George Bull

Written by: George Bull

George Bull

Senior Tax Partner

Muddled thinking in the UK’s approach to renewables subsidies

By any standards, the UK’s approach to energy subsidies is shockingly inconsistent.

Well-planned subsidies have a vital role

At their best, government-sponsored subsidies achieve two laudable aims. First, to address market failures. In the energy sector, an example would be to address the price disparity between renewable energy and fossil fuels when environmental costs are not accounted for. Second, to kick-start the development of new technologies with the aim of bringing them to a point where they are capable of standing on their own feet financially.

In the case of renewable energy, the UK experience has been mixed. Subsidies for wind power and solar electricity have regularly been criticised as being excessively complex, too modest in their aims, subject to frequent changes and likely to be withdrawn at short notice. 

What does a successful subsidy look like?

Without a doubt these subsidies have been worthwhile, but it is arguable that much more could have been achieved for the cost incurred by the state if, instead of being driven by detailed rules alone, each of the subsidies was underpinned by a clear policy understanding as to what it is intended to achieve, and what success would look like at the point the subsidy was to be withdrawn.

Subsidies shouldn’t last forever

With renewable energy becoming price-competitive with fossil fuels, it will soon not need subsidies. Supporters of the government’s policy will argue that subsidies have achieved their intended effect at minimum cost. This reflects the fundamental mechanism of subsidies: once a market failure has been corrected or necessary development undertaken to the point that a new technology is commercially viable, state-sponsored subsidies should be withdrawn with the market left to determine the way forward. However, it also reflects the shocking inconsistency in the approach of the UK government.

Inconsistencies in the UK’s approach

That inconsistency is exposed in a 2019 report on energy prices and costs in Europe, published by the European Commission. The EC makes it clear that the UK provides far more financial support to fossil fuels than any other member state. Although the level of that support has dropped from around €13bn in 2008 to approximately €11.5bn in 2016, the maintenance of fossil fuel subsidies at this level means that it will be extremely difficult for the UK to meet its obligations under the Paris Agreement. It’s all very well for the UK to declare a climate emergency and commit to net zero by 2050, but neither those developments (nor criticising the Trump administration for its threats to withdraw from the Paris Agreement) mean anything if the UK quietly continues with this huge level of fossil fuel subsidies.

Tax reductions account for the greatest part of the fossil fuel subsidy. The biggest components of this in the UK are the 5 per cent rate of VAT on domestic gas and electricity and the continuing fuel duty freeze, which mean that the Exchequer has foregone around £46bn in revenues through to 2018/19. 

The inconsistency is compounded by another recent change imposed on the government by a decision of the European Court of Justice. Notwithstanding the widely held view that the best way to reduce UK domestic heating costs is to improve the insulation of homes, solar panels and domestic insulation look set to suffer VAT at 20 per cent instead of the previous rate of 5 per cent.

Is it all about the votes?

The gilets jaunes experience in France demonstrates that there are no votes to be won from changing tax-based fossil fuel subsidies. But there are no votes to be won from ignoring the issue so that the UK misses its Paris Agreement commitments and its other very important climate change targets.

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