Aviation Taxation

IFS

Aviation Taxation

Cormac O’Dea

(Institute for Fiscal Studies)

[email protected]

February 2008 Aviation Taxation© Institute for Fiscal Studies, 2008

Outline

• Some background– Rising greenhouse gas emissions– Aviation rising particularly quickly– Rationale for Environmental Taxation

• Restructuring Air Passenger Duty– Deficiencies– Some simulations

• Emissions Trading– EU Emissions Trading Scheme


Global CO2 emissions, 1971–2004

0

5

10

15

20

25

30

19

71

19

73

19

75

19

77

19

79

19

81

19

83

19

85

19

87

19

89

19

91

19

93

19

95

19

97

19

99

20

01

20

03

Bil

lio

n t

on

ne

s

Bunkers

Africa

Latin America

Other Asia

China

Non-OECDEuropeFormer USSR

Middle East

OECD Total

Source: OECD (2007)



0

5

10

15

20

25

30

19

71

19

73

19

75

19

77

19

79

19

81

19

83

19

85

19

87

19

89

19

91

19

93

19

95

19

97

19

99

20

01

20

03

Bil

lio

n t

on

ne

s

Bunkers

Africa

Latin America

Other Asia

China


Middle East

OECD Total

UK

Source: OECD (2007)



0

5

10

15

20

25

30

19

71

19

73

19

75

19

77

19

79

19

81

19

83

19

85

19

87

19

89

19

91

19

93

19

95

19

97

19

99

20

01

20

03

Bil

lio

n t

on

ne

s

Bunkers

Africa

Latin America

Other Asia

China


Middle East

OECD Total

USA

UK

Source: OECD (2007)


Aviation CO2 emissions (UK)1970 - 2005

0

5

10

15

20

25

30

35

4019

70

1973

1976

1979

1982

1985

1988

1991

1994

1997

2000

2003

mill

ion

to

nn

es

Aviation emissions

Source: DEFRA e-Digest of Environmental Statistics


Aviation CO2 emissions (UK)1970 - 2005

0

5

10

15

20

25

30

35

4019

70

1973

1976

1979

1982

1985

1988

1991

1994

1997

2000

2003

mill

ion

to

nn

es

0%

1%

2%

3%

4%

5%

6%

7%

8%

shar

e o

f to

tal e

mis

sio

ns

Share of total

Aviation emissions

Source: DEFRA e-Digest of Environmental Statistics


UK emissions targets

• Kyoto Protocol (1997)– Reduce greenhouse gas emissions 12.5% by 2008–12

compared to 1990 level

• Domestic targets– Reduce CO2 emissions by 20% by 2010 compared to 1990

level– Reduce CO2 emissions by 26-32% by 2020 compared to

1990 level– Reduce CO2 emissions by 60% by 2050 compared to 1990

level

• International Aviation Emissions are not counted towards any of these targets

??


Why use taxes?

• Environmental damage as a market failure• Externalities argument

– Costs of damage to society not taken into account by polluter

– Tax increases private costs to match social costs– Generates socially optimal level of pollution – NB not zero!– Balance costs of pollution reduction with benefits of

production

• Green taxes as “Pigovian Taxes” (Pigou, 1920)• Tax rate should be set to equal the size of the

marginal externality at the socially optimal outcome


Pigovian Tax

MSC

MB

MPC

p0

P1

q0q1 Number of Flights


Pigovian Tax

MB

MSC

t

p0

P1

q0q1

MPC + t

MPC

Number of Flights


What about a “double dividend”?

• Argument often used: green tax revenues used to reduce other distorting taxes

• Environmental benefit + more efficiency in tax system = double dividend (Terkla, 1984)

• Political soundbites:– “Tax bads not goods”– “Pay as you burn rather than pay as you earn”

• Highly controversial– Not clear that green taxes less distortionary. Can exacerbate

existing distortionary taxes (Bovenberg and de Mooij, 1994)– Erosion of tax base - Tax revenue inversely related to extent to

which you reduce the pollutant (if you cut out all the carbon emissions you get zero tax revenue)

– Green taxes should be justified by their environmental impacts only


Revenues in 2006

TaxRevenue

(£b)

% of environmental

taxes

% of all taxes

and SC

Fuel duty (+VAT) 27.76 77.9

Vehicle Excise Duty 5.01 14.2

Air Passenger Duty 0.96 2.7

Climate Change Levy 0.71 2.0

Landfill Tax 0.80 2.3

Aggregates Levy 0.33 0.9

TOTAL 34.95 100.0

Source: ONS Environmental Accounts, Autumn 2007


Revenues in 2006

TaxRevenue

(£b)

% of environmental

taxes

% of all taxes

and SC

Fuel duty (+VAT) 27.76 77.9 5.7

Vehicle Excise Duty 5.01 14.2 1.0

Air Passenger Duty 0.96 2.7 0.2

Climate Change Levy 0.71 2.0 0.1

Landfill Tax 0.80 2.3 0.2

Aggregates Levy 0.33 0.9 0.1

TOTAL 34.95 100.0 7.3

Source: ONS Environmental Accounts, Autumn 2007


What determines the magnitude of the Marginal Social Cost?

