Paying for net zero

The government is committed to the target of reaching net zero greenhouse gas emissions by 2050 but it has yet to set out a plan for how to get there, or how to pay for it. Working out a fair way to distribute the costs will be among the most important determinants of a successful transition.

The Treasury is reviewing the issue of “who pays” for net zero and developing principles to underlie the government’s approach. It published an interim report in December; its final report, which was due in the spring, is expected soon. 

How should we think about the costs and benefits of net zero?

There are several types of cost and benefit to consider, globally and domestically.

The most important benefit, of course, is avoiding catastrophic climate change. Put another way, the costs of failing to bring climate change under control would be much larger than those associated with decarbonisation. A wide range of experts agree on this.^[1] Increasingly frequent extreme weather events offer just a glimpse of the devastation that could be caused by higher temperatures, fiercer storms, heatwaves, droughts, floods and sea level rises.^[2]

The UK cannot secure this outcome alone; it makes up only around 1% of global emissions (albeit just under 5% of historical emissions).^[3] There is always a risk that others will not act, even if we do. But net zero targets now cover more than two thirds of the global economy.^[4] Meeting these targets, and hoping others do too, remains the only viable diplomatic strategy.

To reach net zero domestically will require a wide range of investments in new assets such as electric cars, windfarms and heat pumps. People will also have to adjust their behaviour; some will have to change their jobs – and government will need to target retraining to avoid the sort of scarring that happened in the 1980s with the switch away from coal mining.

But there is much to benefit from better insulated homes, cleaner air and improved health due to more active travel. Restoring peatlands and increasing the amount of woodland and hedgerows would improve biodiversity and strengthen our resilience to heatwaves and floods.^[5] In the long run these changes will lead to savings, meaning some low-carbon investments could ultimately pay for themselves.

How much will it cost to reach net zero?

The upfront investment required will be substantial. Only around £10bn of public and private investment in the UK in 2020 went towards low-carbon projects,^[6] but the independent Climate Change Committee think this needs to rise to about £50bn per year by the late 2020s – mostly on transport, renewables and buildings – and stay around that level until 2050.

But the savings will be substantial, too. By the late 2030s, the CCC thinks this extra investment (capital expenditure) will be offset by reductions in day-to-day spending (operational expenditure), including due to the extra efficiency of electric vehicles.

Other analyses have come to broadly similar conclusions. In a July 2021 report on fiscal risks, the Office for Budget Responsibility estimated a net cost of the UK reaching net zero by 2050 to be £321bn, or just over £10bn per year.^[7] This is made up of around £1.4trn in costs, offset by around £1.1trn in savings.

The OBR says these costs could be “significant” but are “not exceptional” and contrasted them with the larger cost of responding to the coronavirus pandemic. It noted that delaying action would increase costs, while losing control of climate change would increase them many times over.

The business department’s impact assessment – which used a slightly different methodology, placing a value on each tonne of carbon saved – estimated that the UK’s net zero target offered a net benefit to society of £266bn over 30 years.^[8] It emphasised that technology costs had fallen faster than anticipated when the UK first legislated to tackle climate change.

Are these big numbers?

The £50bn per year figure should be seen within the context of overall UK economy. In 2019, only a fraction of investment across the whole UK economy, which totalled £390bn, went on low-carbon projects. Over the next 30 years the UK’s total investment could be around £6-10trn: the challenge is to channel enough of this investment towards net zero.^[9]

Another way of thinking about the cost of net zero is as a percentage of GDP. In all of the pathways set out by the CCC, the cost of reaching net zero is less than 1% of GDP per year, before benefits are counted.^[10] This is well within the 1-2% of GDP cost that parliament first signed up for when it passed the 2008 Climate Change Act (and recommitted to when it upgraded the target to net zero). The government, the OBR and others such as Energy Systems Catapult all agree that net zero can be achieved within this cost envelope.

This does not mean that net zero will be a drag on economic growth. The benefits could be substantial and not tackling climate change would result in a much bigger hit to GDP. In fact, spread over 30 years the impact on the economy is relatively small: the CCC estimate that, even before counting the benefits, the economy will be as big in April 2051 if net zero is delivered as it would have been only four months previously without transitioning.^[11]

Falling behind in the global shift towards decarbonisation would present its own risks, too. The OBR note that the UK could end up capturing less of the benefits of new green industries and being reliant on technology produced abroad.^[12]  

Could the costs change?

Yes. The costs of a three-decade, economy-wide transition – from an economy powered by carbon to one that is near emissions free – are difficult to forecast. Much will depend on advances in technology, the speed of behavioural change and the timing of policy decisions – all of which are uncertain.

The CCC has twice reduced its estimate of the costs of tackling climate change because it underestimated how quickly technology costs would fall. In 2008, parliament agreed to an overall cost of 1-2% of GDP per year to deliver an 80% cut in emissions by 2050. By 2018, the CCC said the UK could reach net zero by 2050 for the same amount. In its most recent assessment, which included updated assumptions about behavioural change, it said the cost of net zero could be lower than 1% of GDP.

