George Bull

Written by: George Bull

George Bull

Senior Tax Partner

Will a carbon-added tax (CAT) help save the world?

Taxes won’t cure all of the world’s ills, but they might help with some of them. In RSM’s tax brief, we have regularly commented on the likelihood that governments’ responses to climate change will mean that carbon-based taxes become more important as climate change forces nations to address the balance between greenhouse gas emissions and financial performance. There are two key elements to this. 

First, if governments are serious about meeting their Paris Agreement commitments, then reducing fossil fuel incentives would in fiscal terms be the easiest approach. A recent IMF report estimates that these subsidies are currently running at around $5 trillion per year.

Second, to use tax systems rather like the proverbial carrot and stick, combining tax incentives for businesses and individuals who are striving to reduce their carbon emissions with extra taxes on those who are not.

The stability and sustainability which humanity needs in its physical environment are also desirable traits in any tax system. Here the UK government has not acquitted itself well. While one can understand how the UK government has used tax incentives to prime the pump for new technologies and to change old behaviours, the early or rapid withdrawal of reliefs, or changes to reliefs which cause confusion, leave businesses and individuals alike doubtful as to whether it’s worth relying on the tax system when it comes to making financial decisions. Over recent years, changes to the feed-in tariff, to grants for hybrid and electric cars and to the capital allowances regime for energy-efficient expenditure have left people genuinely confused and disinclined to engage with one of the most pressing issues of our time.

So, what might a new tax, intended to reduce carbon emissions, look like? Think of it as a carbon-added tax (CAT). It would work by taxing carbon added at each stage in the creation and sale of goods or services. The greater the amount of carbon dioxide emissions, the greater the amount of tax. As the product passed through the supply chain, each successive contributor to the process would charge output CAT to their customers and reclaim input CAT paid to their suppliers. 

The rates of CAT would be set by the government for all classes of goods and services and would reflect the amount of carbon dioxide emitted at each stage. For example, furniture made from timber originating in the tropics and shipped to UK would be subject to a higher rate of CAT than furniture made from manufactured board and composites created from recycled timber.

By now the analogy with VAT should be obvious. That brings many advantages, not least almost half a century’s experience of the way an indirect tax can be effectively structured and administered. There would however be significant differences between the two taxes. 

For example, while the CAT rate structure would be kept as simple as possible, it would reflect carbon added to the atmosphere rather than value added to the product. This is important to ensure that ultimate users of goods and services pay a price which reflects carbon emissions. It also allows manufacturers and others in the supply chain to improve their competitive position by incorporating low-carbon alternatives at every stage in the process. 

Then there is the concept of zero-rating. For example, in the UK VAT system supplies of unprocessed foodstuffs for human consumption such as raw meat and fish, vegetables and fruit are zero-rated. To ensure that a CAT achieves its intended effect, a different approach might be required. It’s easy to make a case for zero-rating vegetables and fruit which are consumed in the country of production. But what about exotic meats and out-of-season vegetables flown thousands of miles from foreign producers to UK consumers? They’re all foodstuffs, but the levels of greenhouse gases involved in getting them on to British tables are wildly different.

While care would be required to define the underlying policy of CAT and its precise structure, it would offer the enormous benefit of simultaneously reflecting carbon consumption in the price of goods and services, while incentivising the adoption of low-carbon alternatives. 

At present, such a tax may fall foul of European legislation restricting member states’ entitlement to introduce taxes that are like VAT. However, if and when the UK leaves the European Union there should be no such restriction. And who knows, if Brexit doesn’t happen then the rest of Europe may want a CAT of their own!

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