Fuel prices: why Labour has got it wrong on indexation

Finding oneself potentially in agreement with George Osborne is disconcerting.  But, watching the debate over the indexation of fuel duty, it’s difficult to avoid the conclusion that Labour, in calling for a further delay in the proposed 3p per litre indexation of duty, are calling this one badly wrong.

Labour’s concern is that people will be hit by increases in fuel duty at a time when household costs are already rising.  It would be wrong to deny that they have a point. The recent announcement of a 10% increase in domestic energy costs has hit people hard.  More generally, living standards for all but the wealthiest in society are falling; a significant increase in household expenditure on motoring – especially for those who have to use their cars – has the potential to be painful for many middle and lower income families.

Economic issues

However, I’d argue the overall economic effect of a freeze is likely to be regressive, for a number of reasons.

First, it is overwhelmingly the case that expenditure on motoring, and on fuel in particular, is closely linked to income.  Essentially, the more people earn, the more they spend on fuel.  Fuel duty is, by its nature, a progressive tax.  (It’s also very cheap to collect and, apart from around the Northern Ireland land border, very difficult to evade – reasons why the Treasury under Governments of all colours is keen on it). And – in a media world that is overwhelmingly geared towards the views of what might be described as the aspirational middle – it’s often forgotten that a third of the population have no access to a car at all.  And these are very often the poorest and most vulnerable people of all. The 2011 ONS report on the effect of fuel duties on household income shows that while those in the lowest income groups pay more in terms of proportion in income in fuel duty – where they have a car – they pay less in cash terms than those in the higher income groups who are far more likely to have a car. (I’d argue that rather than holding down tax rates for the better-off, the impact on lower-income motorists should be offset through general tax rates and benefits).

According to the RAC Foundation, in 2008 approximately 14% of average household expenditure goes on transport – 88% of that on motoring costs.  The average household expenditure on fuel is about 4%.  Clearly that will vary widely – that figure will be higher in rural areas, and traditional family units have higher expenditure.  But over the long term, the real cost of motoring has fallen enormously – by 17% between 1997 and 2008, at a time when public transport costs rose steadily.  As I’ve argued here before, the so-called War on the Motorist is a pernicious fiction; and it’s important to remember that the external costs of motoring – in terms of pollution, safety and community severance – fall overwhelmingly on the poorest in society.

Moreover, the pump price of petrol has fallen by 10p per litre since the spring; and crude oil prices fell by nearly 5% in one day last week.  If there is ever a good time to index fuel taxes, this is it; in a competitive forecourt market it is quite likely that much of the duty increase will be absorbed, meaning that the hit is taken by oil companies rather than motorists.  None of this is to trivialise the impact of even small increases in prices on people who are on the financial edge; but there are much bigger issues in play here, like domestic energy prices and benefit cuts.

And recent thinking from the IMF and others is that the multiplier – the multiple by which public expenditure is more stimulating than tax cuts – is higher than Government has assumed.  In other words, the economic cost of cutting taxes is higher than has been recently assumed.  If the failure to index fuel duty is offset by additional cuts in expenditure, the effect will be to suck more demand out of the economy.

The political consequences

Labour’s decision may be dodgy economics, but looks like quite good politics; it looks like a party standing up for that politically iconic section of society, the squeezed middle.  But is it? The problem for Ed Balls is that, in overall terms, the effect on household spending is likely to be relatively small and unpredictable (especially if oil prices continue to fall): but that, in the longer term, the failure to index taxation effectively undermines the tax base.  Failure to index fuel tax (and remember, this is about maintaining the tax level in real terms, not increasing it) means that as an incoming Chancellor, Balls would have less revenue to play with.

It also binds Labour further into the rhetoric of low taxation and – by implication – more cuts.  Ed Balls is no stranger to that rhetoric; and I’d guess that George Osborne – a Chancellor who appears to see his role as political activism rather than keeper of the public finances – is quietly satisfied at the way that Balls is reducing his room for political manoeuvre as we pass the mid-point of the political cycle.  One of the interesting aspects of the ONS report I cited earlier is that the proportion of the fuel price accounted for by duty is in decline – and that it itself an indicator that the fuel tax base is declining and that indexation is needed.

In conclusion, it looks as if Labour could be boxing itself further into a tax-cutting and expediture-cutting agenda when all the economic evidence is pointing the other way, in pursuit of a measure that is likely to benefit the 4×4 owner on the school run far more than the poorest and most vulnerable society. It reinforces the impression that Labour has bound itself into the same economic assumptions as the coalition.  And it makes it far easier for Tories and Liberal Democrats to attack Labour’s economic position as inconsistent.


3 thoughts on “Fuel prices: why Labour has got it wrong on indexation

  1. Oh dear:

    “Fuel duty is, by its nature, a progressive tax.”

    Interesting statement.

    “while those in the lowest income groups pay more in terms of proportion in income in fuel duty”

    Entirely refuted by that one. The poor paying greater than in proportion to income is a useful definition of a regressive tax.

    Rare to see someone manage to refutes themselves in the same paragraph so well done there.

    • Er, wrong. You’ve missed the point. Those families with cars pay more; but in general far fewer families on low incomes have cars. In general terms, the tax is progressive. And, as I say in my piece, there are better mechanisms for addressing the impact on low-income families.

      Frankly if that’s the best you can manage it’s little wonder that your economic experiment is crashing around your ears.

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