– Emissions Generated by the engine• Length of the flight• Efficiency of the Engine (Older engines tend to be less efficient)

– Congestion at airport (and in the skies)– Effect of noise

• Type of plane• Is the airport in a densely populated area?• Time of departure?

– The load factor of the plane– The ideal tax will take account of all these, but

administrative cost could be prohibitive


Aviation Taxes: APD

• First charged from November 1994• Most passengers departing from most UK

airports• Varies according to destination

(Europe/Other) and, since 2001, travel class• Currently four rates: £10 / £20 (Europe),

£40 / £80 (Other)• Around ¾ of passengers pay lowest rate• £2 billion revenue forecast for 2007-08


Air Passenger Duty- Rates

Air Passenger Duty

Europe Non-Europe

Economy Class

Business Class

Economy Class

Business Class

APD £10 £20 £40 £80


Pigovian Tax

MB

MSC

t

p0

P1

q0q1

MPC + t

MPC

Number of Flights


Pigovian Tax: Larger ExternalityMSC

MB

p0

P1

q0q1

MPC + t

MPC

Number of Flights

t


Which tax base

– Passenger?• Simple, but no variation in burden according to load factor• Should it be a fixed charge or percentage (currently no VAT on

tickets)?

– Flight?• Passengers on empty planes pay more.

– Fuel?• Correlates well with emissions, but international agreements prevent

using it

– Emissions?• Ideal environmental tax, but hard to measure?

– Combination of the above?• Keen and Strand (2007) show that the optimal tax is a combination of

VAT and fuel duty


Illustrative simulation: a per-seat tax

• Per-seat tax akin to a flight tax: tax on empty seats has to be passed on or absorbed– Incentives to load aircraft fully– Environmental incentives would require sharper targeting

• Data from CAA: departing flights, passengers and number of seats by departure airport and destination (2006)– 1.2 million flights, 120 million passengers

• Simulate two per-seat taxes and compare to APD• Various assumptions:

– Revenue-neutral relative to APD– No behavioural change by airlines or passengers


Simulated taxes

• All options generate revenue of £1.96bn– Mean per-passenger payment of £16.58

• Passenger tax (APD)– £10 / £40 per passenger depending on destination

• Seat tax– £7.53 / £30.14 per seat depending on destination– Payment depends on load factor explicitly


Simulated taxes

• Two-part seat tax– Fixed component covering e.g. noise costs,

variable component covering distance-based costs• Tax = £S + £(Y x km)

• There is an infinite number of S,Y pairs that will yield any given revenue target.

– £3.78 fixed charge + £4.22 / 1,000 km– At the cost of additional complexity, could vary:

• S by airport of departure or time of day

• Y by cleanliness of the engine


Per-passenger tax

0%

10%

20%

30%

40%

50%0-

2

4-6

8-10

12-1

4

16-1

8

20-2

2

24-2

6

28-3

0

32-3

4

36-3

8

40-4

2

44-4

6

48-5

0

52-5

4

56-5

8

>60

Per passenger tax (£)

Per

cen

tag

e o

f p

asse

ng

ers

Seat tax

Two-part tax


Seat tax: example flights

Destination

(aircraft type)Distance (approx.)

Load (%) APD Seat taxTwo-

part tax

Sudan

(A300 – 600)

Canada

(B767 – 300)



Destination



part tax

Sudan

(A300 – 600)5,000 km 30.0

Canada

(B767 – 300)5,200 km 96.3



Destination



part tax

Sudan

(A300 – 600)5,000 km 30.0 £40.00 £100.46 £83.06

Canada

(B767 – 300)5,200 km 96.3 £40.00 £31.29 £26.98

• The point of the tax is to reduce the number of flights. Flights with low capacity are obvious candidates for flights to be cut


Per-seat tax: winners and losers relative to APD

• Winners: flying short distances on fully-loaded aircraft

• Losers: flying long distances on empty planes• More complex structure would vary patterns

of relative beneficiaries more:– Flying on clean, quiet planes departing airports

away from residential areas


EU Emissions Trading Scheme

• Emissions Trading Scheme (ETS)– An overall emissions cap set. Each tonne of

emission requires a permit.– Permits allocated using some mechanism

(auctioning/grandfathering).– Firms that don’t use their permits can sell them to

firms who exceed their allowance.– Those firms that can abate most efficiently will do

so. Cash incentive for abatement.


