The impact of fuel duty on work incentives

March 4, 2013

According to a review commissioned by the Department of Social Security, ‘the costs of travelling to work will … be a factor in some people’s decisions about whether to look for or accept employment’. Indeed, one survey found that 50 per cent of unemployed people cited ‘extra costs such as travel’ as a major cause for concern about leaving benefits. Moreover, ‘travelling costs will also be a regular expense which may influence decisions about whether to remain in a particular job’. Studies of low-income families suggest that earnings from low-paid employment are significantly reduced by travel-to-work costs, with a particularly acute problem in rural areas. Since around two-thirds of working adults who travel to work do so by car or van, it is clear that motoring taxes – and fuel duty in particular – have a significant impact on travel-to-work costs. 

The impact of travelling costs on work incentives is likely to be most pronounced for those individuals that already experience very high effective marginal tax rates (EMTRs). Within certain income ranges, some workers face EMTRs as high as 96 per cent. High EMTRs reflect the withdrawal of welfare payments such as housing benefit and tax credits, as well as the imposition of income tax and national insurance. While EMTRs of over 90 per cent are experienced in quite narrow income bands, EMTRs of 70 per cent or over affect a large number of employees on relatively low incomes.

Accordingly, travel-to-work costs can make a large difference to the financial incentives to enter work. Case studies illustrate the magnitude of the effect. A single person over 25 in low-cost rented accommodation would typically be around £70 per week better off in a full-time job paying the minimum wage than on benefits, which works out at £1.75 an hour. However, if average costs for those driving to work (about £20 per week) are applied, this means the person is now only £50 per week better off, or £1.25 an hour. When a realistic estimate of the time spent travelling is incorporated, the effective hourly rate falls further to around £1.10 an hour. Thus, in this case study, under plausible assumptions, travel-to-work costs reduce the returns from entering work by almost 40 per cent.

A significant proportion of motorists, such as many in rural areas, face very much higher costs.  Travel-to-work costs of £40 per week would reduce the benefit of working to just £30 per week, equivalent to just 75p per hour, a drop of almost 60 per cent. At this point the financial incentives for entering employment may be extremely weak, particularly since there are likely to be additional in-work costs such as food and clothing. Worse still, several groups, such as single-earner families or households in private rented accommodation receiving large housing benefit payments, face even weaker incentives to enter relatively low-paid work. In such cases, travel-to-work costs may mean work does not pay or even makes the household worse off.

The AA estimates that fuel accounts for approximately two-thirds of car running costs (which do not include ‘standing charges’ such as insurance and VED). This suggests fuel duty accounts for roughly one third of the costs of those travelling to work by car or van. As the government introduces welfare reforms designed to improve work incentives, there is a strong case for policymakers to consider in detail the effect of travel-to-work costs, of which motoring taxes form a major component. 

The economic impact of motoring taxes is analysed in a new IEA paper, Time to Excise Fuel Duty?

19 November 2012, IEA Blog

Filed under transport Tagged with , ,

A radical proposal for privatising the UK’s road network

March 4, 2013

For decades governments have used motorists as a cash cow. Fuel duty and road tax now raise around £35 billion a year, while less than £10 billion is spent on road maintenance and improvements. Indeed, as motoring taxes have increased, investment in new road capacity has collapsed.

Transport policy has gradually become dominated by a green agenda that seeks to reduce emissions and shift journeys to public transport. In terms of revenues, however, this policy is beginning to backfire.   

Drivers are now buying smaller and more fuel-efficient cars, meaning they pay much less tax. Electric vehicles also threaten a collapse in receipts.

The potential shortfall explains the urgency with which the government is exploring new ways of charging motorists. This week it emerged that officials are considering a two-tier system of road tax, with motorists paying a higher rate if they wish to use motorways.

Charging that better reflects different levels of usage makes sense. But motoring taxes are a very crude way of doing this. Ideally, charges should reflect infrastructure costs and congestion levels. Drivers should pay more to use an expensive urban motorway with huge peak demand than a relatively empty rural motorway, or a minor road that has barely been improved since the 1930s.

In practice an efficient road network can only be obtained through more widespread pricing. The government, however, is not well suited to the management of a tolled network. Pricing and investment decisions would be influenced by special interests and political expediency. Tolls would probably be added on top of existing taxation, or unwarranted environmental levies imposed. Under political control, many of the benefits of road pricing would be lost.

A better long-term solution is therefore to transfer ownership and control to the private sector. Pricing would then be based on consumer demand rather than political calculation. New investment would be directed to those locations where the highest returns could be achieved. Productivity-boosting innovations would also be possible, such as raising speed limits and increasing lorry weights.

But privatisation and pricing need to be combined with a very substantial reduction in motoring taxes to be both politically acceptable and economically efficient. In the IEA’s new report, Which Road Ahead: Government or Market?, we set out a way of achieving this. Flotation receipts from the privatisation of motorways and trunk roads – estimated at around £150 billion – would be used to abolish road tax and reduce fuel duty by at least 75 per cent. Public spending on transport would gradually be phased out and in the longer-term the Treasury would also enjoy a large increase in general tax revenues as efficiency gains such as lower congestion fed through into higher economic output.

The denationalisation of roads is therefore a win-win policy. For most drivers, tax cuts would mean cheaper journeys despite the introduction of tolls. And for the government, substantial short-term flotation receipts would be followed by a lower spending burden and a major boost to the wider economy.

30 October 2012, City AM

Filed under transport Tagged with ,