Ensuring the tax regime supports heat decarbonisation
The transition to net zero over the next 25 years will see changes to the UK tax regime. This transition will involve people and businesses investing upfront to switch from inefficient fossil fuel systems to cleaner alternatives for transport and heat. A mixture of carrots and sticks will support that switch. Greening the tax system can support heat decarbonisation.
The UK government has consistently used the tax system to facilitate the transition to net zero over the last decade. In transport, we are seeing the impact of a combination of direct grants and preferential tax rates to incentivise the shift away from internal combustion engines to Electric Vehicles (EVs). The UK government initially offered a plug-in car grant for EVs of £5,000. As manufacturing costs fell and innovation in the car sector increased, the level of grant available reduced and was eventually removed altogether in 2022. This is an unalloyed success. EV sales increased from less than 1,000 in 2011 to more than 250,000 in 2022. There are now more than 900,000 EVs on British roads.
Similar incentives are on offer to facilitate heating decarbonisation, which is one of the most challenging sectors to decarbonise. The UK government has:
zero-rated VAT for heat pumps from 2022 to 2027, a flexibility provided by Britain leaving the EU.
increased the Boiler Upgrade Scheme grant for air-source heat pumps from £5,000 to £7,500 in October 2023.
extended the Boiler Upgrade Scheme’s availability to 2028.
invested in energy efficiency measures in building through schemes such as ECO, LAD and HUG.
The £7,500 grant now matches the size of the Home Energy Scotland grant available from the Scottish government. The UK government has recently consulted on following the Scottish approach of providing an uplift for heat pumps installed in rural properties.
As well as using the tax system to support consumer uptake, the UK government is supporting manufacturers to invest in low carbon heating solutions to reshore manufacturing and reduce costs. Grants of up to £15 million are available through the heat pump investment accelerator competition, while the Clean Heat Market Mechanism encourages boiler manufacturers to diversify. Full expensing is available from March 2023 to March 2026, allowing businesses to claim 100% capital allowances on qualifying plant and machinery investments.
The Autumn Statement on 22 November 2023 is likely to be the penultimate fiscal opportunity event of this Parliament for the Chancellor to reform the tax system to encourage heat decarbonisation. This is a chance to reduce carbon emissions, lower bills and encourage investment into the UK. The Chancellor can take long-term decisions by presenting a positive set of green changes to the tax system.
HM Revenue and Customs and HM Treasury consulted over the summer on modernising the list of Energy Saving Materials eligible for VAT zero-rating. A joint letter coordinated by Thermal Storage UK in May 2023 called for zero-rating to extend to heat batteries, electro-chemical batteries and EV chargers. This letter was co-signed by a diverse group of organisations, including EON, EDF, Ovo, UK Power Networks, Citizens Advice, the Energy Saving Trust, Nesta, Sunamp, tepeo, Caldera and Powervault.
The scale and pace of the transition means further changes to the tax regime are coming. The UK government has committed to rebalancing electricity and gas prices over time to incentivise switching to EVs and electric heating. Electricity costs around four times as much as gas (28p / kWh versus 7p / kWh in the current price cap), with green levies making up around 10% of the electricity bill. As electric heating and transport is more efficient than burning fossil fuels, even relatively minor reductions in electricity prices could make the operating costs for fuel switching appealing.
Organisations are proposing further changes to ensure the transition is fair. E3G has proposed a discounted unit rate for electricity used in heating technologies, following the lead of Denmark. The Sustainable Energy Association is calling for the Boiler Upgrade Scheme to expand to cover a wider range of heating technologies. This could include smart thermal stores.
The costs of the various carrots and sticks outlined above pale in comparison to the £40 billion spent subsidising energy bills for people and businesses when gas prices rose rapidly during 2021 and 2022.
The UK government will likely need to explore deeper reform of the tax system as the transition accelerates. This includes the costs of decommissioning at least parts of the gas grid, financing the expansion of the electricity network and supporting business models for both hydrogen and carbon capture, utilisation and storage (CCUS). These are long-term and expensive infrastructure projects. Investment in the electricity transmission and distribution network alone is expected to cost between £40 billion and £110 billion over the next 25 years. Much of this cost is slated to fall on energy bills.
It is no surprise that there are upfront costs to the transition to net zero. We are rebuilding much of the foundational infrastructure of the economy. Building an energy system that no longer burns fossil fuels in homes, vehicles, industry or power generation will deliver long-term benefits, including improved air quality, enhanced efficiency and lower emissions. The tax system will need to keep pace with this change in infrastructure, including reflecting changes in tax revenues, people switching to low carbon options and the upfront costs of the transition. A transition to net zero that is pragmatic, proportionate and realistic - as the Prime Minister wants - will need to tackle the tax system. The forthcoming Autumn Statement is a good place to start.
Elements of this blog are taken from this longer piece published by Utility Week on 6 November 2023.