Fuel tax confusion

The UK Government is coming under pressure to abandon the planned 2p a litre increase in fuel taxes that is scheduled for October. Indeed, with global oil prices setting new highs every week, and the average price of a litre of unleaded somewhere near £1.10, there are calls for it to go further and reduce its current tax take, which amounts to about two-thirds of the pump price.

There are suggestions that the Government can "afford" to make such a move because it is raising much more than expected from fuel taxes, thanks to the high price. Most of the tax take is accounted for by excise duties, which aren't affected by the world oil price. However, the Government also collects VAT, at the standard rate of 17.5%, on all fuel sales. This can, of course, be reclaimed by the haulage industry and others, but not by private motorists. One motoring organisation, the RAC, claims that the Government could afford to cut fuel duties by 9p a litre and still rake in as much revenue as it projected at budget time.

This is almost certainly wrong. The extra VAT on fuel is not money out of thin air. People are having to cut back either on savings or on other purchases in order to pay the higher cost of fuel. The household savings rate in the UK is very low, so most of the extra spending on petrol can be assumed to be offset by lower spending elsewhere. To the extent that the things people are cutting back on are themselves liable for VAT -- and almost everything apart from food bought for home consumption is -- the added taxes coming in via the fuel pump are offset by smaller receipts from other consumption items.

Of course, this works both ways. The Government can't really claim that it can't afford to cut fuel taxes, unless it thinks that people will save the money rather than spend it on other VAT-generating items. It's a policy choice, rather than a fiscal dilemma: with inflation rising and household budgets under pressure, is a fuel tax cut the best way for the Government to provide a bit of relief?