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Economics - Fuel Tax

PetrolThe price of fuel in the UK is a complicated business and it changes month to month as the cost of crude oil rises and falls with international demand. British drivers also pay two taxes on the petrol they buy at the pump - Fuel Duty and VAT. Of these, fuel duty remains by far the most significant, and remains the most controversial. If a litre of unleaded petrol costs 85p, 21.7p will be the production costs and profit, around 51p will be duty and 12.5p will be VAT on top of all that.

The major change in petrol taxation came under the Conservatives in 1993 with the introduction of the Fuel Price Escalator. The escalator was designed as a means both to raise money and discourage car use on environmental grounds. At the time, British fuel was the third-cheapest in Europe. It is now the most expensive. The annual fuel escalator was set in 1993 at 3% above the rate of inflation. On its introduction it added three pence to a litre of fuel and raised the tax burden on unleaded petrol to 72.8% of the total cost.

When the Conservatives left office in 1997, the escalator was at 5% and had contributed a 11.1 pence rise to the cost of unleaded fuel. Tax as a proportion of total cost stood at 76.3%. On taking office, Labour's chancellor Gordon Brown increased the fuel escalator further and put three pence onto a litre of petrol in his first Budget. That pushed taxes up to 81.5% of the total price of fuel. While duty rose by two pence a litre as part of the 2000 Budget, Gordon Brown also scrapped the fuel price escalator, saying that future increases would be decided on the basis of the "due Budget process".

At the time, and perhaps rather ironically given current events, the AA said that it was the first budget in seven years in which "drivers can take some heart". According to the Tories this isn't good enough. They say that since Labour came to office, the petrol pump price of unleaded petrol has risen by around 71%. And while there have been large jumps in the price of oil, the party blames what it says is Labour's 16p per litre rise in taxes. Figures from the Institute of Fiscal Studies tell a slightly different story. The Conservative figure of 16p per litre is a combination of duty and VAT.

While the actual amount brought in by VAT rises with increases in fuel prices and duty, it is calculated at the same 17.5% level which the present government inherited from the Conservatives. Fuel campaigners argue that VAT should only be calculated on the cost of the fuel rather than on the fuel and the duty together. If VAT was not charged on the duty, the motorist would save around 8p per litre at September 2000 prices. None of the parties appear to support that move. Leaving aside VAT, fuel duty increases under Labour amount to 12 pence per litre - just slightly more than the rise caused by the escalator under the Conservatives.

Because of the rise in world oil prices, the proportion of the total fuel cost that is tax has fallen from 85% (March 1998) to 72.3% today - still one of the highest levels in the world - something that ministers have sought to stress in interviews. With the Tories pledging a three pence a litre cut should they come to power, the question is whether the Government should cut fuel duty and whether the country can afford it.

Gordon Brown is raking in so much extra tax from rising oil prices that he could afford to cut 11p off a litre of petrol. If oil went up to $50 dollars a barrel, the Chancellor could even drop the basic rate of income tax by 2p without denting his coffers. Maurice Fitzpatrick, economics chief at business advice group Numerica, said, "If the oil price reached a sustained $50 a barrel then the price of petrol would be above 90p a litre from 80p now. The Treasury would be receiving a windfall of an additional £5.5billion per annum. This would be sufficient to cut fuel duties by 11p per litre, or income tax by 2p."

The Government's climate change strategy is seriously off course and current policies have yet to make a significant impact on UK carbon emissions, an all-party committee of MPs has warned. The Environmental Audit Committee calls for a more imaginative and radical strategy, particularly for transport and domestic energy efficiency. It also warns that the Treasury cannot expect industry to provide investment in alternative fuels unless it has a long-term strategy itself.

Politicians are accused of failing to make the case for the environmental benefits of taxing fuel and despite recent oil price rises, petrol is still at least 10% cheaper than four years ago in real terms. The MPs said in a report that the Government should consider recycling the proceeds of future fuel tax increases to subsidise public transport spending and alternatives to conventional fuel.

The MPs say that as a percentage of total tax, the revenues from environmental taxes have recently been at their lowest level since 1993. But the continued growth of carbon emissions from transport remains one of the most serious problems and the Government's commitment to sustainable development will be called into question unless it takes steps to confront the issue.

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