Fuel Duty: the hidden costs

Fuel duty rose by 2p this week, the third increase in the last ten months. Governments tend to view petrol taxes as a convenient source of revenue when budget deficits are high. Indeed, the last Conservative government increased fuel duty dramatically in the mid-1990s, introducing a tax escalator at the tail end of the last recession.

The demand for fuel is relatively inelastic, meaning that higher prices do not lead to a big fall in consumption. The tax is also relatively cheap to collect, difficult to evade and can be justified rhetorically on environmental grounds. But despite these political advantages, fuel duty has harmful hidden effects that politicians rarely discuss. One of these is the impact of higher travel costs on labour mobility.

Employment is not worthwhile when travel-to-work expenses are too high, particularly given the availability of welfare benefits to the unemployed. And subsidised public transport typically offers restricted access to workplaces – perhaps only to town centres and narrow route corridors. Opportunities may therefore be severely limited for job-seekers taxed and regulated out of car ownership or unable to afford inflated running costs. 

The result is not just additional unemployment. Businesses may also face higher labour costs as the pool of potential employees is reduced. In addition, transport taxes tend to decrease the number of potential customers by shrinking the area within which exchange is profitable. In wider economic terms, competition is stifled, economies of scale are lost and the deepening of the division of labour is suppressed – with the knock-on effect of lower productivity growth.

The tax receipts from higher fuel duty rates are therefore likely, in the long run, to be undermined by the general losses to the Treasury associated with the higher costs imposed on the production of wealth. In the context of Britain’s worst-ever peacetime fiscal crisis, and an apparent unwillingness to make significant cuts to public spending, the latest tax rise may be yet another example of short-term political expediency overriding the imperatives of longer-term economic efficiency.

3 September 2009, IEA Blog

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