EVs: a taxing problem for the Treasury

2017 has been a monumental year for electric vehicles. The discussion switched from “Are electric vehicles the future?” to “When will electric vehicles arrive en-masse?”. That argument is raging, but no-one is having a discussion about the social effects that this en-masse arrival will have.

So let’s start with the only thing guaranteed in life apart from death.

Current Taxes

The UK’s fleet of cars has provided the Treasury with a handy source of funds in recent years. There are three main ways motorists currently pay taxes; vehicle excise duty (VED); fuel duty; and VAT.

VED is a one-off payment that effectively gives your car the right to be driven on the roads.

Fuel duty is more pay-per-use - the more you drive, the more fuel you use, the more you pay. VAT is added to fuel duty at a rate of 20%.

Crucially at the moment, all three taxes are weighted towards encouraging vehicles that emit less tailpipe carbon (and the reality is that these are electric). VED rates for pure electric vehicles (EVs) are zero, and obviously EVs are not powered by petrol or diesel so pay no fuel duties.

VED is easily changed, and almost certainly will be in the future to incorporate EVs. But fuel duty and VAT are a different case, as EVs don't use petrol or diesel. (VAT is charged on household electricity bills at 5%, although it is possible for a household to avoid this charge by making their own electricity.)

In the tax year 2016/17, the Treasury received £27.9 billion in fuel duties, out of a total tax take of £568.7 billion (ie 5% of the total). Receipts from these have been solid and steadily rising. Indeed, the Office for Budget Responsibility has projections out to 2021/22.

Remember, the actual tax receipts are 20% higher than these figures, as VAT is added.

Projected tax decrease - When will the crunch hit?

However the Treasury has a future issue. It is encouraging the uptake of zero carbon vehicles; but the more zero-carbon vehicles on our roads, the less money it will receive. As uptake accelerates - and it is rapidly accelerating - this will change the DNA of the UK’s passenger car fleet. Indeed, one recent study predicted that there would be no new sales of cars with combustion engines after 2025.

The actual amount of fuel duty money the Treasury receives is a function of miles travelled, the fuel efficiency of the UK petrol/diesel fleet, and the percentage of miles driven by electric motors. There are simply far too many variables to accurately predict when receipts will start falling dramatically, but there are a few statistics to bear in mind.

The number of cumulative miles we drive each year seems to have plateaued recently. In 2016, we collectively drove 323.7 billion miles on British roads, and this is only 4% higher than in 2006.

Presuming we suddenly do not start driving more, and the Chancellor keeps the fuel duty 'escalator' at the same level (as seems to continually happen) then fuel duty receipts will fall as the proportion of electrically-driven miles increases. And this begs the question, when does this become a problem? After all, taxes are useful - they pay for good stuff like schools and hospitals (and if you’re cynical, bailing out banks and floating duck islands).

So the big questions are: how quickly will electric vehicles displace combustion engine vehicles? And how can the Treasury replace the future missing fuel duties?

The following table helps demonstrate how long a car stays part of the UK fleet:

So in 2016, 99.9% of vehicles first registered in 2015 were still on the roads. 98.6% of vehicles first registered in 2014 were still active, etc.

You can immediately see that it takes about 10 years for any year's car fleet numbers to start dropping dramatically, and then takes a further decade for them to all but disappear.

So, what does that tell us? Or more importantly, what does that tell the Treasury? Well, fuel duty receipts for the next few years look good. This calendar year over a million new diesels have been sold, despite all the negative press (and this is better in absolute numbers than every year except the last four).

But if diesel year-on-year sales figures continue to tank while the number of alternatively-fuelled vehicles continues doing the opposite (they probably will), new combustion engine vehicles continue becoming more and more fuel efficient (they certainly will), and electric and hybrid vehicles continue getting better and better (again a certainty - in the next five years or so, nearly all new electric vehicles will have a range of at least 200 miles, which most industry observers say is the range requirement to achieve mass adoption) then fuel duty receipts could start falling rapidly within about a decade.

This therefore means we have less than a decade to get a replacement plan in place. And if we’re going to have a new system, we may as well try and address some of the other problems currently associated with cars: namely air pollution and congestion.

Relief

Everyone knows what congestion is, and everyone who has ever been delayed by other cars will know the frustration it causes. Put simply, congestion costs money - some £30 billion a year according to one estimate.

It is not just a London problem; Blackpool has the highest weekend congestion rates of every town/city in the UK: Weekend traffic in Brighton average 4.3mph; and congestion costs Birmingham businesses £1m per day (but if you’re in the UK think yourself lucky. The longest traffic jam ever recorded was in Beijing, China. It lasted 12 days, and stretched 62 miles).

Air pollution is a silent killer. DEFRA divides the UK into 43 zones, and all but six of them exceeded their annual limits for NO2 (NO2 increases the risk of respiratory diseases). Around 40,000 deaths in the UK are attributable to exposure to outdoor air pollution (whilst internal combustion cars are significant contributors to air pollution, they are not responsible for all of it).

Of course, there is no set rule that says the missing fuel duty tax take has to be replaced by the nation's cars. Should road maintenance be paid for exclusively by drivers?. After all, ‘walkers’ do not pay for pavements.

As almost everyone uses the roads, they could (should?) be considered as a public good. However, the more a vehicle is driven on roads, and the heavier a vehicle is, the more damage it does to those roads (meaning future VED may well be based on the weight of your car), so it seems right that car owners should pay something.

Road Pricing

Fuel Duty essentially means that the more you drive and pollute, the more you pay. In the EV era, road pricing is the obvious way to supplant this.

The theory is simple. You are charged an amount per mile your vehicle travels. The amount charged can vary up and down depending on location and time period, and can indeed be zero.

Choose to travel in inner London at rush hour, and you will be charged more per mile than travelling at night on a country lane.

There are obviously pros and cons, and some will immediately say that road pricing is unfair (but that implicitly suggests that the current system is fair).

In the UK we already pay an average of 10.3p per mile* travelled in fuel duty (and associated VAT).

But due to the way we pay that (ie in one go at the pump) it encourages us to view individual journeys by car as ‘free’, when they are clearly not. And ‘free’ journeys on ‘free’ roads equals the above-mentioned congestion and air pollution problems.