But the costs could be much higher if the transition is poorly managed. For example, ongoing uncertainty about policy and regulation would make it more expensive to finance investments, which would add to costs for taxpayers and consumers. Big changes, such as mass housing retrofit, could also be more expensive if they are implemented chaotically.

Forecasters have, if anything, tended to be too conservative.^[13] But it is possible that current assumptions could turn out to be too optimistic. For example, the Treasury noted in its interim net zero review that other forecasters were less optimistic than the CCC about falling costs for batteries and savings from switching to EVs.^[14]

Will the transition only be about additional investment?

No. There will also be a significant impact on government revenue. The Treasury’s review highlighted the importance of the loss of revenue from taxes on fossil fuels, with up to 4% of tax revenues (some £37bn) at risk.^[15] Most of this, around £30bn per year from fuel duty and £5bn per year from Vehicle Excise Duty, will disappear with the transition to electric vehicles.

Although lower taxes would be a benefit to taxpayers because they would be left with more money in their pockets, the government will need to find alternative revenue sources to make up the shortfall if other spending is unchanged. Many experts have suggested it ought to look to road pricing and will need to start planning for what will be a tricky transition now.^[16] The transport department had little to say on this in its recent decarbonisation plan.^[17]

Who will pay for net zero?

Most of the investment is unlikely to come from government; the CCC says there will need to be a “major nationwide investment programme, led by government but largely funded and delivered by the private sector and individuals”.[18] Public money will need to be used in a targeted way to unlock private investment and meet costs that the private sector is unlikely to.

Broadly, there are three overlapping groups policy makers can look to when thinking about how to distribute costs:

• taxpayers, by funding changes through general taxation;
• consumers, for instance by regulating to restrict the use of high-carbon options or imposing costs onto energy suppliers, who have traditionally passed these onto bills; or
• businesses, which ultimately means the burden is borne by shareholders, employees and/or consumers of their products.

Ministers also have a fourth option which is to look to future generations. They could do this by borrowing now and adding to the national debt which will have to be serviced and will ultimately be borne by future taxpayers. Or they could find ways to make future consumers cover some costs, for instance by offering guarantees of future minimum prices – such as with the deal for the Hinkley Point C nuclear power station.

Many economists argue that the most efficient way to reach net zero would be applying slowly rising carbon prices across the economy.^[19] This would spur innovation and act as an incentive to consumers (and businesses) to switch from high- to low-carbon activities. Some consumers would not immediately alter their behaviour, so they would pay more, and government would raise additional revenue (some of which could be spent on net zero infrastructure).^[20]

If politicians chose this route, they would need to find ways to cushion the impact on consumers least able to pay. If other countries did not follow suit, policy makers may also need to look at carbon border mechanisms to avoid emissions being offshored and UK businesses losing out.  

Why not just borrow?

This question is hotly debated among policy wonks. Proponents of a “Green New Deal” on the American and British left have argued for large scale investment to be funded by borrowing, taking advantage of historically low interest rates. They see this as the only way of securing investment quickly enough at the level required.^[21]

Critics of this approach argue variously that: it ducks the difficult but necessary work of getting people to pay for the damage caused by their own carbon consumption; it is unfair to defer most of the cost to future generations who will already inherit huge environmental damage; and current low interest rates are not guaranteed to last and substantial further borrowing, on top of the massive increases in debt during the pandemic, could be risky.^[22] 

Ultimately, politicians will need to make judgements about the strategic approach to funding net zero that is most appropriate in their domestic contexts. It is likely that a combination of approaches – policy and regulation, carbon pricing and public investment – will be needed, and the best approach will vary between policy areas.

How much will each household need to pay?

Even if the overall costs of net zero to the economy could be relatively small, the changes required might not feel small to individuals having to make them. The biggest changes people will face will be to how they heat their homes and how they travel.

Homes

The UK’s housing stock is mostly draughty and inefficient and will need upgrading, while around 90% of the UK’s 29 million homes are heated by gas and oil boilers that will need to be replaced. Costs will vary based on the size, type and age of homes. The CCC has estimated that the overall cost of upgrading the UK’s homes (including installing energy efficiency measures and low carbon heat) at around £250bn, with the average home facing a cost of nearly £10,000.^[23] Others have forecast a higher cost: a housing association in Surrey and Sussex estimated it would need to spend around £20,000 per home to decarbonise its stock.^[24] The key question is how quickly costs fall. While changes are currently unaffordable for most homeowners, costs could fall quickly as programmes are scaled and companies innovate (and the extent to which government supports this). Octopus Energy, Britain’s sixth largest energy supplier, is aiming to reduce heat pump costs to £5,500 within 18 months for a typical UK home.^[25] Consumers who insulate their homes will benefit from lower bills (or warmer homes) but unless there are tax changes most of those who switch to heat pumps could face higher bills because electricity is currently taxed more than gas.^[26]