EU Emissions Trading Scheme

• Phase 1 2005-2007, Phase 2 2008-2012

• Covers CO2 emissions for relatively big firms in certain industries

• Countries allocate permits to firms in their jurisdiction based on past emissions levels

• Firms must hold enough permits to cover their emissions at the end of each year– €100/tonne penalty for insufficient permits– “Cap-and-trade” system

– Trading establishes ‘market price’ of a tonne of CO2


Aviation and the ETS

• Planned reform to APD in 2009• Current plans from EU environment ministers to bring

aviation into ETS from 2012– Aim to cover all flights to / from EU countries– Plan to auction 10% of permits– Allocations to airlines depending on tonnage-kilometres

flown between 2004 – 2006• What role for aviation duty?

– CO2 externality effectively internalised by ETS– Other greenhouse gases, noise and congestion costs

provide rationale for ongoing aviation taxes

• Ideally auction CO2 permits and target domestic taxes on other externalities


How will the ETS and Aviation Duty interact?

– If Aviation Duty is maintained at its current level• Passengers pay twice for the same externality.• One of these payments goes to the government, one of these

goes to the airlines (as there is an opportunity cost to the airlines using the permit)

• Net transfer from passengers to aviation sector

– If Aviation Duty is abolished/reduced• Government loses a source of revenue• Net transfer from government to the aviation sector

– Aviation Sector gains either way!• This is not surprising, as they’re being endowed with permits

which have a value• Either way, the incentive to reduce CO2 emissions is preserved


Conclusions

• Aviation contributing fast-growing share of UK carbon emissions

• Current APD system not particularly well-targeted on environmental costs

• Per-flight tax provides scope for sensible reforms• Would create more variation in payments to reflect

e.g. load factor, distance, emissions, noise etc. • Complexity in administration to be considered against

better targeting of the external costs• Interaction with proposed reform of Emissions

Trading Scheme crucial


References

• Aviation Taxation in the UK– Leicester, A and O’Dea, C (2008), “Aviation Taxation” in Chote, R., Emmerson, C., Shaw, A. and

Miles, D. (eds.), IFS Green Budget 2008, (http://www.ifs.org.uk/budgets/gb2008/08chap9.pdf)• What is the marginal cost of flying:

– Dings, J. M. W, Wit, R. C. N., Leurs, B. A and Davidson, M. D. (2003), “External Costs of Aviation”, Centre for Energy Conservation and Environmental Technology, http://www.umweltdaten.de/publikationen/fpdf-l/2297.pdf

– Pearce, B. and Pearce, D. (2000), “Setting Environmental Taxes for Aircraft: A Case Study of the UK”, CSERGE Working Paper GEC 2000-26, http://www.uea.ac.uk/env/cserge/pub/wp/gec/gec_2000_26.pdf

• UK Green Tax Instruments– Leicester, A. (2006), “The UK Tax System and the Environment”,

(http://www.ifs.org.uk/comms/r68.pdf)– Etheridge, B. & Leicester, A. (2007), “Environmental Taxation” in Chote, R., Emmerson, C.,

Leicester, A. and Miles, D. (eds.), IFS Green Budget 2007, (http://www.ifs.org.uk/budgets/gb2007/07chap11.pdf)

• UK Green Tax Revenues– ONS Environmental Accounts (http://www.statistics.gov.uk/statbase/Product.asp?vlnk=3698 for

latest, published twice a year)• HM Treasury Consulation

– Aviation: A Consulation (http://www.hm-treasury.gov.uk/consultations_and_legislation/aviation/consult_aviation_duty.cfm)


References

• Emissions Statistics Data– Global: OECD Factbook 2007 (http://www.sourceoecd.org/factbook)– UK: DEFRA (http://www.defra.gov.uk/environment/statistics/globatmos/download/xls/

gatb05.xls)• Theoretical Discussion of Green Taxes

– Keen M. and Strand J., ‘Indirect taxes on international aviation’, Fiscal Studies, 2007, 28(1): 1–41

– Pigou, A. C. (1920), The Economics of Welfare, (http://www.econlib.org/library/NPDBooks/Pigou/pgEWtoc.html)

– Smith, S. (1995), “ ‘Green’ Taxes and Charges: Policy and Practice in Britain and Germany”, (http://www.ifs.org.uk/comms/r48.pdf) – Chapters 2 & 3

– Stern, N. (2006), The Stern Review of the Economics of Climate Change, (http://www.tinyurl.com/vgzxv)

• Double Dividend– Terkla, D. (1984), “The Efficiency Value of Effluent Tax Revenues”, Journal of

Environmental Economics and Management, Vol. 11, pp. 107–123– Goulder, L. (1995), “Effects of Carbon Taxes in an Economy With Prior Tax

Distortions: An Intertemporal General Equilibrium Analysis”, Journal of Environmental Economics and Management, Vol. 29, pp. 271–297

– Bovenberg, A. & de Mooij, R. (1994), “Environmental Levies and Distortionary Taxation”, American Economic Review, Vol. 84, No. 4, pp. 1085–1089

Aviation Taxation

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