While the UK is yet to release a tax strategy for reaching net zero, there has been much debate about how the tax system could be used to support that journey. Although the pros and cons of doing so can be debated, governments regularly, and often successfully, do use tax as a tool to drive behavioural change.

HM Treasury published a high-level interim review on how to pay for net zero in 2020 and was expected to deliver a follow-up report in spring 2021. Although published in the autumn of that year, in its recent report Net Zero and the Tax System, the Institute for Government observed that this “adds to the sense that the Treasury is dragging its feet on net zero”.

Noting ICAEW’s ten tenets for a better tax system, which states that taxes should be simple, certain and reasonable, this article explores potential taxation strategies the Treasury might employ to meet net zero goals. These are not recommendations, but merely suggestions for further consideration. Any tax changes must be consistent with a wider plan. Businesses and individuals need certainty if they are to plan for transition. A roadmap for the government’s plans to tax a net zero economy would be useful from that perspective.

Transport

Transport is a major emitter of carbon in the UK, responsible for around 26% of total greenhouse gas emissions in 2021. Road transport alone accounts for about 91% of domestic transport emissions. To reduce these emissions, more electric vehicles (EVs) will be needed on UK roads. Although there are more than a million battery EVs on UK roads as of January 2024, this number needs to increase substantially if the UK is to achieve net-zero targets. 

Yet UK tax policy is not optimised to encourage the adoption of low-polluting vehicles, or the use of cleaner means of transport. Fuel duty has been frozen since 2011, effectively subsidising travel in petrol and diesel cars to the tune of £50-£100bn in that time. Meanwhile, rail fares have increased by 30% in the same period.

Vehicle excise duty (VED) was reformed in 2017 so that for cars first registered after 1 April 2017 the current standard £165 rate, payable from the second year onwards, applies whether emissions are 1g/CO2/km or 255g/CO2/km. While there is currently a £0 rate for zero emissions vehicles, this will be removed in April 2025, meaning there will be no VED incentive to buy an EV.

VAT policy regarding EVs could be tweaked to encourage the purchase and use of electric vehicles. Norway, where over 80% of new vehicles registered in 2023 were battery EVs, has had a zero rate of VAT on the sale of EVs for many years. The UK could follow suit if it is serious about encouraging the switch to EVs.

The government could also introduce a reduced rate of VAT (5%) for public EV charging (currently 20%) to align this with the rate people pay to charge at home. Although evidence suggests that a VAT rate cut such as this might not lead to lower prices for consumers, it should lead to more investment in public vehicle charging, as profit margins are increased, helping the UK to achieve its target of 300,000 public EV chargers by 2030. 

There is a tension here though, as this shift to EVs poses a challenge to government revenue. Both fuel duty and VED are key sources of tax revenue: around £25bn and £7.5bn respectively in 2022/23. While the government has already taken steps to address the implications of the move to EVs for VED, revenue from fuel duty will continue to decrease as people move away from cars with internal combustion engines. Introducing road pricing could be an effective alternative to these dwindling taxes. Urban clean air zones, like the 15 across the UK, including London’s Ultra Low Emissions Zone, provide evidence for the effectiveness of such pricing strategies.

Finally, air passenger duty (APD) could also be reformed to align it more closely with environmental goals. Currently, APD isn’t proportional to the actual emissions generated by the flight. Neither does it incentivise investment in cleaner aircraft technologies. A carbon pricing model might be more effective.

Energy

Reforming the UK’s energy sector, which contributes 17% of total emissions, will be key to achieving a low-carbon economy. A particular concern is the uneven distribution of ‘green levies’ on energy bills. About 12% of an average domestic electricity bill consists of environmental and social levies, compared with just 3.4% for gas bills. It has been suggested by some that this imbalance is hindering the adoption of low-carbon technologies, such as air source heat pumps. It is estimated that up to 80% of homes will need heat pumps by 2050 if the UK is to achieve net zero, but only around 1% currently have one.

For businesses, business rates can inadvertently discourage energy-efficiency investments. This is because improvements such as building upgrades or solar panel installations can increase property values, leading to higher rates. While welcome exemptions exist until 2035 for certain measures, including onsite renewable energy generation and electric vehicle charge points, not all energy-efficiency upgrades qualify. Broader reform of business rates could be considered to better align with environmental goals, but implementing targeted financial incentives such as grants or tax credits to offset potential rate increases from efficiency improvements might be a more immediate and effective solution.

Some commentators have suggested that implementing a ‘super deduction’ for renewable investments, while reducing or eliminating R&D tax credits for fossil fuel extraction, could redirect financial resources toward sustainable technologies. 

The tax treatment of solar panel investments for businesses demonstrates the current complexity in this area. Solar panels are ‘special rate’ assets that generally only qualify for a 6% writing down allowance. This means that companies can only claim a 50% first-year allowance under current tax laws, not full expensing. When the government consulted on targeting R&D tax credits towards development of green technologies, ICAEW members had mixed views. While some welcomed the idea, others expressed concerns about potential market distortions and added complexity.

In an era when so much investment expenditure qualifies for relief at 100% or 50% rates, what is the policy rationale for excluding certain forms of expenditure relating to major renewable infrastructure projects from attracting tax relief? This should be addressed. 

One point often cited for holding back adoption of greener energy is having a workforce with the right skills. A tax policy relating to reskilling the workforce would be helpful (see ICAEW REP 30/18).

Read part two of this series, which takes a look at housing and carbon emissions.