Transport

There are around 40m registered cars in the UK of which only around 300,000 are EVs. EVs are currently more expensive to buy than petrol and diesel equivalents; they start at around £17,000, though prices are falling and expected to reach parity with internal combustion engine vehicles by the 2030s. They are also considerably cheaper to run: studies suggest a driver who spends £1,000 on petrol a year could spend as little as £300 a year on EV charging, and maintenance costs are also lower.^[27] This means drivers are expected to recoup the cost of switching vehicles, while some of the upfront cost could be reduced through financing schemes (there are also currently government grants available).

Even if costs fall faster than expected, poorer households could still find it difficult to pay for changes. Policy makers will need to consider how to support people in a range of circumstances, including different income levels, to make the changes required. This may involve looking at subsidies and how to facilitate access to low-interest loans, as well as thinking about the cumulative effect of policies in different areas.

How much is the UK already spending on net zero?

Government and the private sector have invested substantially, particularly in the energy sector. But the CCC has said the current level of public and private investment is well below what is required to get the UK onto a net zero trajectory.^[28]

The government has brought forward several policies and funding commitments, including a plan to phase out petrol and diesel vehicles and £3bn of funding for decarbonising homes and buildings (although this is less than the £9bn pledged in the manifesto and only part of it was spent before the scheme was scrapped).^[29] Last November, the prime minister announced a 10-point plan focussed on offshore wind, nuclear and hydrogen which pledged £12bn of government investment which would hopefully lead to “three times as much as that from the private sector”.^[30] 

Further detail on how to raise the public and private investment required for net zero, and distribute the costs of that investment, is expected in imminent departmental strategies, particularly the Treasury’s costs review, the heat and buildings white paper and the government’s net zero plan.

1. See, for example, the work of International Panel on Climate Change, the International Energy Agency, the Climate Change Committee and the Office for Budget Responsibility
2. https://www.ipcc.ch/report/ar6/wg1/
3. https://www.unep.org/emissions-gap-report-2020
4. https://www.ox.ac.uk/news/2021-03-23-net-zero-pledges-go-global-now-action-needs-follow-words-oxford-eciu-report
5.  https://www.theccc.org.uk/publication/sixth-carbon-budget/
6. https://www.theccc.org.uk/publication/sixth-carbon-budget/
7. https://obr.uk/frs/fiscal-risks-report-july-2021/
8. https://www.legislation.gov.uk/ukia/2021/18/pdfs/ukia_20210018_en.pdf
9. https://obr.uk/frs/fiscal-risks-report-july-2021/ . Investment figures based on ballpark assumptions about GDP growth and levels of investment (based on historical trends)
10. https://www.theccc.org.uk/publication/sixth-carbon-budget/
11. https://www.theccc.org.uk/publication/sixth-carbon-budget/
12. https://obr.uk/frs/fiscal-risks-report-july-2021/
13. See the CCC’s net zero report, p219-220
14. https://assets.publishing.service.gov.uk/government/uploads/system/uploads/attachment_data/file/945827/Net_Zero_Review_interim_report.pdf
15. https://assets.publishing.service.gov.uk/government/uploads/system/uploads/attachment_data/file/945827/Net_Zero_Review_interim_report.pdf
16. https://institute.global/policy/we-need-talk-about-fuel-duty
17. https://institute.global/policy/we-need-talk-about-fuel-duty
18. https://www.theccc.org.uk/publication/sixth-carbon-budget/
19. See for example Helm D, Net zero: How the world can stop causing climate change, 2020
20. For a detailed argument in favour of implementing economy-wide carbon pricing see Helm D, Net zero: how we can stop causing climate change, 2020
21. https://www.newstatesman.com/world/north-america/2021/04/america-s-race-net-zero
22. https://www.theccc.org.uk/publication/sixth-carbon-budget/
23. https://www.insidehousing.co.uk/news/news/housing-association-says-zero-carbon-will-cost-20000-per-home-66885 ;
24. https://www.ft.com/content/4579837a-46f1-4ba3-a76c-ca8b4565aadc
25. https://www.ft.com/content/4579837a-46f1-4ba3-a76c-ca8b4565aadc
26. https://institute.global/policy/ps10000-increase-your-energy-bill-making-economics-heat-pumps-stack
27. Goodall C, What we need to do know: For a Net Zero Carbon Future, Profile, 2020
28. https://www.theccc.org.uk/publication/sixth-carbon-budget/
29. https://www.instituteforgovernment.org.uk/explainers/government-covid-stimulus-package
30. https://www.gov.uk/government/publications/the-ten-point-plan-for-a-green-industrial-revolution/title