William Blyth argues that a more honest and rational approach to energy subsidies would benefit consumers

In its 3 March response to the Environmental Audit Committee inquiry on energy subsidies, the government continued to deny that it provides subsidies to fossil fuels.  This prevents an open and honest debate about how energy production and consumption choices are made and influenced. It also chokes off a source of financing that could help tackle one of the UK’s most deep-seated energy problems: the poor efficiency of its housing stock.
The EAC inquiry identified energy subsidies in the UK worth around £12 billion annually. Of this, the usual high-profile suspects of renewable energy and nuclear power each receive around £2-3  billion, both set to increase substantially over the coming decade.
Perhaps more surprising is the £6  billion of subsidies to gas and electricity in the form of VAT rate reductions. The UK is almost unique amongst developed countries in providing such discounts to consumers.
This suggests that the UK government has a unique attitude to energy, compared with other governments.
EU countries are allowed to reduce VAT for an agreed set of essential goods, such as children’s clothes, books, basic foodstuffs and medical supplies. Under EU law, a reduced VAT rate for energy is also allowed, but this was largely introduced to the legislation to accommodate the UK, which in the 1970s had a zero VAT rate for energy. The increase to 5% VAT (the minimum allowable under EU law) was seen as the most that the electorate could bear at the time.
Given the furore over energy prices in recent months, one might make the same assessment now.
The government might argue that such VAT rates are justified on the basis that energy is indeed an essential good. Other countries do not seem to agree. Nor do independent bodies such as the OECD, which classifies such VAT reductions as a subsidy.  This is because, although all taxes distort consumption choices, charging different tax rates on major expenditure items like energy exacerbates these distortions and leads to inefficient choices. In particular, it further encourages high levels of energy consumption relative to other types of consumption.
Harmonising energy VAT rates with the rest of the economy could help the UK finance a solution to its problem of poor housing stock.  Additional VAT revenues of £6 billion dwarf the budget of £1.5 billion for the Energy Company Obligation (Eco) scheme.
Reducing consumer bills for the neediest households in the UK requires stepping up the spending levels on energy efficiency, not trying to roll it back as the government announced in December. A combination of higher prices and greater expenditure on energy efficiency measures would help to reduce the UK’s dependence on high energy consumption patterns. The events in Ukraine may provide a timely reminder to us all of the precious – and precarious – nature of the energy resources that we allow to escape through our walls, windows and rooftops.

Dr William Blyth is associate fellow at Chatham House, and honorary research fellow, Imperial College London and Oxford Energy Associates

This article is taken from New Power, April 2014 edition.  Also in this issue:

CCS: what is the global position?

Energy markets: have we built in the right flexibility?

Interview: Steve Riley, chief executive, GDF Suez UK, Europe

And much more. For a sample issue: [email protected]