As transport electrifies, governments can still make up for lost fuel duty revenues

As customers shift to electric vehicles loss of fuel duty could cost governments billions in tax revenues. Even as environmentalists, we should be taxing electric cars

William Todts is Executive Director at Transport & Environment

One of the most popular but least successful ideas in transport economics is the idea that cars should pay per kilometre travelled. The appeal of such smart tolls is that they encourage more environmentally conscious travel, and can be used to battle congestion.

Just as Karl Marx remarked that the end of capitalism was inevitable, transport economists have long argued distance based tolls were “inevitable”. The only problem – so the story goes – is that shortsighted politicians lack the courage to do what’s right.

The original sin of kilometre charging advocates is their attempt to design a perfect policy that solves all problems – be that congestion, climate, pollution or equity – all at once. For it to deliver on all its supposed benefits, charges would need to be steep and highly differentiated by vehicle type, and by time and place.

Belgium and the Netherlands are a case in point. Despite two decades of promises to introduce road pricing and millions spent on consultants, neither country is any closer to  it.

Kilometre charging usually dies as soon as the government announces who would need to pay what fees. That leads to the inevitable story of how a nurse with a 10- year-old Fiat Panda driving on the ring road during rush hour would pay a lot more than her Tesla driving, office-working neighbour. That begs the logical question: how is that fair?

Of course smart economists have an answer. To deal with equity issues we should embed km-charging into a wider tax overhaul where taxes for nurses go down and taxes for Tesla owners go up.

Perhaps all of this is possible in theory, but in the real world of political economy, it is not.

The good news is that we don’t need a road pricing revolution. Other measures work better and where they don’t, piecemeal reform will actually do the trick.

Cutting carbon pollution from cars doesn’t require distance based tolls. A combination of CO2 standards and car purchase taxes works much better. That’s why the auto and oil industries frequently call for them to be scrapped.

Neither do you need economy-wide km-charges to deal with local congestion. London, Stockholm and other cities with local congestion charges are great examples of that. Parking fees or simply reassigning road space to cycling or public transit can work just as well.

But, say the economists, what about electrification? Surely if people go electric and stop paying fuel taxes an economy wide kilometre tax becomes inevitable? They have a point.

Electricity for households is heavily taxed in most European countries, averaging just over 40% of the final price before the energy crisis. For petrol and diesel, it is 52% of the price. But the “trouble” with electric cars is that they are so damn efficient and consume so little taxable energy. This means EVs are likely to generate on average four times less revenue than ICE cars for every kilometre they drive.

We estimate EU governments could lose €36 billion in fuel tax revenues from cars in 2035. That is a lot. That shift is regressive as rich people drive more and thus pay more fuel duty. Increasing fuel duty, or levying carbon taxes on fuels can help halve that fuel duty loss to €17bn, but it can only be part of the answer. Low income people are likely to go electric last.

What to do?

Enter Iceland.

According to T&E’s Tax Guide Iceland has a great green vehicle taxes. It has registration taxes, purchase grants for EVs, differentiated company car tax and it is part of the EU’s CO2 standards. As a result nearly 60% of new cars registered on the island are electric.

Now Iceland has also found a very neat solution to the problem that has been bugging transport economists for decades. A new scheme introduced this year requires electric car drivers to pay a tiny kilometre fee of 4 cents per kilometre. You just have to register on a website and you get charged every month. The scheme explicitly compensate for fuel duty loss with BEVs paying more than gas guzzling PHEVs.

The beauty of the Icelandic system is that it is easy to explain, easy to implement and enforce and politically savvy as it targets a small, but rapidly growing group of EV drivers.

Give it a decade or two and all cars on Iceland’s roads – including future driverless vehicles – will be paying distance based charges, realising the dream of transport economists in a most unexpected manner. Every state or country that is passing the critical 50-60% EV sales threshold should follow Iceland’s example.