Government clashes with Europe over carbon permit revenue

The Government is on course for an embarrassing showdown with the European Union, business groups and environmental charities after refusing to guarantee that billions of pounds of revenue it stands to earn from carbon-permit trading will be spent on combating climate change.

The dispute follows the publication yesterday of a discussion document by the Department of Environment, Food and Rural Affairs (Defra) outlining how the UK will operate phase three of the EU's Emissions Trading Scheme, which begins in 2012.

While the EU has insisted that revenue earned by member states from the sale of carbon permits should be used to combat climate change, Defra specifically ruled out such a commitment, either in phase three of the ETS or in phase two, which began this year.

Defra's document was published on the same day that the CBI added its voice to the growing campaign for earmarking of carbon permit revenues, known as hypothecation. In an open letter to the Prime Minister, the CBI, its Climate Change Task Force and the conservation group WWF-UK said phase two of the ETS would raise at least £1.6bn in additional revenues for the Government and called for a pledge that the money would be spent on "supporting emerging climate change technologies".

Richard Lambert, the CBI's director-general, said: "If the Government does not recycle the revenue from its carbon permit auctions into green measures, it risks undermining the trust of business and the public in green taxes."

David Nussbaum, the chief executive of WWF-UK, said: "Auctioning revenues offer an excellent opportunity for the Government to jump-start the industries that will help us build a One Planet Future."

The European Commission has begun consulting on a directive that would make it illegal for member states not to earmark carbon-auction revenues for green measures once phase three of the ETS begins. The move reflects growing irritation among the EU's officials in Brussels that governments across the bloc have not given a commitment to spend the money raised by the scheme in this way.

A spokeswoman for Defra said the Government had a policy of not hypothecating any tax revenues, on the grounds that doing so could distort spending priorities. "We don't even know yet what the carbon price will be," she said. "Money raised from these auctions will be channelled across all government spending departments."

Environmental campaigners have argued that without hypothecation, money raised from green taxes could end up being spent on road building projects or other initiatives that could actually exacerbate climate change. Defra added: "Hypothecating revenues that do not yet exist and which will depend on the carbon price is a vexed proposition."

Under the ETS, launched in 2005, energy-intensive businesses bid for carbon permits in government auctions and can subsequently trade the permits in order to meet caps on emissions.

The dispute is coming to a head now because business leaders and EU member states expect phase two of the ETS to produce much more sizeable revenues than phase one, which was undermined by the over-issuance of carbon emission permits by many governments.

The CBI argued yesterday that the Government had already set a precedent for hypothecation of green taxes because a parallel scheme launched in the UK last year for non-energy-intensive organisations, including public sector departments, channels revenues raised back to the most energy efficient participants. However, Defra claimed the Carbon Red-uction Scheme operated under different principles.