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Andrew Lilico: Understanding the price stabilising fuel duty

When I originally proposed the price stabilising fuel duty back in 2000, the context was rather different from today.  Then, oil prices had tripled from $10/barrel to around $30/barrel in under two years, and about 75% of price of petrol was tax.  Today, oil prices are closer to $100/barrel and the proportion of the petrol price that is tax is a little under two thirds.  Then, the UK was a significant net oil exporter (exporting more than twice as much as we imported).  Now, matters are closer to balance (though at current oil prices, given recent North Sea finds, we would be likely to become significant net exporters again).

But despite this changed context, the basic rationale for introducing a price stabilising fuel duty is the same, namely that of a green tax.  The very high proportion of petrol prices that is tax reflects the fact that revenue-raising is not the only function of fuel duty.  The government has, since the early 1990s, always been explicit that fuel duties are higher than would have been the case merely for revenue-raising purposes, because their purpose is to incentivise reduced consumption of petrol (or diesel) and accelerated innovation of low-petrol-consuming cars and vehicles based on alternative energy sources (such as electricity).  To deliver these incentives, the government imposes so much tax on petrol that it virtually sets the price.

The concept of the price-stabilising fuel duty is that, if the government is to set the petrol price for these green purposes, it might as well do so competently, achieving the price it wants.  If, for example, the government sets fuel duty to achieve a price of £1.20 per litre, and sets tax accordingly, but then oil prices fall so the actual petrol price falls to £1.05 per litre, then the price has not turned out as the government intended.  It might feel that some of that fluctuation represented real supply cost issues that it felt should legitimately lead to price variation, but other of the fluctuation might have been caused by demand issues – but demand is precisely what the government wants to manipulate via the tax level, so it might not want to validate all of that with price changes.  So, if the price of petrol would tend to fall below what was intended when oil prices fell, the fuel duty could rise.  Similarly, the government isn’t simply seeking to get the petrol price as high as possible.  If oil prices rise too much (especially if such price rises are demand-driven), then the government could reduce fuel duty so that the final price was closer to its intended level.

Some commentators have suggested that such stabilisation could be fiscally neutral in any one year, because the government would gain from VAT and petroleum revenue taxes (directly on the North Sea oil industry) as the petrol price rose.  Even in 2000 I argued that that was unlikely.  Today, with oil much less significant as a net export, it was no surprise that the OBR concluded that in-year fiscal neutrality was unlikely.  Instead, the measure would need to be fiscally neutral across an oil price cycle.

Now, it is, of course, difficult to determine just how much of an oil price rise is cyclical (“temporary”, in OBR terms) and how much is structural.  Of course, just the same can be said of economic growth.  And yet the government finds no especial difficulty in identifying the structural deficit and setting a policy targeting of eliminating the bulk of it.  In much the same way, we can produce estimates of the structural and cyclical components of oil price changes.  As with our estimates of the structural deficit, we might need to vary our view as to the structural component of oil price changes every now and then – and the fuel duty stabiliser formula would change accordingly.  (Perhaps not at every revision of the oil price cycle estimate, though.)

Thus, the fuel duty stabiliser is not, in the first instance, a measure to assist household budgets (as it was mis-presented by the Conservatives at Party Conference 2008).  Neither is it likely to be fiscally neutral in-year.  And it certainly isn’t intended to eliminate all variability in fuel prices.  Rather, it is a green tax, intended to achieve more precise delivery of the government’s objective of quasi-setting fuel prices, that is fiscally neutral over an oil price cycle.  That’s how to understand it, and how to make it work.


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