Chapter 16: Exercise Duty & Road Pricing - Transport Energy Policy

A Personal Introduction

I wasn't a typical student, even by Cambridge standards. Back in 2009, I co-founded a non-partisan student think-tank called the Wilberforce Society with a Wordpress blog on which I'd penned a controversial article advocating road pricing. When the Government of the day floated ideas in this area, my article was found by a number of journalists who approached me for comment. They were somewhat disappointed to hear I was a mere undergrad. As an economics student, road pricing made intrinsic sense to me and continues to do so. However, to most people it's deeply controversial.

The Economics of Fuel Duty

Petrol and diesel duties are about 58p per litre, or roughly 40% of the total price when you throw in 20% VAT. For the Government, this makes them an incredibly important tax, raising over £25 billion annually, or about 3% of total tax revenues. Indeed, they raise more than corporation tax on small businesses, inheritance tax, and capital gains tax combined - making fuel duty one of the government's most reliable and substantial revenue streams.

What makes fuel duties particularly attractive to the Treasury is how easy they are to collect. Unlike income tax or VAT which require millions of individual transactions and returns, fuel duties are collected from just a handful of major oil companies and import terminals. The tax is levied at the wholesale level before it reaches consumers, meaning collection doesn't directly involve individual voters or require complex enforcement. This makes it both politically convenient and administratively efficient - a perfect cash cow for any government.

From a policy perspective, fuel duty also has some merit as a proxy for road usage and environmental impact. All things considered, the tax per litre is not a bad approximation for the number of miles vehicles travel, the size of the vehicle, and the level of its emissions. Larger, heavier vehicles consume more fuel per mile, so they pay more tax. More fuel-efficient vehicles pay less. And the more you drive, the more fuel you buy and the more tax you pay. While not perfect - it doesn't account for congestion, road wear, or the specific location of journeys - it's a reasonable first-order approximation that has served Britain's transport policy for decades.

The Limitations of Fuel Duty

The main social problem (externality in technical speak) that petrol/diesel tax doesn't address well are the more urban problems of congestion and localised air pollution. A diesel car or delivery truck driving around the countryside poses no risk to those with lung problems and asthma - the same car idling outside a suburban school gate does. Fuel duty treats all fuel consumption equally regardless of where it happens, but the social costs vary dramatically by location and timing. This creates a fundamental mismatch between the tax and the actual harm caused.

This shortcoming is why cities like London, Manchester and others have sought to introduce extra charges - especially on higher emitting vehicles. The London Congestion Charge, Ultra Low Emission Zone (ULEZ), and similar schemes in other cities are attempts to address the specific urban externalities that fuel duty cannot capture. These local charges target the vehicles that cause the most harm in the most sensitive locations, creating a more targeted approach to managing urban transport problems.

While the efforts of these cities are laudable, the lack of a coordinated national approach creates the risk of a race to the bottom where dirtier vehicles are recycled or relocated to more provincial towns and cities. As London and other major cities implement stricter emissions standards, older, higher-emitting vehicles don't simply disappear - they often end up being sold to buyers in smaller towns or rural areas where such restrictions don't exist. This can create a perverse outcome where urban air quality improves at the expense of air quality in areas that may have fewer resources to address the health impacts of poor air quality.

What Fuel Duty Actually Costs Per Mile

To put fuel duty in perspective, let's work out what it actually costs per mile to drive. A typical VW Golf with a 1.5-litre petrol engine might achieve around 35 miles per gallon (mpg) in real-world driving conditions. With fuel duty at 58p per litre and 4.55 litres per gallon, that works out to about £2.64 in fuel duty per gallon. At 35 mpg, this means fuel duty costs approximately 7.5p per mile driven. This gives us a baseline understanding of what drivers currently pay for road usage through fuel duty - a figure that will become increasingly important as we consider alternatives.

For a typical driver covering around 8,000 miles per year, this works out to about £600 annually in fuel duty. When you add VAT at 20% on the total fuel cost, the total tax burden rises to around £720 per year. This is a significant sum that drivers have become accustomed to paying, and it represents the revenue that any alternative road pricing system would need to replace if fuel duty were to be abolished or significantly reduced.

This contrasts sharply with Vehicle Excise Duty (VED), which is a flat annual tax based on vehicle emissions rather than usage. For a typical petrol car, VED might be around £180 per year - just 25% of what the same driver pays in fuel duty. This highlights the fundamental difference between the two taxes: VED is a fixed cost that doesn't vary with how much you drive, while fuel duty is a variable cost that directly reflects road usage. It's this usage-based nature that makes fuel duty such an effective proxy for road usage, but also makes it vulnerable to changes in driving patterns and vehicle technology.

To put this 7.5p per mile fuel duty in context, it's worth comparing it to other motoring costs. The total cost of motoring (including fuel, insurance, maintenance, depreciation, and other running costs) typically ranges from 30p to 60p per mile depending on the vehicle. So fuel duty represents about 12-25% of the total cost of driving. However, many of these 30-60p costs are invisible or annualised from the perspective of the end user - depreciation happens gradually, insurance is paid annually, and there's an opportunity cost of having cash tied up in a vehicle rather than invested elsewhere or paying down debts or a mortgage off early. By comparison, a typical bus journey costs around 15-25p per mile, while rail travel varies dramatically from 10p per mile for long-distance advance tickets to over 50p per mile for peak-time commuter journeys. This shows that fuel duty, while significant, is just one component of transport costs, and any replacement system needs to consider the broader financial impact on households.

