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Fuel duty and road tax: how to replace £35 billion a year of lost revenue

July 01, 2022 by

The rise of EVs is blowing a big hole in the Government’s tax take from cars, but a solution is slow to emerge

  • Petrol and diesel cars bring in £35 billion a year through road tax and fuel duty
  • But EVs generate no fuel duty and are exempt from road tax
  • As sales of new petrol and diesel end in 2030-35, so will the revenue they provide

Nobody likes to imagine that their income is going to be severely curtailed, but that’s precisely the scenario facing the UK’s HM Revenue and Customs and Treasury as we move to electric cars (EVs) after over a century of petrol and diesel-powered motoring.

Background

The UK government receives tax revenue from drivers of petrol and diesel cars via two key methods: fuel duty, which brings £28 billion a year into government coffers, and Vehicle Excise Duty (road tax), which nets roughly £7 billion. Combined, these sources make up 1.5% of the UK’s GDP and account for around 4% of all tax revenue.

The Treasury’s problem stems from the fact that electric cars pay neither road tax nor fuel duty. So as new cars with petrol and diesel engines are banned from sale between 2030 and 2035, those two income streams face constriction and eventual extinction, representing the “largest fiscal cost” of the UK’s net zero ambitions, according to the Office for Budget Responsibility.

We know for a fact that the government is working on something to address this issue – it said as much when responding to a 2019 freedom of information request – though it also declined to explain what it was considering, as the information related to “an area of live policy development.”

The Transport Select Committee (TSC) – a cross-party group of MPs that advises the government – has offered more detail on potential solutions, saying that it “has not seen a viable alternative to a road charging system based on technology which measures road use.”

The TSC also advised the issue is “urgent”, and said the Department for Transport and Treasury (which sets taxation policy) should work together to set out their “preferred options” for replacing fuel duty and road tax.

The TSC isn’t the only group to think this. The Climate Change Committee (CCC), which advises the government on emissions, recently said: “it will be necessary to introduce some form of road pricing, whereby drivers (of any vehicle type) are charged for how much (and possibly when/where) they drive”.

But precisely how will this be achieved, and what new schemes will be introduced to replace the £35 billion that drivers of petrol and diesel cars contribute to the tax chest every year?

Missing road tax – a simple problem to fix

Lost revenue from road tax is an easy problem to solve. At present (in the 2022/23 tax year), the first-year rate of road tax is based on how much carbon dioxide a car emits, and a flat annual rate of £165 follows that, as does a £355 surcharge that runs for five years for cars costing more than £40,000 from new.

Electric cars are currently exempt from all three of those road-tax strands, but all the Treasury has to do is end the exemptions, treating EVs as it currently does petrol and diesel vehicles – albeit without a CO2-based element to the first-year tariff.

Lost fuel duty – a harder nut to crack

Replacing fuel duty is a far trickier problem to solve, and not just because the revenue it brings is higher.

At present, for every litre of petrol or diesel you put in your car the taxman takes 52.95 pence, plus a 20% slice of VAT. This is effectively pay-as-you-go taxation, as the more you drive, the more tax you pay.

The Treasury has even gone so far as to describe fuel duty as a “perfect tax”, and there is even a means-tested element to the system, as drivers after economical motoring can seek out small cars with efficient engines, while those able and willing to buy big, potent cars are generally prepared for big, potent fuel bills.

But electric cars obviously don’t use any petrol or diesel, and with only new EVs and plug-in hybrids able to be sold from 2030, before only zero-emission vehicles can be bought from new in 2035, time is running out for a solution to be devised and implemented, not to mention sold to the motoring public.

One answer would simply be to tax the electricity used to charge EVs. This would be a direct replacement for fuel duty, and electricity is already taxed: you pay 5% VAT on home electricity, and 20% VAT when you use a public EV chargepoint.

But with charging at home a fact of life for many EV drivers, how do you differentiate the electricity used to charge a car with that used to boil a kettle? Smart home wallbox chargers could in theory tell the electricity grid it was a car being charged, but homeowners could just plug a three-pin extension lead into a normal socket to charge their car, circumventing any such communication between grid and charge.

Road pricing is therefore the likely solution to the Treasury’s £35 billion black hole, but this is both complex and potentially unpopular.

Road pricing – overview

UK drivers are already familiar with road pricing. From the Dartford and Severn Crossing, to London’s Congestion Charge and M6 Toll, individual fees for using specific areas or roads may not be as widespread as they are on France’s motorway network, for example, but they’re reasonably well established and accepted in the limited instances they occur.

A nationwide programme of road pricing is more complex, not least because according to the TSC: “the history of road pricing is a history of public unpopularity”, to the extent it has been “too toxic a prospect for successive Governments”.

Three of the most likely methods a nationwide road pricing system could be enacted are:

  • Charging based on the use of individual routes or road types
  • Using GPS-based telematics to track and charge road use
  • Measuring odometers periodically to calculate road use

1. Route taxation

Great Britain has 247,500 miles of road. If the route-based pricing were introduced, every single one of those miles would arguably need to be chargeable. Adding tolls just to motorways and major trunk roads could see cost-conscious drivers divert onto smaller roads, with gridlock (and not enough revenue) the result.

If a nationwide route-based charging system were introduced, this would most likely be based around automatic number plate recognition (ANPR) cameras, as these are cost-effective and have been widely deployed since the 1990s.

