Green taxes and subsidies
Climate change is one of the most serious issues we face. With the Intergovernmental
Panel on Climate Change warning that global temperatures are likely to reach 1.5°C above
levels within the next few decades, ambitious and radical action is necessary to avoid
catastrophic warming. The UK has a target of bringing net greenhouse gas emissions to
zero by 2050 [link 196], with the Prime Minister recently speaking of an ambition to advance the
adoption of renewable energy and make the UK the ‘Saudi Arabia of wind power’ [link 197].
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The State of Green Subsidies.
The UK Government currently administers a range of green subsidies and policies which
promote renewable energy generation and energy efficiency. Some of the most notable
schemes are listed below:
Renewables Obligation (RO): this is the main support mechanism for large-scale
renewable electricity generation. The RO mandates that UK electricity suppliers source an
increasing proportion of their supply from renewable sources. Suppliers receive certificates
for accredited renewable electricity generation and must collect a certain number of
certificates annually, either by their own efforts or by buying them from other suppliers who
have received a surplus of certificates. Any supplier who fails to collect enough
certificates must pay a levy, which is distributed to other suppliers who did meet their
target [link 198]. The practical economic impact of this is that suppliers who generate a large
amount of renewable electricity are financially rewarded at the expense of any of their
competitors whose efforts are insufficient. These costs and savings can then be passed on
to consumers. The scheme has been closed to new entrants since 2017 and is intended to
be phased out and replaced with other measures.
Feed-in Tariffs (FITs): this is a scheme to subsidise relatively small-scale renewable
electricity generation, including generation for personal use. Owners of certified generators
were paid a set rate per unit of renewable electricity they generated, plus a bonus for any
surplus electricity exported to the National Grid [link 199]. This meant that small-scale generators
had a guaranteed rate of return independent from market prices. FIT has also been closed
to new entrants since 2019 [link 200].
Renewable Heat Incentive (RHI): this subsidy provides regular payments to households
and firms who use renewable energy sources for heating. It includes both a domestic and
non-domestic scheme which are administered separately. Eligible homes receive quarterly
payments for seven years after joining, while non-domestic users are paid for 20 years [links 201, 202].
The bungled administration of the RHI in Northern Ireland produced a scandal – termed “cash for ash” – so
serious that it brought down power-sharing arrangements for three years, a serious blow to the peace
process there. Because payments exceeded heating costs and individual recipients could receive an uncapped
amount, many users exploited the scheme by generating as much heat via renewable sources as they could
– including heating empty rooms and buildings – and turning a profit thanks to their RHI payments.
As a result, the scheme greatly exceeded its budget with an overspend of £700 million
projected. Northern Ireland’s First Minister, Arlene Foster, had been responsible for the
implementation of the scheme and was accused of wrongdoing, The scandal led to Sinn
Féin withdrawing from the Northern Ireland Executive in January 2017 and the Executive
would not be restored until 2020 [links 203, 204].
Green Homes Grants: this is a new scheme introduced to encourage households to
improve the energy efficiency of their homes, for example by installing insulation, heat
pumps, solar thermal generators or biomass boilers. Eligible homeowners and landlords
can receive two-thirds of the cost of these upgrades, up to a maximum of £5,000 (£10,000
for low-income households) [link 205].
Contracts for Difference (CfDs): this is the scheme intended to promote new low carbon
energy projects, succeeding RO and FITs. CfDs are contracts between green energy
suppliers and the publicly-owned Low Carbon Contracts Company (LCCC) which set a
pre-determined ‘strike price’ offering a guaranteed rate of return to suppliers. If the market
price that suppliers receive falls short of the strike price the LCCC will make up the
difference. If the market price exceeds the strike price then the suppliers are required to
return the saving to consumers. This is intended to support green energy developments
which have a high upfront cost and which would otherwise face uncertain market prices.
The scheme is funded by a levy that the LCCC collects from electricity suppliers [link 206]. So far,
CfDs seem to have been fairly successful in encouraging low carbon energy development,
with strike prices falling as the amount of new electricity generation agreed rises [link 207].
Who Really Pays?
From a public accounts perspective, green subsides are nearly cost-neutral as spending is
almost all covered by the receipt of levies. According to the Office of Budget Responsibility
(OBR) the Government spent £7.8 billion on ‘environmental levies’ (RO, CfDs, and a few
other schemes) while receiving £7.5 billion, resulting in a net cost of about £300 million [link 208].
However, those levies are imposed upon energy suppliers who can pass off the cost
to customers without necessarily having to pass on all of the savings. The real cost of
these subsidies, therefore, is borne by consumers facing higher energy bills. According to
the energy regulator Ofgem, “environmental and social obligation costs” make up 23% of a
typical consumer’s electricity bill and 2% of their gas bill [link 209]. This means that for an average
dual fuel bill of £1,171 [as of 2019], £153 comes from the cost of green subsidies, an
increase of more than 50% since 2016 [link 210]. The exact cost will vary by consumer and
supplier. Suppliers falling behind on their green obligations will face greater costs than those generating
a lot of renewable energy, while consumers who have made use of green electricity or heating generation
themselves will be better off.