The Electric Vehicle Challenge

This being said, petrol and diesel taxes face significant headwinds. Politically, fuel taxes haven't kept up with inflation since 2010, following intense lobbying and campaigning, under Governments of all parties. And while the total mileage driven has stayed quite steady since 2010 (though there have been shifts from cars and commuting toward delivery vans, especially since COVID and the rise of remote working), the biggest challenge going forward is the growth of electric vehicles. These now account for about 3% of the total vehicle fleet, and 2% of total mileage. But they account for 16% of new vehicle sales, and the Government's own target is for this to reach 100% by the year 2035.

The tax implications of this transition are stark. A typical electric vehicle might use around 0.3 kWh of electricity per mile driven. At a rapid charging station costing 80p per kWh, this works out to 24p per mile - of which the government collects 4p in VAT (20%). At home on an overnight tariff of 7p per kWh, the same journey costs just 2.1p per mile, with VAT of only 0.11p (5%). Compare this to the 7.5p per mile fuel duty that petrol drivers pay, and you can see the problem: even at expensive public charging, EV drivers are paying less than half the tax per mile, while home charging reduces their tax contribution to less than 2% of what petrol drivers pay. This creates a fundamental inequity that will only grow as more drivers switch to electric vehicles.

This VAT disparity creates a particularly perverse social outcome. Better-off households with driveways can charge their EVs at home on the 5% VAT rate, while less well-off drivers and renters who can't persuade their landlords to install chargers are forced to use expensive rapid charging stations at 20% VAT. The result is that wealthier EV owners pay both lower prices and lower tax rates, while poorer EV owners face higher costs and higher tax rates. This is exactly the kind of regressive policy outcome that the energy transition was supposed to avoid, and it highlights why simply relying on electricity taxation to fund roads creates both revenue problems and social equity issues.

The Problem with Electricity Levies for Road Funding

The broader problem with trying to fund roads through electricity levies is that electricity bills already carry significant policy costs - including the Renewables Obligation, Contracts for Difference, and Capacity Market charges that support the energy transition. While these could arguably be considered taxes, they serve specific policy purposes. Trying to raise additional revenue for roads by increasing electricity levies would create perverse incentives that work against other government objectives. Higher electricity prices would disincentivise the adoption of electric heating and heat pumps, which are crucial for decarbonising buildings. They would also make electric vehicles less attractive relative to petrol cars, undermining the very transition that's creating the need for alternative road funding in the first place. This illustrates why road funding needs to be separated from energy policy - the two objectives can conflict with each other.

As discussed in Chapter 10 in this book, there are arguably already too many charges on electricity bills compared to natural gas. Electricity carries the burden of funding renewable energy, grid infrastructure, and energy efficiency schemes, while gas - which remains the dominant heating fuel and a major source of carbon emissions - faces relatively few policy levies. Adding road funding to electricity bills in a bid to replace lost petrol and diesel taxes would only exacerbate this imbalance, making electricity even more expensive relative to gas and further disincentivising the switch from gas boilers to heat pumps. This creates a perverse situation where the cleaner energy source (electricity) becomes more expensive than the dirtier one (gas), working directly against decarbonisation goals.

The Case for Road Pricing

Road pricing, by contrast, is the logical solution that addresses all these problems. Modern vehicles - both electric and petrol - almost universally come equipped with GPS and inbuilt SIM cards, making distance-based charging technically straightforward. With just a handful of major car manufacturers, collecting tax revenues from them could almost be as straightforward as collecting petrol and diesel taxes is from today's oil and gas producers. Integration with insurance companies could create additional benefits, as insurers could offer discounts for safer driving patterns and lower mileage, potentially offsetting some of the road pricing costs for responsible drivers. Perhaps most politically appealing is the opportunity to charge foreign-registered vehicles that use British roads. With around 2 billion miles driven annually by foreign vehicles on British roads, road pricing at 7p per mile could raise around £140 million annually from drivers who currently contribute nothing to road maintenance. Indeed, there's a strong case for charging foreign drivers more than British drivers - after all, they don't pay UK income tax, council tax, or other contributions to public services, so asking them to pay a premium for road usage could be seen as fair. A higher rate for foreign vehicles, perhaps 10-15p per mile, could significantly increase this revenue stream while remaining politically popular. While this is a useful additional revenue stream, it's clear that the main funding would need to come from British drivers - the foreign vehicle revenue is just the cherry on top of a system that treats all road users equally regardless of their vehicle type or charging options.

The Time is Now

For various reasons, the stars are now aligning for road pricing in a way they weren't back in 2009 when I wrote that controversial blog post. The technical barriers have largely disappeared with the ubiquity of GPS and connected vehicles. The fiscal imperative has become urgent as electric vehicles erode fuel duty revenue. And the political landscape has shifted, with growing recognition that the current system creates inequities between different types of drivers and different charging options. What once seemed like an economist's pipe dream is now becoming a practical necessity.