The Royal Commission on Pollution: Rise in fuel cost poses dilemma

The Government will be torn by the Royal Commission's proposal that it should double the price of petrol over the next 10 years. Higher petrol taxes would be unpopular, but the money raised could fund vote-winning cuts elsewhere.

Three-fifths of the money motorists spend on petrol is taken by the Treasury in excise duty - the taxman's share rises to three-quarters when you include VAT. The Chancellor has already promised to raise excise duty by 5 per cent a year above the rate of inflation. But to double petrol prices in a decade, this 'escalator' would have to be raised to 9 per cent.

The impact of price rises on petrol use, pollution and government revenue depends crucially on how motorists react. Department of Transport studies suggest an annual rise of 9 per cent in excise duty would cut petrol use by 2-3 per cent a year. But Phil Goodwin, of Oxford University's Transport Studies Unit, believes the long- term effect of each annual rise in excise duty would be twice as large because people will buy more fuel-efficient cars or choose to live closer to their work.

Because the fall in petrol use is less dramatic than the rise in price which prompted it, the overall amount motorists spend on fuel will rise, thus increasing the Government's revenue from excise duty. Petrol duty is already expected to raise pounds 15bn during this financial year, equivalent to the revenue of nearly 10p on the basic rate of income tax. The Treasury estimates that raising petrol duty by 5 per cent on top of inflation would raise pounds 855m next year. Others suggest this may be an underestimate.

'If the Government wanted to maximise its revenue, it would raise the rate of excise duty considerably higher,' Stephen Smith, of the Institute for Fiscal Studies, said. 'But that is a political judgement'.

However, price increases might need to be even more draconian than the Royal Commission has recommended if pollution targets are to be met and the economy improves. This is because vehicle use tends to increase as people become better off.