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1 INTRODUCTION

As explained in Chapter 2, environmental taxes stem from the assumption that taxation will distort behaviour: hence some of the traditional concepts for the successfulness of a tax regime, such as whether there is a large element of avoidance, need to be considered differently. This chapter looks at these issues in context, demonstrates those points in relation to particular examples of taxes seen in the UK to date and looks to see what the future might hold in this area.

1.1 What is compliance?

When looking at the effectiveness of a tax system, it is usual to look at compliance with the law and the level of tax evasion (ie. the deliberate failure to pay taxes, usually by making a false report). Additionally, the level of tax avoidance, being legal actions taken to ensure that as little tax as possible is paid (for example, through making full use of reliefs and exemptions) is often seen as a measure of how successful the tax is, with low levels of avoidance and evasion being signs of success.

From the perspective of environmental taxes, the logic on tax evasion still applies but the concept of tax avoidance needs to be developed. The recent discussion in the UK on tax avoidance, including the utilisation of terms such as ‘aggressive avoidance’ and ’artificial tax planning’, has led to a strong perception that (legal) tax-motivated behaviour is clearly something that should be seen as distasteful.

Even outside the sphere of environmental taxes, such a wide assumption is questionable, as much tax motivated behaviour is specifically encouraged by government; for example the contribution of earnings to pensions, the giving of money to charities and deposits into child trust funds. However, when considering environmental taxes, if tax is ‘a tool of social and economic policy’ such that it sends clear signals about the behaviour that governments wish to encourage, then the demonization of avoidance is clearly even more questionable.

For an environmental tax to have an impact, arguably we need to see avoidance and the key question for evaluators is whether that avoidance is the one that the policy makers intended. For example, by purchasing cars with lower emissions, taxpayers are ‘avoiding’ the higher rates of vehicle excise duty levied on cars with high emissions. Such intended response could be seen as ‘positive avoidance’ whereas unintended actions that frustrate the intention of the tax (but nonetheless reduce the tax liability) could be seen as ‘negative avoidance’. Of course, with innovation, what constitutes positive avoidance can increase over time, as new ways are developed that both reduce the tax burden and achieve the environmental aim.

So, an effective environmental tax could be seen one with a strong level of compliance (ie. no evasion or at least as little as possible), high levels of positive avoidance and low levels of negative avoidance.

1.2 Evaluating positive avoidance

In evaluating the positive avoidance associated with a measure, and hence the effectiveness, care needs to be taken to look throughout the supply chain, rather than at the mere immediate instance of taxation. Some environmental taxes will be visible to all participants of the supply chain whilst others will only be transmitted through the economic impact of the taxation (for example increasing the cost of certain activities). Even where the tax is not included in the price, information may be readily available that makes the tax burden very evident – as seen in the ongoing debates about the taxation of road fuel.

A further complication to the evaluation is that, for many environmental taxes, the tax merely increases the cost of a good or service. Consequently many businesses are already seeking to reduce the cost, and other innovations and developments may well be occurring simultaneously that have a greater impact on the environment than the tax, frustrating an evaluation. This lack of measurability was demonstrated in the 2003 Pre-Budget Report when the government published in a table listing 'The Environmental Impacts of Budget Measures'¹. This purported to show the impact of the Budget measures but, whilst it gave results based on models for some items, the bulk of the table was qualitative. For example, when listing the budget measure of “Tax relief for cleaning up contaminated land”, the environmental impact was shown as “Increases in the clean up of contaminated land”, along with a note across all descriptions that “These estimates are subject to a wide margin of error”.

2 TWO EXAMPLES

So, in many cases, any evaluation of compliance and effectiveness will be against an unknown counter-factual and causality will be hard to prove. What can we learn from the UK’s compliance regimes so far?

2.1 Climate change levy

It is tempting to judge the compliance success of the Climate Change Levy (CCL) by its outturn, both in terms of taxation and environment. When it was introduced in 2001, it was intended to raise £1bn in revenue per year. In practice, the actual tax receipts have ranged from a high of £832m in 2002/03 to a low £688m in 2007/08 (the last year measured); clearly a slight shortfall of revenue. However, looking at the environmental aim set out in PBR 2003 as “savings of at least 5m tonnes of carbon per year by 2010”, there seems a strong argument for success, as Treasury figures now predict a cut in annual emissions of 12.8m tonnes of carbon by 2010. This represents a 15% annual fall in energy consumption which, although the counter-factual is unproven, is still a strong improvement.

However, whilst this is a good outcome, there remains the question as to whether a better outcome could have been achieved. As noted above, part of the focus on environmental taxes is to “send clear signals” about the behaviour that the government wishes to encourage. The response to the CCL shows that that this signal has been received by the taxpayers, but is this end of the story?

Companies are far more aware of their environmental impact than they were when CCL was first introduced and their indirect exposure to the CCL could be a good way to measure this, particularly as some taxpayers can reduce their obligation by signing Climate Change Agreements, committing to agreed changes (discussed further below). Such agreements are powerful in effecting change for the taxpayer, but could they have been made even more powerful through a more suitable compliance regime?

The current compliance regime does not require the CCL taxpayer to refer to the CCL or its quantum or basis on billing documentation. Whilst this may be seen as saving administrative costs, this means that business customers can find the tax levy opaque and there may often be no awareness of the quantum of CCL actually paid.

This is the opposite of the normal incentive for government, where the famous quote of Jean Baptiste Colbert (that “the art of taxation consists in so plucking the goose as to obtain the largest possible amount of feathers with the smallest possible amount of hissing”) generally holds true. From the business perspective, there are mixed incentives as keeping administration simple would militate against disclosure whereas being able to blame increases on the government can be attractive.

2.2 Enhanced capital allowances

Arguably, measuring the compliance success of the CCL is at the easy end of the spectrum as this is a relatively new tax designed with a particular environmental motive in mind. An evaluation is more complex where the element of environmental taxation is itself merely an element of a wider tax regime, such as enhanced capital allowances within corporation tax.

Since their introduction in 2001, enhanced capital allowance claims have perhaps not been as prevalent as intended. The regime allows 100% of the costs to be written off against profits for tax purposes in the year that they are incurred and should, therefore, be an attractive incentive. This applies for expenditure on designated energy saving technologies set out in the 'Energy Technology List'. Here the compliance regime is a critical factor in determining the success. Consider the following two examples: pipe-work insulation and combined heat and power plants:

• Businesses looking to invest in technology such as pipe-work insulation, radiant heating and refrigeration equipment are likely to respond to the incentive as they can easily distinguish between the products that attract the beneficial tax treatment and those that do not. The availability of faster relief, and therefore, cash flow benefits, is understood by business as a pointer towards the technology it is beneficial to invest in.
• In contrast, the compliance regime acts to frustrate the benefit of ECAs as a tool to encourage combined heat and power (CHP) plants. CHP is the simultaneous generation of usable heat and power in a single process and is widely thought to lead to cost savings and lower emissions. This is, unsurprisingly, exactly the sort of technology the Government wishes to encourage investment in. At the start of the process of procurement, the business buyer is attracted to the technologies that will qualify for ECAs. However, in practice it is very difficult to take advantage of this relief due to the compliance regime. Firstly it can be burdensome and problematic to identify which elements of a combined heat and power project would actually qualify for the enhanced capital allowances and consequently it is very difficult to obtain clear guidance. Furthermore any qualification must be certified and renewed annually, creating an ongoing, onerous compliance challenge.

As a result, many businesses that could, and indeed would, invest in CHP do not pursue this form of investment. Thus the complex and time-consuming compliance regime is frustrating the goals of the policy maker.