McCrone: Electric Cars and the Response of Tax-Strapped Governments

By Angus McCrone
Chief Editor
BloombergNEF

Honeymoons are a time of passion. Afterward, the mood may cool just a little as the realities of washing dishes and paying mortgages sink in.

Electric vehicles are currently in a honeymoon phase. You can see that in investors’ eyes: according to BNEF’s figures, Chinese EV companies accounted for the six largest venture capital and private equity new money deals in clean energy globally in the first three-quarters of 2018.

Many governments are also feeling the “lurve” for EVs. Policies have been encouraging motorists to go electric, because ministers want to be seen to be acting to reduce CO2 emissions and urban pollution. Some countries have been offering subsidies.

The honeymoon passion of governments in developed economies for electric cars is likely to fade a bit as the EV market grows. One reason lies in public finances and their reliance on tax revenues from road fuel.

OECD figures show that the Group of Seven advanced economies raised some $223 billion in excise duty and local taxes on hydrocarbon oils in 2016. And then there was the revenue raised in value added tax or sales tax on gasoline and diesel – probably somewhere in the $50-100 billion range.

The degree of dependency on taxing road fuel varies within the G7: I estimate from less than 2% of total government tax revenue in the case of the U.S., to 4% in the case of Germany and more than 5% in the case of the U.K. – equivalent in money almost to what that country spent on defense in 2016. For all of the G7, road fuel taxation is important enough to create a hole in the public accounts if it disappeared.

Fading tax source

Disappear is what it looks like doing, albeit gradually, as gas-guzzling cars get displaced by electric models. BNEF’s Long-Term Electric Vehicle Outlook, published in May, shows the cost of electric cars falling in the years ahead, largely due to deflation in lithium-ion battery prices. By the mid-to-late 2020s, EVs will be cheaper than internal combustion engine, or ICE, vehicles on both a lifetime-cost and an upfront-cost basis.

ICE cars will not, of course, vanish from the roads at that moment. Gasoline and diesel will continue to be needed. Our forecast has EVs making up 55% of global new light-duty vehicle sales in 2040, but “only” 33% of the total fleet. The figures for individual countries will vary around that average, so for instance Germany would reach 76% of new car sales and 55% of the fleet by that date.

With the total number of cars on the road hardly growing any more in most G7 countries, the prospect is for the absolute number of ICEs to fall sharply during the 2030s, if not before. Meanwhile, the impact on the tax take may be magnified by three other factors. The first is that makers of ICE cars will be trying their hardest over the next decade and more to improve fuel economy in order to stay competitive with EVs, so each conventional vehicle is likely to need significantly less fuel. BNEF clients can see our estimate of this effect to 2040 in Figure 102 of BNEF’s Electric Vehicle Outlook report.

The second is that some other road transport sectors will also go electric, so reducing or eliminating their thirst for hydrocarbon fuels. BNEF sees electric buses making even faster inroads into their market than electric cars. By the late 2020s, delivery vans and two-wheelers may be going the same way.

The third is that many of the car drivers who do go electric in the early years will be very heavy road users looking to cut the costs of their high annual mileage.

BNEF’s Electric Vehicle Outlook does not assume any particular changes in taxation of fuel, electricity or vehicles in the coming decades. That is sensible: a forecast should concentrate on the economics and not try to second-guess the future actions of politicians.

But, in practice, changes in tax policy there may well be. Before discussing some of those, and what effect they might have on the EV revolution, we need to look at the question of timing.

Timing of the tax impact

How quickly will the advance of EVs impact government finances? Well, in a small way it is already. To take the U.K. example, electric vehicles made up 1.9% of new car sales in 2017, and a far lower proportion of the total fleet. The pure battery EV subset made up just 0.15% of licensed cars in 2017, according to the Department of Transport. Nevertheless, my estimate is that this means the U.K. government received 23 million pounds less in road fuel excise duty than it would have done if the same vehicles had instead been average ICEs.

