The new government has major decisions to make on transport, including how to tax petrol and diesel fuel, how to improve local transport including bus services, and how to fix the dire condition of Britain’s roads. The good news is it might be possible to tackle them together.
Fuel duty receipts (before VAT) are an important source of revenue for the Exchequer. They stood at around £25bn in 2022/23, which is down about a third on the 1999/2000 peak (in real terms, allowing for consumer price inflation). This is because manufacturers are improving their vehicles’ efficiency in terms of miles per gallon, while the number of electric vehicles is increasing and the duty rate has fallen. Successive chancellors have held the fuel duty rate stable and in 2022 Rishi Sunak reduced it by 5p per litre. Fuel duty now costs 53p per litre, while VAT is levied at 20 per cent on both the product and the fuel duty: this means if you pay £1.40 for a litre, 64p is for the fuel and 76p is fuel tax and VAT. While the four largest taxes (income tax, national insurance contributions, VAT and corporation tax) have all increased in relation to UK GDP, fuel duty revenue has almost halved.
And receipts are set to fall further as fossil fuels are phased out. In the long term the policy of vehicle electrification will either force a major reform of road taxation—such as the introduction of pay-as-you-go charging—or the Exchequer will have to abandon this source of revenue. Neither of those is likely to happen in the next few years and the government must be considering the advantages of increasing fuel duty in the next Budget. The rate can be changed instantly, and as taxes go it is cheap to collect and hard to evade. An increase would strengthen the consumer incentive to switch to low-carbon vehicles and moderate the increase in road traffic that will accompany the growing economy we all aspire to. That is particularly important for congested roads if, as seems likely, this government proves reluctant to increase road capacity.
Crucially, increasing the rate of fuel duty would generate significant extra revenue. If changes in the rate of VAT and price inflation, based on the Consumer Price Index, are considered, then the August 2024 level of fuel duty plus VAT is only 61 per cent, in real terms, of that in 2011. Suppose that the 2011 level of taxation in real terms were set as the upper limit for any forthcoming increases: that is, fuel duty plus VAT would rise from 64p to 104p per litre. Taking £22bn as a current base figure for fuel duty receipts (a modest traffic recovery from the Covid 19 effect will have created a recent upward trend in road use, but this is probably more than offset by an increase in electric vehicles), an increase to this “ceiling” level would yield an increase in receipts of around £12bn per annum over the next couple of years (allowing for some suppression of demand), plus the VAT on fuel duty. If an extra £5bn per year were the aim, the rate would have to increase by about 15p per litre. This would keep the cash pump fuel price below the 2022 peak and well below that in real terms.
Fuel duty increases have proved politically difficult, and any government would be wary of taking such a step. However, fuel prices have fallen significantly since the 2022 peak driven by the invasion of Ukraine—and the government has made it clear that unpopular tax rises are imminent. An increase in fuel tax can be defended as a “green” tax and consistent with the declared policy of decarbonising road transport.
Even so, an increase that simply disappeared into the “black hole” that is the Exchequer would be badly received, and some mitigation would be required. This could be structured as a lesser increase presented alongside a concession. The government could defer the introduction of vehicle excise duty on zero emission vehicles, which is scheduled for April 2025. This would probably cost between £0.3bn and £0.4bn in the first year, rising to £1bn or so in three years—depending on the take-up of electric vehicles. This expense would be covered by the increase in VAT on the higher fuel duty, and could be further enhanced by a three-year programme (costing £100m a year) for strengthening the trunk road “en route” charging network for electric vehicles and by reducing VAT levied on electricity from public charging points.
There is another way to soften the blow. The finances of local authorities are under great pressure and the need to fund non-transport statutory duties has forced councils to divert central government grant money away from improving bus services and routine road maintenance. Residents, pedestrians, cyclists, car users, buses and commercial vehicles all hate “potholes”. The best independent source, the Asphalt Industry Alliance annual survey, has documented the decline in the condition of our roads—the most valuable single asset local authorities have. It estimates that the outstanding backlog of road repairs in England and Wales has increased to £16bn.
National government wants to increase funding to local authorities for improving bus services and road maintenance, but its funds are very scarce. Much as HM Treasury dislikes the loss of discretion that comes with ring-fencing tax revenues for a particular purpose, an increase in fuel duty rates would be more politically palatable if a substantial part of the extra revenue could be credibly dedicated to these purposes.
Mere promises cannot be audited or enforced and will not be accepted as credible. In any case, under the present system any extra grant to local authorities is at risk of being swallowed up by their other, inescapable statutory duties, such as social care and housing.
Credibility could be established if new, special-purpose local transport funds received a portion of the extra fuel duty revenues. These funds would be capable of being audited and should come with statutory rules that ensure they can only be spent on local transport, while local politicians would be accountable for them. The London government offers a precedent: its Congestion Charge proceeds must be spent on transport in the capital and the mayor and the London Assembly are accountable for this spending.
Such bodies would be able to borrow and, over time, they could enrich local governance. This would help to give substance to the government’s stated wish to devolve more real power—which is only meaningful if control of how funds are managed and spent is devolved along with the statutory powers and duties.
Over the last couple of decades road fuel tax revenues have halved in real terms without anybody really noticing. The government wants to constrain traffic growth, reduce consumption of carbon-based fuels and encourage electrification. Meanwhile, local roads and bus services are in a poor state and neither central nor local government has any money to improve them. The solution seems obvious.