ANPR cameras are widely used and cost effective

Disadvantages

ANPR cameras would possibly need to be installed at regular intervals on every road and junction though, from the busiest motorway interchange to the smallest rural T-junction. Such a project would undoubtedly be both expensive and unsightly, as landscapes become peppered with poles for cameras; the potential for bridleways and similar paths to be used to circumvent charges would also need to be mitigated against.

Leaving these issues aside, the TSC considers it may be “impossible to deliver a national road pricing scheme” due to the numerous devolved tolls and charging zones that already exist in the country.

2. Telematics taxation

A more likely solution is one that relies on GPS satellite-based telematics that track where, when and how a vehicle is driven. Indeed, the TSC says it “has not seen a viable alternative to a road pricing system based on telematics.”

Such technology is also well established, with ‘black box’ insurance policies being closest to the system that the TSC considers likely to replace fuel duty.

Telematic-based taxes would most likely see electronics wired into the car to track when and where a car is driven, with this data used to calculate tax owed. Electric cars could be the first to be subject to such a programme, with petrol and diesel vehicles continuing to be taxed via fuel duty.

Black box telematics trackers are sometimes installed to reduce insurance costs

Disadvantages

Potential issues related to telematics-based road pricing include:

Privacy: Mobile phones already collect vast amounts of data and are widely popular, but the idea of a government knowing when and where the 41 million citizens who hold driving licences are travelling represents a very different proposition, even if data anonymity is promised.

Security: With all cars tracked, the opportunities for criminal activity are myriad; data privacy would have to be beyond watertight.

Mission creep: Telematics taxation could bring higher charges for driving in urban areas and at peak times, while calculating speed (and issuing speeding penalties) based on time and distance travelled would be a matter of simple mathematics. The perceived possibility of these extensions could make telematics too unpopular to implement.

Telematics systems could in theory issue speeding penalties

The TSC itself recommends the government “must examine the role that telematic technology can play in delivering a replacement road pricing mechanism that sets the cost of motoring based on the duration and time of the journey”.

Technical problems: Drivers have been threatened with cancelled car insurance after they were accused of driving badly despite their car being parked at the time. Extrapolate this to a national level (there are 31 million cars in the UK), and opportunities for errors only increase. Government IT projects are also not renowned for their smooth or on-budget implementation.

3. Odometer taxation

Rather than relying on telematics black boxes being installed in cars to log individual journeys, a broader but comparable solution would be for cars’ odometers to be read periodically, with drivers charged for how many miles the car has been driven.

The big advantage odometer-based taxation would have is that a central system for logging vehicle mileages already exists in the DVSA’s MOT database. While cars do not require an MOT until they are three years old, the UK’s network of MOT garages could presumably allow for newer cars to check in once or twice a year for mileage readings.

Few people would be likely to want to pay for a year’s worth of road use, but a monthly payment scheme could be introduced, with drivers being refunded or charged extra to mop up any discrepancies between the miles they cover.

A similar scheme already exists in New Zealand, where petrol is taxed at the pump, but diesel is not.

To make up for this, drivers of diesel vehicles pay a road user charge (RUC), which currently costs $76 per 1,000km driven (£39 for 621 miles). Drivers buy tickets that log odometer readings from various official outlets, with police spot checks enforcing adherence to the rules.

Disadvantages

Electric cars are exempt from New Zealand’s RUC at present, but conversations have already begun about ending this exemption, or even replacing the RUC scheme with a more GPS telematics system.

Part of the reason for this is that odometer-based charging is a relatively blunt instrument: it doesn’t allow for the more sophisticated applications telematics or road-based charging offer, such as varying the cost of driving based on what time of day it is, or whether a journey is being made in an area of high congestion.

Means testing

Whatever system is implemented to replace fuel duty, some degree of means testing – similar to the one that allows drivers to seek out small, efficient petrol and diesel cars cars – will need to be considered.

Taxing electricity is likely to be too problematic to implement, so it will not be possible to simply rely on the fact that bigger, heavier, more powerful EVs use more electricity than smaller, lighter, cheaper ones. In fact, some expensive electric cars have better battery chemistries and management systems, and are actually more energy efficient than cheaper EVs.

The Treasury may decide to vary the amount it charges for road use based on a number of factors. Cars that weigh more, cost more, have more power or larger battery packs could cost more to drive per mile, or alternatively drivers’ incomes could be taken into account.

It may also be that road charging is first introduced to electric cars, with fuel duty continuing for petrol and diesel drivers – not least because using vehicle-based measurements such as cost when new, or power, will be difficult if not impossible for older vehicles whose specifications may not be easy to determine.

What do we really know?

Not much, is the honest answer. The Transport Select Committee has recommended that: “Any alternative road pricing mechanism must be revenue neutral to the Government rather than causing drivers, as a whole, to pay more than they do currently. Such a mechanism should be phased in before fuel duty and vehicle excise duty decline to zero. The situation is urgent; work must begin without delay

We asked the Treasury what the current state of play was, and were told: “The government has committed to ensuring that motoring tax revenues keep pace with the changes brought about by the switch to electric vehicles, whilst keeping the transition affordable for consumers.

The Treasury added: “We will respond to the [Transport Select] Committee’s recommendations in due course.”

So despite the relative certainty and urgency of the issues faced by the Treasury; the vast scale of any likely solution; and calls from the TSC for “an honest conversation with the public” on the subject, we still have no idea what the actual plans for replacing fuel duty and VED are. All we can do is sit, wait, and hope that whatever plans come about are workable, palatable, affordable, fair and secure.