tax measure requires an understanding of how people will perceive it, and then how they will respond to it once perceived.
