Undercover Economist

Congestion tax is the way to go

Subjecting an undertaxed activity to duties might provide a solution to a thorny problem

Imagine yourself to be a key adviser to the chancellor, George Osborne. Clearly, keeping tax revenue buoyant is a thorny problem both in the short term – because the deficit is colossal and the tax base has shrunk – and in the long term, because there will be intense pressures to spend money both on an ageing population and as interest on a growing public debt.

How to do it? Well, here is a thought. There is an economic activity that is currently scarcely taxed. Unlike buying food or burning domestic fuel, this activity consumes proportionately more of the income of the middle class and the rich than of the poor, so taxing it would be progressive. The activity is widespread, meaning that substantial revenues could be raised. Unlike high-frequency trading, or declaring corporate profits, the activity is price inelastic – meaning that when taxed it does not evaporate.

You might think that the case for a tax on this activity is so compelling as to be self-recommending. Let me tilt the scales a little more and point out that the activity generates a vast “negative externality”, which means that it is an activity that imposes a cost on people who get no say in whether the activity happens or not (graffiti spraying is one example of this). Ever since the Cambridge professor Arthur Pigou analysed the problem in 1920, most economists have believed that taxing negative externalities is often an excellent idea.

The activity I have in mind is driving in a congested area. As a driver myself, I know that drivers are subject to hefty taxes: vehicle excise duty, fuel duty and VAT on fuel add up to £38bn, about 7 per cent of all tax revenues. Fuel taxes alone average five or six pence per kilometre driven, according to Fuel for Thought, a recent study conducted by the Institute for Fiscal Studies (IFS) and paid for by the RAC Foundation. But as the IFS goes on to point out, the actual cost imposed (as a total) on all other motorists when a driver thickens the traffic in rush hour approaches £2.50 per kilometre, almost 50 times the fuel tax.

My environmentalist friends tend to dislike cars in general, and big, bulky, dangerous cars in particular. I don’t like lorries dressed up as cars either, but I am forced to acknowledge that the costs we drivers impose on society accrue less from what we drive and far more from when and where we drive it. For example, an SUV driven in rural Wales at 10pm on a Sunday imposes far less social cost than a Prius driven into central London at eight o’clock on a Tuesday morning.

What we drive matters far less than one might think, partly because engines are much cleaner than they used to be and, therefore, emissions of important pollutants (with the key exception of carbon dioxide) have fallen precipitously over the past two decades. No, the real problem with cars is that they get in the way of each other, and a super-efficient car gets in the way of other cars just as much as the most ridiculous Chelsea tractor.

As the IFS research makes clear, the curious upshot of the way that motorists are taxed in the United Kingdom is that we probably pay too little tax in total, despite the fact that half of all miles driven are taxed too much relative to the social costs involved, and another quarter or so are taxed at about the right level. It’s the remaining quarter of miles driven – on the M6 and M25 at rush hour, around the south-east, and in city centres around the country – which are undertaxed, many by a factor of 10 or more.

Fuel duty should be cut from almost 58p a litre to about 20p a litre, and motorists should instead be taxed through a system of congestion charging based on location and time of day. The economic logic is solid; the political calculus, of course, points in another direction.

Also published at ft.com.