William Blyth
Associate Fellow, Energy, Environment and Resources
Drax Power Station, Selby, U.K 11 March 2014. The operator of the U.K.'s biggest coal-fired power station reported a 23 percent slump in full-year profit as carbon prices rose. Photo by Chris Ratcliffe/Bloomberg/Getty Images.Drax Power Station, Selby, U.K 11 March 2014. The operator of the U.K.'s biggest coal-fired power station reported a 23 percent slump in full-year profit as carbon prices rose. Photo by Chris Ratcliffe/Bloomberg/Getty Images.

UK politicians are mired in a fruitless blame-game about energy prices. But high prices are not the problem. It is the total bill that matters, especially to poorer consumers. Dealing with the poor efficiency standards of existing UK housing stock is the way to tackle this. And reducing fossil fuel subsidies could provide the source of finance to do so.

Unfortunately, in its 3 March response to the Environmental Audit Committee inquiry into energy subsidies, the UK government continued to deny that it provides subsidies to fossil fuels. This prevents an open and honest debate on a key aspect of energy policy.

The EAC inquiry identified energy subsidies in the UK worth around £12 billion annually. Of this, the usual high profile suspects of renewable energy and nuclear power each receive around £2-3 billion, both set to increase substantially over the coming decade. Perhaps more surprising are the £6 billion of subsidies to gas and electricity in the form of VAT rate reductions. Apart from Luxembourg, the UK is the only OECD country to provide such tax discounts to consumers.

This suggests that the UK government has a rather unique attitude to energy compared with other governments. From 1973 when VAT was introduced until 1993, energy was zero-rated for VAT, perhaps a reflection of the North Sea oil era, when the UK was largely self-sufficient in energy. As this era came to a close, the plan to phase-in standard rate VAT for energy in 1994 stalled when parliament rejected the second stage of the increase, leaving VAT for energy at the reduced rate (then 8%, now 5%).

EU countries are allowed to reduce VAT for an agreed set of ‘essential’ goods, such as children’s clothes, books, basic foodstuffs, and medical supplies. The list of such exceptions is far longer for the UK than any other EU country. The government might argue that reduced VAT rates for energy are similarly justified. Other countries do not seem to agree. Nor do independent bodies such as the OECD, who classify such VAT reductions as a subsidy. This is because, although all taxes distort consumption choices, charging different tax rates on major expenditure items like energy exacerbates these distortions and leads to inefficient choices. In particular, it further encourages high levels of energy consumption relative to other types of consumption.

Globally, through the G20, attempts have been made to reduce energy subsidies and in 2009 leaders committed to phasing out inefficient fuel subsidies, to improve energy security, encourage investment in clean energy and free up resources for pressing social issues.  In September 2013, the member states of the EU called upon other members of the G20 to ’make progress on phasing out fossil fuel subsidies’. 

The UK has a good record in promoting domestic energy efficiency. Between 2000−11, the largest reduction (23%) of any major European country brought UK household energy consumption per dwelling to just below the European average on a climate adjusted measure. Policy works. This should give policy-makers the confidence to go further and continue these improvements.

Harmonizing energy VAT rates with the rest of the economy could help the UK finance such improvements. Reducing consumer bills for the neediest households in the UK requires stepping up the spending levels on energy efficiency, not rolling it back, as the government announced in December for its ECO (Energy Companies Obligation) programme. A combination of higher prices and greater expenditure on energy efficiency measures would also help to reduce the UK’s dependence on imports and help meet international commitments. The events in Ukraine provide a timely reminder to us all of the geopolitical implications of the precious – and precarious – energy resources that we allow to escape through our walls, windows and rooftops.

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