The government’s commitment to achieving net zero by 2050 is an ambitious one that will involve costs to households and firms. The tax system has a key role to play in incentivising households and firms to reduce their emissions.
Our current tax system imposes wildly different effective tax rates on emissions from different sources. Emissions from electricity are taxed much more heavily than emissions from gas, especially if the energy is used by a business: a tonne of carbon dioxide arising from (non-carbon-intensive) business activities is taxed £249 if it comes from electricity and just £52 if it comes from gas. This creates a clear incentive to prioritise reducing emissions from businesses’ electricity use, even if (ignoring the tax), there are cheaper ways to reduce emissions by cutting their use of gas.
Households too face a higher effective tax rate on emissions from electricity than from gas, which discourages them, for example, from switching to heat pumps. This is working against the government’s ambitious target of installing 600,000 heat pumps annually by 2028.
The government should reduce the tax gap between emissions from gas and electricity, ideally applying the same tax rate to all sources of carbon dioxide emissions. Equal tax rates on all emissions would allow households and firms to choose the cheapest way to reduce their emissions without tax incentives biasing the decision, resulting in a less costly transition to net zero.
Bobbie Upton, Research Economist at IFS and an author of the briefing, said:
‘The tax system has a crucial role to play in reducing emissions and achieving net zero as painlessly as possible. Unfortunately, the current design of the tax system taxes emissions from electricity far more than emissions from gas, meaning households and firms are incentivised to prioritise cutting down on electricity, even when there are cheaper ways to cut down on gas.
‘Much of the tax gap between electricity and gas comes from the choice to fund green subsidies through taxes just on electricity, instead of a tax on all energy sources, for example. If the government wants to help households and firms with the costs of net zero, rethinking these taxes on electricity would be a good first step.’