Since poorer householdspay a greater proportion of their income on energy bills, this method of funding green subsidies is effectively regressive . Based on 2016 data,
researchers found that the poorest 5% of UK households paid 1.10% of their income
towards green subsidy costs, whereas the richest 5% paid just 0.18% [link 211]. This is despite the
fact that higher income households account for a greater proportion of greenhouse gas
emissions [link 212]. Meanwhile some green subsidies, such as the small-scale-focused FITs
disproportionately benefit richer households, who can afford to install energy generation
systems, with the average recipient estimated to have an annual household income of
more than £60,000 [link 213]. This has been described by the Centre for Sustainable Energy as a
“triple injustice”: low-income households are the least responsible for greenhouse gas
emissions, benefit the least from green subsidies, but nevertheless bear the heaviest burden [link 214].
The long-term direction of the cost of green subsidies is unclear. On the one hand, the
availability of these subsidies has helped expand and improve the supply of renewable
energy, bringing down prices over the long-run. The latest round of CfD bids saw
developers agree lower strike prices, as the price of offshore wind power in particular has
fallen dramatically, leading to the real possibility of “negative subsidies” as suppliers pay
back consumers if their strike price is below the market price [link 215]. On the other hand, the
disruption of the Covid-19 pandemic has led to a fall in energy demand and a
corresponding fall in market prices, which means that market prices have generally fallen
below strike prices, causing a rise in subsidy costs [link 216].
Who Really Benefits?
Most methods of generating renewable energies ultimately depend upon having suitable
land with the right weather conditions. This differs from fossil fuels and nuclear power,
which involve using specific resources. This means that, as renewable energy generation
becomes more valuable, there is likely to be a knock-on effect increasing land values in
spots which receive lots of sunlight, are particularly windy, and so on.
Green subsidies have helped many landowners turn relatively unproductive land into
lucrative, consumer-subsidised wind or solar farms. In 2015 farmers and landowners were
responsible for 28% of independent renewable energy projects [link 217]. The UK’s largest solar
farms make more money from the receipt of subsidy payments than they do from actually
selling the electricity they generate [link 218]. A study of the introduction of feed-in tariffs for wind electricity in Germany found that they resulted
in a substantial increase in land prices in windy locations, leading to much of the proceeds being captured
by landowners [link 219].
Fossil Fuel Subsidies.
The UK Government claims that it does not subsidise fossil fuel energy production.
However, environmentalists [link 220] and the European Commission [link 221] have accused them of
doing just that, possibly giving more support to fossil fuels – an estimated £10.5 billion per
year – than to renewable energy, undermining the effectiveness of green subsidies in the
process.
These differences of opinion are a matter of how you define subsidies. The Government
defines fossil fuel subsidies “as government action that lowers the pre-tax price to
consumers to below international market levels” and on that basis insists that the UK does
not subsidise fossil fuels. However, others have offered a broader definition which
includes, for instance, the reduced rate of VAT on domestic gas and electricity
consumption.
Other policies which some have defined as fossil fuel subsidies include:
Capacity Market: as part of plans to ensure stable electricity supply the Government pays
suppliers of reliable sources of capacity [link 222]. Since one problem with renewable sources of
electricity, such as solar and wind, is that their supply is variable, the capacity market
strongly favours fossil fuel power plants. Early rounds of capacity market auctions paid out
£373 million to old coal-fired power stations and £176 million to new diesel generators,
both highly polluting forms of electricity generation [link 223]. A study by Greenpeace found that,
across the EU, 66% of capacity market funds went to coal power plants alone, and almost
all of the rest to other fossil fuel sources or nuclear power plants [link 224].
North Sea industry: North Sea oil and gas producers recently became a net burden on the
taxpayer for the first time, with tax reliefs such as those for transactions and
decommissioning efforts [link 225] exceeding tax revenues by £396 million in 2016 [link 226].
This comes after a series of tax cuts to help keep oil and gas fields which have cost more than £1
billion [link 227].
UK Export Finance: the UK’s export credit agency, which provides loans and financial
guarantees to UK companies engaged in business abroad, continues to support overseas
fossil fuel projects to the tune of up to £6 billion, accounting for about one-fifth of all of its
investments [link 228].
Externalities: the International Monetary Fund (IMF) has one of the broadest definitions of
fossil fuel subsidies, counting the underpricing of energy relative to its real environmental
cost as an implicit subsidy. In economics, “externalities” are costs (or benefits) of
production or consumption that the responsible agent does not have to pay for (or
is not compensated for) [link 229]. The use of fossil fuels imposes heavy environmental costs on us all, most
obviously through air pollution and greenhouse gas emissions, which energy suppliers do not have
to directly or entirely pay for themselves. This makes energy generated from fossil fuels cheaper (and green
energy relatively more expensive) than it “should” be [link 230].
