Written by: Sheena McGuinness

Sheena McGuinness

Corporate Tax Partner

Decarbonisation challenge for the UK government to avoid regional and sectoral disparity in the energy transition

Following COP26, we now have a path to limit global warming to somewhere between 1.8 and 2.4 degrees, albeit we have not got the cast iron commitments that would deliver that. The International Energy Agency says the world needs to double plans for solar and wind energy, and rapidly advance technologies to abate emissions from fossil fuels. Currently, half of all projected emission cuts come from technologies that are only in prototype or demonstration stages. Clearly technological advancements are required to deliver on these targets. There must also be agreement between countries along with clear policies within countries to deliver a fair energy transition. 

In the UK, there will be distributional challenges in meeting the legally binding commitment to reduce carbon emissions. Fossil fuels have created a concentration of labour in particular areas. As production is phased out there will be regional imbalances in employment as the UK moves through this transition. Creating jobs in these areas, for example in the much-needed innovation space to deliver on the advances required to progress technologies, will be key to avoiding high unemployment in particular areas. Expanding the number of enterprise zones to these areas and possibly increasing the fiscal incentives further than the current business rates and enhanced capital allowances could be used to encourage investment in the areas that would otherwise suffer in the energy transition.

The challenge of managing the sector distributional disparity should also be front of mind for the Chancellor. There will be clear winners and losers in the decarbonisation of the UK. For example, there are cost savings in the power sector as the cost of producing renewable energy is decreasing. In the automotive sector, electric vehicles (EVs) are becoming cheaper to buy, more reliable and cheaper to run (benefitting from cheaper renewable power). Furthermore, the move to EVs is reducing tax revenues as the amount of fuel duty will decline, leaving a £27.5bn per annum hole to fill. To date the government has been silent as to what the replacement mechanism will look like. Whilst a road use tax is considered the most likely, don’t underestimate the cost of implementing the infrastructure required to enable the government to track, calculate and collect the tax due.

In contrast, the UK construction industry is facing increasing costs, particularly with domestic carbon taxes on steel and cement which make them more expensive versus their overseas competitors who may not be liable to the same carbon taxes in their country of origin. There is talk of a carbon border adjustment mechanism (CBAM) to reduce the issue of carbon leakage (ie if one country imposes a price on emissions, as seen in the UK and the EU, supply chains might move to a country that doesn’t). A CBAM should help to ensure that UK businesses are not unfairly beaten on price. There would be a credit or exemption for goods and raw materials originating in a country which applies a carbon price, thus providing an incentive to encourage more countries to introduce carbon pricing domestically. However, there is a lot of opposition to this suggestion from overseas, with questions as to whether such a mechanism is permitted under international trade rules. 

To deliver on the aspirations of COP26, the UK Government will need to be cognisant of the forthcoming regional and sectoral disparities as the UK delivers on its decarbonisation promises and introduces tax policies to mitigate any resultant inequality. It is undeniably a big job for the Chancellor to implement tax policies that can spread the cost and the savings across all sectors to ensure fairness. Layered on top of the domestic challenge is the international political minefield of carbon border taxes. It seems, despite the deforestation, we are not out of the woods 

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