Air fuel tax risks being counterproductive

Date: 07/01/1999

The European Commission is considering calls for a tax on aviation fuel to combat pollution. But Thierry Lebeaux insists the potential impact of such a levy must be examined in the wider context of all EU policies affecting the air transport industry

THE European Union is currently considering a proposal to tax aviation fuel, with the aim of targeting the environmental impact of air transport.

A study has been commissioned from Dutch consultants, using a methodology close to that of a similar study presented to EU transport ministers in March last year.

The risk inherent in this process is that the taxation of aviation fuel will be considered in isolation from other measures likely to affect air transport.

Many direct aviation policy issues (such as noise, airport charges and restrictions on flight times) and indirect ones (such as energy taxation and the abolition of duty free) which could have a significant cumulative impact on airlines and their passengers are currently in development.

In addition, some environmental measures may have conflicting implications: reducing the noise 'footprint' around airports may, for example, necessitate a steeper take-off climb rate which in turn will increase emissions.

The cost benefit of a fuel tax must be assessed within a broader context.

Nobody disputes the contribution made by air transport to man-made emissions (around 3%). However, output is one thing: before defining options for action, policy-makers must be clear that regulation will work.

The problem in this case is that while the tax debate has been predicated on an assumption that air transport pollutes the environment, there is no more than tentative evidence of the extent of that pollution, given that in some conditions aircraft emissions can decrease the global level of methane, which is itself a greenhouse gas.

If policy-makers are being guided by the 'polluter pays' principle, a primary task must be to ensure that cost-based penalties are proportionate to the environmental impact they seek to address.

In this context, the effectiveness of policy options must be considered. The scope for a reduction in the consumption of aviation fuel by raising its price is limited. Alternative, 'lean-burn' engine technologies do not yet exist, and the European Commission has allegedly ruled out the use of taxes to cut demand for air travel, particularly as there are often no alternatives to flying except for short-haul journeys (and not even then for much travel from the UK, Ireland, the Greek islands or Scandinavia).

A large majority of EU travellers fly for leisure reasons, paying for their holidays from their disposable income, and even a small increase in fares will have a significant impact on demand.

The impact of a rise in operating costs can be illustrated by Greece's attempt in the Eighties to increase airport charges, which led to passengers voting with their feet by travelling to other tourist destinations outside the Union.

Business traffic may not be affected, but the competitiveness of EU companies will be damaged.

If, however, the aim is purely fiscal and fuel levies are really meant to raise revenue, the industry and the travelling public should be told and the proposal should not be dressed up in environmental clothing - it will, in effect, be a holiday tax.

If so, its adverse impact on airlines and other industries may in any event lead to a reduction in overall fiscal revenue by benefiting resorts and travel spots outside the Union.

Knock-on effects on other Union businesses must be anticipated. For example, the higher price-elasticity of leisure versus business carriers will force the former to seek appropriate responses to maintain profitability.

One possible reaction could be that holiday packages offered by tour operators to destinations outside the EU would be cheaper than those within it, which would have an impact on the tourism industry.

And if other Union policies, such as the abolition of duty-free sales (which will both reduce airline revenues and raise airport charges) plus new member state taxes such as the UK's air passenger duty, are added to the introduction of an EU fuel tax, there will be a cumulative impact which the Commission has not sought to measure. The ability to pass on additional costs to holiday-makers will be limited.

On the basis of a number of indicative tax levels, the study presented to Union transport ministers last March assessed the likely increase in airline operating costs at between 9% (short haul) and 15% (long haul).

It considered that the charge "would generate incentives to reduce pollution and to improve fuel efficiency", and that carriers would be able to "absorb part of the initial price increase". On this basis, the study concluded that a fuel tax (associated with other measures) would reduce emissions. But that is not the full story.

How long will it take for emissions to fall? Aircraft are capital assets with a long amortisation period. A fuel charge will not reduce emissions from existing fleets (except from a reduction in flights, which, as said before, is not a policy objective) and will therefore only start to show results when new aircraft are delivered, even assuming that cleaner technology will be developed in the future.

What will the process cost? Whenever more efficient engines are developed, the cost of replacing older technology will be high and not all airlines will be able to meet it.

Thus, the price of technology change (ie investment in new aircraft and shorter amortisation of 'old' technology airframes/engines, some of which are just at the beginning of their life cycle) may make new generation aircraft more expensive to operate than more heavily taxed planes.

Even if new technology were available, the effectiveness of a fuel tax as an encouragement to use this cleaner technology should also proceed from an assessment of the airline's economics. Ignoring capital costs in the assessment of the impact of the tax would, in the short to medium term, penalise carriers who invested in new aircraft.

Given that typical aircraft last around 30 years (several times longer than a car), the reduced profit will erode airlines' ability to invest in new, cleaner technology as early as possible. A fuel tax would therefore have precisely the opposite effect to that intended For global industries such as air transport, EU regulation cannot be designed unilaterally, independently from the rest of the world, especially in dealing with fuel taxation, given that some airlines would be able to escape a proportion of an intra-Union measure by taking fuel on board outside of the EU, distorting competitiveness. The ability of EU airlines to escape liability for an aviation tax will be further increased in the case of alliances with companies based outside Europe.

The Union should wait for the conclusion of current discussions on fuel taxation within the International Civil Aviation Organisation rather than duplicating work already under way.

No single EU policy development represents an overwhelming threat to airlines. The risk is in the aggregate impact on airline profitability of several measures.

The current lack of a binding framework for the Commission's business impact assessment rules, which are in practice restricted to judging the impact of proposed measures on small- and medium enterprises, makes this risk very real.

Aircraft fuel taxation and its business impact assessment will therefore be a test case for the Commission's new philosophy of 'legislating less, legislating better'.

Thierry Lebeaux is head of Public Policy Europe (the Brussels branch of the London Public Policy Unit) and is a consultant to the charter airlines industry.

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