A More Equitable Transition?
Transitioning to an environmentally-sustainable future will require massive collective action
and behavioural changes, which we all need to buy into. This effort could be undermined
by any perception that environmental policy is unfair and inequitable. The current system
of green subsidies where consumers are burdened with higher energy bills and much of
the proceeds go to big companies and wealthy landowners ought to undergo a rethink.
Both the Chief Executive of the energy company Centrica [link 231] and the trade union GMB
[link 232] have called for green subsidies to be funded from general taxation rather than levies
imposed on consumers. Since the overall tax system is broadly progressive, this would be
a fairer and more appropriate way of sharing the costs of subsidising renewable energy, to
the extent that it is needed.
As the renewable energy sector advances and its costs fall, we may be approaching the
point at which subsidies are no longer necessary to make green energy an attractive
investment and competitive with fossil fuels. If that is the case, then in the future
governments may find there is more to be gained from properly accounting for the real
cost of fossil fuels than continuing to subsidise renewable energy. Carbon pricing
schemes, such as carbon taxes or “cap-and-trade” schemes, which force fossil fuel energy
suppliers to internalise the real environmental costs of their actions, would be a strong
incentive to further transition towards green energy [link 233]. With the increasing availability of
competitively-priced renewable energy options to switch to, imposing a carbon price would
not necessarily be excessively burdensome on consumers.
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196 https://www.gov.uk/government/news/uk-becomes-first-major-economy-to-pass-net-zero-emissions-law
197 https://www.bbc.co.uk/news/science-environment-54285497
198 https://www.ofgem.gov.uk/environmental-programmes/ro/about-ro
199 https://www.ofgem.gov.uk/environmental-programmes/fit/about-fit-scheme
200 https://www.ofgem.gov.uk/environmental-programmes/fit/about-fit-scheme
201 https://www.ofgem.gov.uk/environmental-programmes/domestic-rhi/about-domestic-rhi
202 https://www.ofgem.gov.uk/environmental-programmes/non-domestic-rhi/about-non-domestic-rhi
203 https://www.instituteforgovernment.org.uk/blog/ni-rhi-report
204 https://www.bbc.co.uk/news/uk-northern-ireland-38301428
205 https://energysavingtrust.org.uk/advice/green-homes-grant-scheme/
206 https://www.cfdallocationround.uk/what-is-the-CFD-scheme
207 https://researchbriefings.files.parliament.uk/documents/CBP-8891/CBP-8891.pdf
208 https://obr.uk/efo/economic-and-fiscal-outlook-march-2020/ (tables 3.3 and 3.13)
209 https://www.ofgem.gov.uk/data-portal/breakdown-electricity-bill
210 https://www.ofgem.gov.uk/publications-and-updates/infographic-bills-prices-and-profits
211 https://www.tandfonline.com/doi/full/10.1080/14693062.2020.1773754
212 https://link.springer.com/chapter/10.1007/978-3-319-20571-7_9
213 https://www.climatejust.org.uk/resources/distribution-household-carbon-emissions-uk
214 https://www.cse.org.uk/projects/view/1206
215 https://eandt.theiet.org/content/articles/2020/07/negative-subsidies-anticipated-for-plummeting-cost-of-
offshore-wind-electricity/
216 https://www.smart-energy.com/renewable-energy/uk-customer-bills-to-rise-due-to-increase-in-the-cost-of-
renewable-subsidies/
217 https://www.farminguk.com/news/farmers-and-landowners-account-for-28-of-all-independent-renewable-
projects-in-2015_39612.html
218 https://www.dailymail.co.uk/news/article-5592691/Solar-farms-receive-cash-green-subsidies-selling-
energy-produce.html
219 https://www.sciencedirect.com/science/article/abs/pii/S0047272718300112
220 https://www.energyvoice.com/opinion/234139/uk-fossil-fuel-subsidies-exist-by-the-back-door/
222 https://www.gov.uk/government/collections/electricity-market-reform-capacity-market
223 https://www.ippr.org/research/publications/incapacitated
225 https://www.bbc.co.uk/news/uk-scotland-scotland-politics-39198839
226 https://www.carbonbrief.org/analysis-north-sea-industry-cost-uk-taxpayers-396m-2016
227 https://neweconomics.org/2016/07/the-looking-glass-world-of-fossil-fuel-subsidies/
229 https://www.investopedia.com/terms/e/externality.asp
230 https://www.imf.org/en/News/Articles/2015/09/28/04/53/sonew070215a
231 https://businessutilitiesuk.co.uk/time-uk-come-clean-green-energy-taxation/
232 https://businessutilitiesuk.co.uk/time-uk-come-clean-green-energy-taxation/
233 https://www.lse.ac.uk/granthaminstitute/news/eu-countries-focus-carbon-pricing-instead-subsidies-
renewable/