The impact of fuel duty on work incentives

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

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