Why is the chancellor not putting his £2bn of VAT receipts from energy bills to better use?

Andrew Warren

The average household energy bill has more than doubled over the last eight years. If you ask who have been the beneficiaries of these amazing price hikes, most people would respond, “The Big Six energy companies”.

Conveniently forgotten is somebody else who gains each time fuel bills go up. That person is the chancellor of the exchequer.

Because built into every fuel bill is a 5% surcharge.  It is called Value Added Tax. Each time prices rise, so does the Treasury’s revenue. This year VAT receipts from fuel bills are set to top £2bn, well over twice the amount raised in 2004-5.

For most businesses, VAT is simply a pass through, reclaimable, cost. So adding to the amount of VAT raised is purely an administrative (and possibly a cashflow) matter. All registered businesses can, and do, simply reclaim any amounts charged.

But that is not the position for householders. Because we are each of us at home effectively the “final consumer”, we can never reclaim VAT. And VAT is the only obligatory tax required from all member states of the European Union.

To date nobody much (apart from me) seems to have noticed quite what a nice little earner the 5% VAT rate on energy consumption has been for the Chancellor

Governments have always been free not to charge VAT on certain items. But once VAT is introduced upon any given commodity, the rules say it can never be removed - or reduced below a minimum of 5%.

That is why, for the initial twenty years of the UK’s membership of the EU, no government sought to levy VAT on domestic fuel. When in 1993, the Major government did introduce VAT (at the eccentric rate of 7.5%), it instantly became a genuinely divisive political issue. Consequently when Labour won the 1997 election, one of the first moves was to reduce VAT on energy consumption to 5% - the rate currently charged.

Recognising the idiocy of charging VAT on energy consumption at 5% but energy conservation at full rate (now 20%), the Labour government did take partial steps to rectify that absurd distortion. A curiously eclectic list of energy saving products (microgeneration, thermostatic radiator valves, insulation installed by contractors) currently can be charged at that 5% rate too – a lower rate now being challenged by the European Commission as illegal.

Should the European Commission succeed, the clamour – at least on ecological grounds – to raise the VAT rate on energy consumption up to the full rate of 20% will be significant. And will probably be covertly encouraged by those whose job it is to maximize government revenue. 

Tactically that might not be too smart a move. To date nobody much (apart from me) seems to have noticed quite what a nice little earner the 5% VAT rate on energy consumption has been for the chancellor. Bringing in £2bn a year is not peanuts. Quadrupling that to £8bn a year would undoubtedly attract attention. 

Why, it might even lead the UK government to start spending some of its ill-gotten gains from this, and from all of the other energy taxes (Climate Change Levy; floor price for carbon; Carbon Reduction Commitment etc) upon helping improve the profligate way we now use energy. Now that could be a genuinely virtuous circle.

Andrew Warren is director of the Association for the Conservation of Energy