Response to scrapping of Carbon Price Support

The government yesterday announced that Carbon Price Support (CPS) will be abolished from April 2028. CPS is a tax on the carbon emissions of electricity generators in Great Britain, first introduced in 2013 and currently charged at a rate of £18 per tonne of CO2 (or equivalent) emitted. As things stand, CPS serves to distort emission reduction choices without providing any benefits in terms of directly reducing overall carbon emissions. Its removal is a welcome (if modest) improvement to the UK’s often confused approach to carbon taxation. 

CPS was originally intended as a 'top-up' to the price of carbon permits issued under the Emissions Trading Scheme (ETS). The ETS is a 'cap-and-trade' scheme, capping the total emissions from certain sectors (including electricity generation) and allowing firms to trade carbon permits with each other. The great advantage of the ETS is that the market for permits ensures that emissions reductions are made by those who are able to undertake them at the lowest cost. CPS contradicts this logic by imposing a higher cost on emissions produced in the production of electricity than on other ETS activities. It also widens the gap between the tax on emissions from electricity and that on emitting activities that fall outside the ETS, such as the direct use of gas by households. The ultimate effect of these distortions is to make emissions reductions more costly to the economy as a whole. The removal of CPS and the distortions it creates therefore marks a clear improvement to the government’s approach to carbon taxation.

Moreover, as CPS applies to activity that is already covered under the ETS, its removal will have no direct effect on total UK emissions. That is because the total number of permits issued under the ETS (and therefore total emissions from relevant sectors) is fixed. So, while the removal of CPS will reduce the cost of emissions for electricity generators, any resulting increase in emissions from electricity generation will be completely offset by emissions reductions from other activities covered by the ETS.   

Yesterday’s reform will make electricity cheaper, but insofar as that price reduction leads to higher demand for electricity, it will also lead to a higher ETS price, meaning that the overall tax on emissions from electricity generation, and therefore the price of electricity, will fall by less than the level of CPS itself. It will also make other products that require ETS permits – such as steel, chemicals and flights within the UK or European Economic Area – more expensive. 

While the removal of CPS is an improvement, the UK's approach to carbon taxation remains haphazard. Greenhouse gas emitting activities (from flights to farming) are often taxed at wildly different rates. To take just one example, gas burned to generate electricity is subject both to CPS, imposing a charge of £18 per tonne of CO2 (or equivalent) emitted, and to the UK ETS, which at current prices imposes an additional cost of £45 per tonne of CO2 (or equivalent) emitted. Gas burned directly in a home for heating incurs neither of these costs. Inconsistencies such as these result in a tax system that leads more costly emissions reductions to be undertaken ahead of less costly ones.  

From a fiscal perspective, yesterday’s announcement is a minor one. While the revenue from CPS will be lost from April 2028 onwards, this was already forecast to dwindle to £200 million by 2028–29, both because the CPS rate is frozen in nominal terms and because of continued growth in the share of electricity generated from low-carbon sources.