End £2bn VAT subsidy on gas, which benefits well off, to fund warm homes for poorer households, report says

• Wealthier households using large amounts of energy benefit most financially from the 5% VAT rate on domestic heating fuels, like gas and oil. The richest households gain twice as much as the poorest.
• Ending this fossil fuel subsidy and ringfencing the funds for redistribution and home energy efficiency improvements for poorer households could be a powerful measure to address fuel poverty while cutting carbon.
• The subsidy on household gas, and other fuels like oil, means the Treasury is losing over £2 billion a year in potential tax revenue.

The VAT system drives perverse environmental and social outcomes while benefiting the wealthy over those on low incomes. It is also seriously hampering the UK’s ability to cut carbon fast enough to tackle the climate emergency, says a new report by Green Alliance. [1]

The new analysis shows the government is still subsidising domestic gas and other heating fuels to the tune of £2.2 billion a year, through a discounted VAT rate. This is a significant subsidy that is incompatible with the need to cut carbon faster across the economy. (The UK is not on track to meet its legal decarbonisation targets.)

And, at a time when the government is focused on levelling up, this discount is also unfair, benefiting the wealthy who use more fuel. The richest 10% of UK households use over twice as much heating fuel as the poorest 10%. [2]

According to the report, the government should end this regressive fossil fuel subsidy and bring VAT on gas up to the standard rate of 20%. It should then ringfence the extra revenue, which will come mainly from the better off, to provide targeted help to lift people out of fuel poverty.

This should include more help for those on low incomes to improve the energy efficiency of their homes and switch to low carbon heating to bring their fuel bills down, as well as redistribution through the benefit system to directly help those most in need to heat their homes.

In this autumn’s budget and its net zero review, the government has the chance to change VAT to make the system fairer and support greener policies. Currently, it is discouraging activities that would lead to more secure jobs and a greener, healthier society, while at the same time it is encouraging activities that damage our environment, make us unhealthy and suppress job creation.

The recent Climate Assembly UK recommendations made it clear that fairness is key to public acceptability of net zero policies, and showed that ringfencing tax revenues for specific purposes makes taxes more acceptable. [2] Ending an unfair subsidy and redirecting the revenue to help those that need it most is likely to be popular with the public.

Professor Paul Ekins, director and professor of resources and environmental policy at the UCL Institute for Sustainable Resources, said:

“Like most fossil fuel subsidies, reduced VAT on household energy disproportionately benefits the wealthy because they use more energy than less well-off households. This not only makes no sense in itself, it also disincentivises richer households from making their own investments in energy efficiency, at a time when the government is making subsidies available for this too. This is bad economics that makes it harder and more expensive for the UK to reach its zero-carbon goal.”

Dr Arun Advani, assistant professor in economics and impact director of the Centre for Competitive Advantage in the Global Economy (CAGE) at Warwick University, said:

“Current government policy ‘protects the poor’ by making it cheap for them, and everyone else, to burn high carbon fuels. It would be better to end the subsidy and invest the revenue in energy efficiency and low carbon heating for those on low incomes, so they can have comfortable homes without damaging the planet.”

Libby Peake, head of resource policy at Green Alliance, said:

“We now have the perfect chance to reconsider what taxes are for, including what is taxed and why. For the government to show it is serious about its promises to both green the economy and level up the country, it must end this massive subsidy to the fossil fuel industry and use the funds to ensure those who are less well-off have warm homes that are inexpensive to heat.”

Notes for editors

Green Alliance
Green Alliance is a charity and independent think tank, focused on ambitious leadership for the environment. With a track record of over 40 years, Green Alliance has worked with the most influential leaders from the NGO, business, academic and political communities. Our work generates new thinking and dialogue, and has increased political action and support for environmental solutions in the UK. www.green-alliance.org.uk

TransformTax
This is the first report for Green Alliance’s TransformTax project. The project, supported by the Joseph Rowntree Charitable Trust, is using a multidisciplinary approach, looking at the history of taxation, analysing alternative approaches from abroad, comparing fiscal instruments and, crucially, incorporating behavioural science. As part of this, we will be using deliberative democracy techniques to understand what the public wants from the tax system.

The aim is to show how taxes can be applied in a way that helps society to navigate away from an economic system founded on the ever increasing consumption of goods, with little consideration of its impact on the wellbeing of people and the planet. We are particularly interested in opportunities for the tax system to enable people to make more sustainable choices.

[1] Value added: Improving the environmental and social impact of UK VAT (Green Alliance, September 2020)

In addition to ending the subsidy on household gas and heating fuels, the report outlines two other VAT perversities, with adverse social and environmental impacts, and how to they could be easily corrected:

• Building renovation: VAT for repair and renovation of buildings should be zero-rated, in line with new build, which will end what the government’s Building Beautiful, Building Better Commission called “the unnecessary and ecologically unacceptable destruction of adaptable and durable buildings, and their replacement by short-lived glossy boxes”. [3]
• Repair services: in a move that is possible because of Brexit, VAT on repair services should be zero-rated to stimulate the repair industry. This would be popular with the public, who find it hard to get broken items mended, leading to unnecessary waste. It would also boost local jobs across the country by growing the repair sector. Green Alliance’s research shows the repair industry could support 34,000 jobs, while remanufacturing could provide more than 300,000.

[2] Office of National Statistics (ONS), March 2020, ‘Family spending workbook 1: detailed expenditure and trends’

[3] Climate Assembly UK, September 2020, The path to net zero: Climate Assembly UK full report

[4] Government’s Building Better, Building Beautiful Commission, January 2020, Living with beauty; promoting health, well-being and sustainable growth