OK, that is not a lot for a large economy. But the figure is only going to escalate. By the way, I simplified the calculation by leaving out plug-in hybrids, which are generally classed as a type of EV but use some road fuel as well as electricity. And I also left out VAT – both the tax charged at 20% on road fuel and that charged at 5% on electricity.

BNEF forecasts that EVs will make up 3% of the total European Union car fleet by 2025, rising to 12% in 2030, to 28% by 2035 and 45% by 2040. Meanwhile, the number of internal combustion engine cars sold in the EU will peak in 2022, and the total number on the road will top out in 2025 at 267.8 million. The latter figure is seen falling 9% by 2030 and 41% by 2040. It would be reasonable to expect the tax take on light-duty vehicle road fuel to fall by at least those percentages.

There would be a minor offset in the shape of extra VAT on the electricity used to charge EVs. However, the cost of the electricity per mile would only be a fraction of the cost of hydrocarbon fuel per mile.

Pile more pain on ICE vehicles

One way of recouping the shortfall in tax on road fuel would be to load even more taxation onto the gasoline and diesel vehicles that remain – probably by raising the rate of excise duty or local road fuel tax. This might be welcome for the EV industry and for environmentalists, since it would add to the urgency for drivers to drop their fossil fuel cars and go electric instead.

The disadvantages would be three. First of all, the extra road fuel tax would fall not just on diehard ICE fans (the famed “petrol heads”) but also on those driving around in old cars because they could not afford to buy new ones. France is currently trying to square this circle by increasing the cost of road fuel via a carbon tax, while also offering incentives for low-income households to buy electric cars.

Second, parts of the transport fleet that had not electrified, for instance trucks, would face heavy increases in their fuel bills. The trucking industry tends to be a powerful lobby.

The third disadvantage is a practical one to do with public finances. Turning the screw on ICE drivers would probably be so effective that it would push them onto electrics at an accelerated pace, eroding further the government’s tax revenues.

Put a tax on distance traveled

The most obvious way to tax distance traveled would be by taking a monthly or annual read-out from a car’s odometer, otherwise known as mileage clock. This would have to be transmitted electronically to a tax office or charging center, making the instrument akin to a smart meter.

That remote charging entity would then bill car owners. The amount per mile or kilometer could vary depending on the type of vehicle. For ease-of-collection purposes, the fees would be taken automatically from bank accounts. There could be a pay-as-you-go variant in which vehicle owners would pay upfront for a certain number of miles or kilometers.

Tampering might be a problem – although telematics are established in commercial vehicles in some countries to check that regulations are being observed. And enforcement of collection could be laborious and acrimonious, possibly involving the seizure or immobilization of the vehicle.

There would also be the question of how this tax could be made to apply to older vehicles already on the road. Would a new-tech odometer really be retrofitted to Uncle Henry’s 1952 Bugatti, or for that matter to the hundreds of millions of cars sold over the last two decades and still being driven?

As far as the low-carbon transition in transport is concerned, this idea could be neutral or negative. Neutral if it coincided with the continuing collection of tax on gasoline and diesel, so the incentive to switch to electric (or simply from a thirsty ICE model to a more economical one) would be very much in place.

Negative if tax on hydrocarbon road fuel ended when this new tax came in, delaying the tipping point when lifetime costs of choosing electric go below those of staying with fossil fuels. Or negative if this charge on distance traveled were only applied to electric models, with gasoline and diesel cars continuing to pay existing fuel duties.

Put a tax on road use

The likelihood is that a road use charge would rely on the introduction of new tolls on thousands of major, minor and urban roads – probably policed by camera rather than old-fashioned tolling barrier, and payable by internet.

Like the mileage levy above, it could be charged at a flat rate, or more likely graduated according either to the emissions of the vehicle concerned, or its weight – and therefore likely wear and tear on the road surface.

The concept in some ways is superior to the mileage levy, in that a road use charge could be graduated according to the actual route taken, and even whether the driving was done around rush hour or at quiet times of day or night. The latter might mean that it would contribute to reducing congestion and thereby increasing economic output.

