UK considering broader-based carbon tax, reports suggest

The Times said it had seen a memo from Downing Street and the Treasury sent to all departments, which stated that the "chancellor and the prime minister want a sector-by-sector view on how we could implement some form of carbon pricing and an overall road map to deliver [it] in the next decade". The memo suggested that this could include a ‘direct’ carbon tax, according to The Times.

‘Carbon pricing’ is the name used for any method which aims to reduce emissions by adding a cost, encouraging polluters to find ways to reduce emissions, or to continue polluting and to pay for it.

Pricing can come in the form of a direct tax on emissions created by the business or a market-driven system like an ‘emission trading scheme’ (ETS). Under an ETS, a government issues permits or credits to emit. By restricting the supply of these credits and allowing them to be traded on a secondary market, a market price is created which rises over time unless demand for carbon reduces. Governments earn revenue by auctioning off the credits.

Last summer, as the UK prepared to leave the EU’s ETS, the UK consulted on whether to set up its own ETS or whether to impose a ‘carbon emissions tax’ (CET) on UK businesses. 

"In the end it plumped for a UK-only ETS," said Jason Collins a tax expert at Pinsent Masons, the law firm behind Out-Law. "However, the consultation document also hinted at the possibility of expanding those who are required to obtain credits to emit and, by analogy, those who would have to pay the CET. The Times report suggests the government is still looking at this as a policy option – although recent reports elsewhere have distanced the government from such claims."

The UK has legislated to reduce its net emissions by 100% back to 1990 levels, referred to as 'net zero', by 2050 and in December last year the prime minister announced an intention to have achieved a 68% reduction by 2030. The Times reported that the government review is part of a strategy to "deliver a carbon price for the whole economy" in time for the COP26 UN climate change conference taking place in Glasgow in November.

At present around 30-40% of emissions generated directly in the UK are covered by the UK’s ETS. The scheme only covers heavy industry, power generators and airlines. An extension of carbon pricing would be likely to increase the cost for consumers of the most carbon-intensive goods, such as meat and dairy products and services such as gas used for domestic heating.

Collins said: "A carbon tax is considered to be simpler to administer and arguably provides business with greater certainty, as it is not as variable as the prices for credits under an ETS. It is also better at raising money for the Treasury, as the government can increase rates over time, whereas under an ETS, the amount raised in an auction of credits can be variable and dependent on the secondary market price at the time."

"In either case, one of the biggest issues for carbon pricing is carbon ‘leakage’. If one country imposes a price on emissions, supply chains might move to a country that doesn’t, in order to avoid the cost," he said. 

"Currently the UK – and the EU’s ETS – deals with this problem by giving free credits to businesses which compete with businesses in countries not subject to carbon pricing, which rather defeats the object of having a carbon price in the first place," Collins said.

One solution proposed by the EU is a carbon border adjustment mechanism – or carbon border tax. This applies a price to goods and materials which have been extracted or manufactured outside the EU, in order to ensure that EU businesses are not unfairly beaten on price. There would be a credit or an exemption for goods and raw materials originating in a country which applies a carbon price, thus providing a spur to ensure more countries introduce carbon pricing domestically.

"There is some doubt as to whether such a carbon border adjustment mechanism is permitted under international trade rules," Collins said. "There is also a question about how far one would apply the mechanism. Applying it to imported steel is more straightforward than applying it to finished goods, particularly lower value ones."