ourEconomy: Analysis

As COP26 nears, why is the UK giving a tax break to fossil fuel companies?

The new ‘super deduction’ incentivises further extraction at a time when we should be pivoting away from fossil fuels

Peter Newell Andrew Simms Freddie Daley
16 March 2021, 12.29pm
Rishi Sunak's 'super deduction' will push us closer to climate chaos
REUTERS / Alamy Stock Photo

In the recent Spring Budget, UK chancellor Rishi Sunak increased corporation tax from 19% to 25% from 2023, stating it was “fair and necessary” to ask businesses to contribute to the economic recovery. But what he took away with one hand, he quietly gave back with the other.

In a move that attracted much less attention, the chancellor also granted businesses an enormous handout by announcing a new ‘super deduction’ tax relief. In practice this means that companies that invest in certain qualifying capital assets will be able to cut their tax bill by up to 25p for every £1 they invest. The subsidy is eye-wateringly expensive: according to HMRC it will cost the government an estimated £29bn over three years, and £12bn in its first year alone. In other words: it amounts to an enormous windfall for corporations, particularly those that have large capital expenditure budgets.

The rationale for this huge tax break is that it will supercharge investment, helping to boost the UK’s sclerotic economy and galvanise the UK’s post-pandemic recovery ahead of a looming hike in corporation tax in 2023. Yet the policy has attracted widespread criticism for rewarding investment that would have happened anyway, such as BT’s infrastructure upgrade that is already in full swing, and for giving an indiscriminate tax break to big businesses – including those which have flourished during the pandemic.

The online retail giant Amazon, which reported a 37% increase in earnings last year, is among those that are set to benefit. Despite being one of the pandemic’s biggest winners, the super deduction will wipe out the taxable profits of Amazon’s UK arm, meaning that it will likely not pay any tax. As well as being wasteful, campaigners believe that such an untargeted use of public money could also create new avenues for tax avoidance.

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A fossil fuel sugar rush

The most troubling aspect of the super deduction policy is the impact it could have on fossil fuel investment. In an Environmental Audit Committee meeting after the Budget, Treasury minister Kemi Badenoch explicitly ruled out attaching any green strings or conditions to the new tax break. When pressed on the matter by MPs, Badenoch stated that the government “is not going to strangle our economic recovery with regulation that’s not necessary”.

In the absence of any green conditions, the super deduction leaves the backdoor wide open for a surge of investment in fossil fuel infrastructure at a time when we need to urgently cut emissions and pivot our economy away from polluting fuels. The policy not only lines the pockets of fossil fuel companies at the taxpayer’s expense, it also incentivises further exploration and extraction – locking-in carbon emissions for decades to come.

In the absence of any green conditions, the super deduction leaves the backdoor wide open for a surge of investment in fossil fuel infrastructure

Similar policies elsewhere have had disastrous impacts on the environment. In the US, the ‘Intangible Drilling Costs’ tax deduction has encouraged oil companies to drill more wells, more frequently, because the upfront costs are tax deductible, thereby boosting cash flow at the beginning of the investment cycle.

The UK’s super deduction could generate a similar sugar rush for the industry, where tax deductible investment into further exploration and extraction incentivises oil majors to do more damage, instead of pivoting their businesses away from polluting fuels.

A race against time

The super deduction must also be seen in the context of what is a rapidly changing energy landscape. Although oil consumption collapsed at the beginning of the COVID-19 pandemic, it has since recovered rapidly. Renewables continue to attract vast amounts of investment, and are outperforming oil majors on stock markets. Renewable energy is now a prominent feature in all future energy scenarios – even the ones written by oil majors.

Facing a future of clean energy abundance which would leave many fossil fuels in the ground, oil majors are in a race to extract and sell as much oil as they can while it remains profitable, flooding the market and driving prices down further. Despite the recent raft of net-zero pledges from oil companies (which are, of course, questionable) they are still legally obliged to maximise profits to their shareholders, who have become accustomed to healthy returns. Giving fossil fuel companies a tax break for investment sends precisely the wrong signal at a critical time.

The policy will send a message to the world: ‘We will continue to support those that are fuelling this fire.’

These problems could be reduced to a degree by attaching tight green conditions to the super deduction. The tax break would then be directed towards scaling up the low carbon industries we need, helping to direct capital towards them. But as things stand the policy will push us closer towards climate chaos and send a message to the world: ‘We will continue to support those that are fuelling this fire.’

Green finance to the rescue?

One potential silver lining could have been the chancellor’s decision to change the remit of the Bank of England’s Monetary Policy Committee, which is responsible for setting interest rates. The chancellor announced that, going forward, the committee’s decisions must be ‘environmentally sustainable and consistent with the transition to a net-zero economy’. But how this is compatible with the Bank of England’s mandate to promote strong GDP growth remains unclear.

Green finance certainly has an important role to play in ‘building back better’ after the pandemic, but there are other tools the government could have turned to. After the financial crisis, the Bank of England introduced ‘macro-prudential’ policy in order to ‘reign in those activities that lead to bubbles, cyclical swings and economic shocks’. Although the policy was designed to tackle the failure of the mortgage market, it would only be a short step further to introduce an ecological interest rate to tackle climate risk.

In the same year that the UK hosts the G7 and the crunch COP26 climate summit, a Budget so bereft of essential climate action amounts to a monumental failure of leadership. Real, bold and decided global action means ending fossil fuel finance immediately and phasing out fossil fuels as part of a global Fossil Fuel Non-Proliferation Treaty.

The new super deduction makes that harder to do – and the world will remember.

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