Those are the benefits. As with the previous option, it could be neutral or negative for EVs, depending on whether road fuel taxes were retained, or abolished, with its introduction.

The appearance of a large number of new cameras on roads, and the collection of vast amounts of additional data on the movements of individual cars, would lead to opposition on civil liberties grounds in some countries. Other places that already have large numbers of cameras checking out for speeding, or like Japan and South Korea already have a big network of road tolls, might find their populations less worried about ‘Big Brother’ issues.

Skeptics might be partially reassured if it was written into law that the proceeds of the road use tax would be used solely to pay for new highway building, improvements and maintenance.

Increase tax on EV electricity use

And then we move onto taxes on EVs alone. Any dilution of the economic case for drivers to switch away from gasoline or diesel cars would be a retrograde step from a climate point of view. However, that does not rule out certain governments choosing to take this approach.

Such a tax could come in at least two forms. The first would be to impose a tax on charging, so that every time an electric car driver plugged in, that electricity used would be subject to a special government impost.

The problem here is that it might be possible to implement this at public charging points, but it would be hard to do so in the home because drivers could simply use the same power socket that is connected to their fridge or kettle. That is, unless a fraud-proof way can be found – inside the home or the vehicle – to meter the electricity flowing into a car battery as opposed to other appliances.

The simpler version would be for governments to lift taxation of all electricity by a significant amount. That would force EV drivers to pay more, in proportion to the amount of charging they needed to do, and therefore to the amount of driving they did.

But additional, blanket electricity taxation would run into howls of protest from consumers. Those not owning cars would complain at having to pay higher bills, and the old and poor might be disproportionately affected.

Registration fees for EVs

A final possibility that might tilt the playing field away from EVs would be the introduction of special registration fees for electric cars. According to the Sierra Club, by April this year there were 17 U.S. states with annual registration fees for electric vehicles, and another nine considering them. In many cases, these fees are above those for conventional cars.

For instance, the state of Tennessee’s Department of Revenue says on its website: “Currently, the registration fee for a hybrid is the same as all other private passenger vehicles, the state fee is $26.50. Electric car drivers will be charged a $100 registration fee in addition to the standard registration fee.”

The Indiana Department of Revenue said in 2017: “HEA 1002 created new supplemental registration fees for hybrid and electric vehicles. These new fees apply to registrations of all hybrid and electric vehicles and will be due and payable each year during the registration renewal process. The supplemental registration fee for hybrid vehicles is $50 per vehicle, while the supplemental registration fee for electric vehicles is $150 per vehicle.”

Such measures erode the relative economic appeal of EVs – even if only to a small extent. That means they are retrograde steps from the point of view of controlling emissions.

The registration fees in some U.S. states could end up giving a boost to plug-in hybrids, or PHEVs, at the expense of pure battery electrics. PHEVs made up 36% of all EV sales globally in 2017, and are forecast to still be 24% of that market in 2025. But they use some gasoline as well as being chargeable from mains electricity.

Possible impact

Above, I have outlined a range of measures that governments could choose from, in order to raise revenue to make up for the approaching shrinkage in their tax take from road fuel. Road use charging applied to all vehicles would appear to be the most elegant option from the point of view of reducing emissions and improving the flow of traffic. For EV sales prospects, it would matter whether such a tax co-existed with current road fuel duties, or whether it replaced them.

It is hard to imagine a government response to the tax issue that would prevent the eventual conversion of vehicle fleets to electric, but there are a few options that might affect the speed of the EV revolution over the next two decades. BNEF will be examining in more depth both the issue and the choices, particularly as it affects Europe, in a research note to be published in the coming months.

National treasuries and economics ministries have so far paid insufficient attention to the low-carbon transition, except for the impact of subsidies on electricity bills. As I argued in a VIP Comment article last August, How Economies May Flex to Transition in Energy, Transport, that transition is starting to become significant for a range of macroeconomic indicators, from GDP growth and inflation, to trade and jobs and tax revenue.

It’s time for finance ministers to start getting to know those “what’s-their-name” colleagues in their governments’ energy and transport departments.

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