Rachel Reeves can’t kick the issue of fuel duty down the road

We have heard a lot about what the chancellor thinks is needed to close the “black hole” she discovered in the public finances. It includes stopping winter fuel payments to most pensioners, against the objections of pensioner groups, trade unions, many Labour MPs and me, in a column here two weeks ago.
Despite all this, it seems there will be no going back on that decision, which the government has turned into a totem of its determination to fix the public finances. Even if, because of higher pension credit take-up, it saves little or nothing.
There is, however, another decision that must be taken. This one, concerning the duty on petrol and diesel, falls into a slightly different category. While cutting winter fuel payments was intended to reduce the size of the black hole, an increase in fuel duty is necessary to prevent it from becoming larger.
Let me explain. The Office for Budget Responsibility told us in March that the previous government would meet its main fiscal rule (of debt falling as a percentage of gross domestic product in the fifth year of the forecast) by the narrowest of margins. Built into that forecast were two assumptions about fuel duty, which were: a reversal from next March of the emergency 5p-a-litre cut in fuel duty announced by Rishi Sunak when he was chancellor; and a further rise in fuel duty in line with the retail prices index.
Readers will have noted that these assumptions look heroic. Even before the emergency 5p cut, fuel duty had not been increased since 2011 as successive chancellors feared the backlash from motorists. Sunak was criticised for not reducing the duty by more than 5p, but no doubt he recognised that such cuts are politically difficult to reverse.
None of this is the OBR’s fault. It is required to do its projections for the public finances based on government policy and, throughout the period of the freeze, policy was to index the duty, to raise it in line with inflation. The 5p cut was presented as a temporary response to the surge in oil prices after the Russian invasion of Ukraine. Oil prices have now subsided.
Retaining these assumptions has contributed to what has been described as a fiscal forecast fiction by the House of Commons Treasury select committee, the Institute for Fiscal Studies and just about everybody else who looks at it. The retail prices index assumption is odd, though. It is no longer regarded as an official statistic by the Office for National Statistics. Any indexing should be in line with the consumer prices index.
As for the temporary 5p duty reduction, now in place for 18 months, late last month we had the unusual, perhaps unique, development of a motoring organisation, the RAC, seemingly urging the government to slap it back on, apparently because petrol retailers had never properly passed on the cut to motorists.
Leaving that aside, a failure to reverse the emergency 5p cut and to reintroduce indexing of duty would leave a gap in the public finances building up to about £5 billion by 2028-29 and would make meeting the debt rule harder. Putting the 5p back on would, on its own, be worth more than the Treasury’s initial estimate for the amount saved by cutting winter fuel payments. Putting it back on, alongside indexing and VAT, would mean about 7p a litre on the prices of petrol and diesel.
The question is whether, in addition to pensioners, the chancellor wants to go into battle with motorists. While most better-off pensioners can see the logic of either losing their winter payments or seeing them taxed, the motoring lobby has tended to see the fuel duty freeze as its God-given right.
Previous chancellors have decided that this is not a hornet’s nest to be poked. Reeves may have no option but to do so and whether this can be done in a way that passes the “no taxes on working people” test will be enough to tax the finest Treasury brains, although the long duty freeze means that the increase would leave duties in real terms lower than they have been for most of the past 20 years.
Many drivers will believe that they are above this fray because they drive electric vehicles and do not have to worry about fuel duty. My message to them, not intended unkindly, is just you wait. The days are numbered for the present period of cheap electric vehicle motoring.
Two reports published this week — National debt: it’s time for tough decisions, from the House of Lords’ economic affairs committee, and Revenue and Reform, from the Resolution Foundation — both identify another hole in the public finances. This is the one, numbering many billions of pounds, that will be left when the shift to electric vehicles leads to a sharp fall in fuel duty revenues, with nothing to replace them.
“A critical area where the government should be getting the ball rolling on reform is the taxation of electric vehicles,” the Resolution Foundation says. “It is well known that electrification will reduce, and is already reducing, fuel duty revenue. By the end of this parliament in 2029-30, this hole will have grown to an estimated £9 billion. And by 2033-34, which will be the final year of the OBR’s fiscal outlook in the potential last budget of this parliament, in 2028, this will have risen to £17 billion. This is an increasingly significant problem that the current chancellor will need to tackle.”
How to do so? The Resolution Foundation says existing vehicle technology could be used to tax electric vehicle drivers an eventual 6p a mile, plus VAT, while providing local authorities with the freedom to charge more in some areas to tackle congestion. It is, it says, important to grasp this nettle soon, so that most of this tax falls on future drivers as electric vehicle take-up increases, rather than existing ones.
Whether the chancellor decides to do so and whether the prospect of increased taxation further increases electric vehicle hesitancy among private buyers are among the very tricky issues that this debate raises.
David Smith is Economics Editor of The Sunday Times