The European Commission recently announced that it would take the UK to court in an attempt to impose the full rate of VAT on energy-saving goods, for example home insulation.
Some commentators, such as the Association for the Conservation of Energy (ACE), seemed shocked by the announcement and suggested that it came out of the blue.
Had they been following the European Commission’s attitude on this issue more closely, however, then it would have come as no surprise. The Commission formally notified the UK of its intent back in September 2011 and has been pursuing reduced VAT rates in member states across the EU.
Introduced by New Labour in 1997, the UK has consistently defended the tax break for energy-saving goods with two main arguments: i) it is vital for the success of environmental policies such as the Green Deal, and ii) it helps achieve social policies such as alleviating fuel poverty.
So should the VAT system be utilised to achieve these important policy goals?
The first point to make is that VAT is a general consumption tax on the supply of goods and services to raise revenue for government. There are always political justifications as to why certain goods or services should be given a reduced rate, but there are few technical arguments which justify this.
Secondly, VAT is a regressive tax which disproportionately affects the poorest in society. This means that a wealthy homeowner looking to apply energy-saving measures to their home will benefit the same as a poor homeowner.
So would it not be fairer and more effective to abolish the reduced rate on energy-saving goods and use the additional revenue to provide direct subsidies for those under a certain income threshold?
Such subsidies could be similar to the recently-abolished Warm Front scheme, which may have had more sustained success had it been better funded. Alternatively, additional tax revenue could be used to fund community-style retrofit projects, like the former Community Energy Saving Programme (CESP), which made use of economies-of-scale and had strong consumer engagement.
Thirdly, reduced rates in general lead to high compliance costs for businesses, especially SMEs. They make the tax system more complex, increase the likelihood of tax fraud and reduce government revenue.
No one wants energy efficiency to be expensive or for fuel poverty to rise. But when viewed in conjunction with the UK’s broader energy policy goals, reduced VAT rates are unlikely to further the sustainability agenda.
This is supported by an OECD report which suggested that the UK’s reduced VAT rate on electricity and gas puts people off making energy efficiency improvements in the first place.
Whether the UK wins in its legal battle with the Commission remains to be seen, although from a legal perspective it is likely that it won’t. That might just prompt the government rethink its confused energy efficiency strategy.
Laurence Webb is Content Editor at amee. He holds an MSc in Environmental Technology from Imperial College London.