Gaurav Batra

Governments worldwide heavily tax petrol and diesel, often accounting for a large portion of consumers' pump prices. In the United Kingdom, for example, the government imposes significant taxes, including Value Added Tax (VAT), which contributes substantially to the cost of fuel and serves as a critical source of revenue. 

Globally, fuel taxes form an essential component of many national budgets. In the UK, fuel duties are expected to generate approximately US$32.5bn (£24.7bn) in the 2023-24 fiscal year, accounting for 2.2% of total government receipts. The trend reflects the global situation, where fuel taxes are a vital source of income for governments.

Consequences of lost revenue

As countries including the UK transition toward EVs by 2035, there is growing concern about how governments will offset the loss of this crucial revenue stream as fuel taxes decline. For instance, the UK anticipates losing US$17bn (£13bn) annually in fuel duty by 2030 due to the increasing adoption of EVs. 

The Office for Budget Responsibility (OBR) forecasts a reduction in tax receipts by US$2.7bn (£2.1bn) in 2026-27, with US$1.8bn (£1.4bn) resulting from lost fuel duty. The transition impacts multiple revenue streams, including fuel duty, vehicle excise duty and potential tax revenues from gas/petrol stations and convenience stores.

Governments exploring alternatives

Given this context, a critical question emerges: how will governments make up for the shortfall when they can no longer depend on fuel taxes to fund their budgets? As Julie Lorenz, former Kansas Secretary of Transportation, puts it: "The future of transportation funding lies in finding a sustainable model that reflects how people use our roads. Road usage charges represent a promising alternative, but there's much work to ensure they are fair and practical for all drivers."

Governments worldwide are discussing and analysing the impending tax deficit from the shift to EVs. The OBR in the UK has pointed out that efforts to combat climate change by moving away from fossil fuels are "rapidly eroding" tax revenues from petrol and diesel vehicles. While governments recognise the challenge, there is still uncertainty about the best approach to address the growing tax deficit. The transition to EVs presents a complex issue that requires balancing environmental goals with fiscal sustainability.

Gaurav Batra is the Global Advanced Manufacturing & Mobility Analyst Leader at EY and a recognised expert in the future of mobility, particularly in EVs and the automotive market. His career includes extensive experience in growth strategy, market entry and business plan analysis. Gaurav has led international teams, worked closely with senior client stakeholders and enhanced EY's service offerings. He holds a Bachelor's degree in Commerce from Delhi University and an MBA from the International Management Institute in Delhi, India. EY provides strategic consulting and advanced technologies, such as ERP and MES, to support the EV industry, helping manufacturers and suppliers navigate this critical transition.

What are the viable options for replacing lost revenue from fuel taxes? 

The frontrunner appears to be distance-based taxation, or ‘road usage charges’ (RUC). The model is relatively simple: drivers pay based on how much they use the roads, whether they drive a personal car, an SUV or a commercial truck. The approach moves away from traditional petrol taxes that indirectly covered road use during the era of internal combustion engines (ICE). Other proposals include:

• Raising existing fuel taxes for ICE vehicles
• Increasing registration fees for EVs
• Implementing new tolls.

In the US, Oregon is considering indexing taxes and fees to inflation. Currently, 24 states and the District of Columbia have variable-rate fuel taxes that adjust with inflation. The method has a short implementation timeline, low collection costs and good revenue potential. Indexing taxes to the Consumer Price Index could yield additional revenue without introducing new taxes.

Other ideas, like taxing electricity usage to charge EVs, might sound straightforward but require a significant infrastructure upgrade, such as installing smart metres and overhauling existing charging systems. Germany is already exploring this, but could it be practical on a global scale? There isn't a one-size-fits-all solution; different countries will need different approaches and what works in one might not work in another.

Each of these options comes with its own set of challenges. For instance, Government tolls can only apply to specific roads, not the entire road network. 

When considering new tax measures, several key questions arise: Can governments truly replace lost revenue? Will they affect the total cost of EV ownership? Are they easy to implement? Are they fair for everyone? Do they support broader goals like reducing emissions, cutting congestion and promoting public transportation?

What challenges do you envision implementing RUC?

So far, road usage charges have checked most boxes, but how do governments sell this idea to the public? For years, taxes have funded road construction. With the introduction of road usage charges, people might feel they are paying again for something they've already funded. How do you explain this, especially when drivers have been encouraged to switch to EVs for the greater good?

Some governments are already feeling the pinch of reduced fuel tax revenues and are testing new strategies, such as the Icelandic approach, to fill the fiscal gap. 

The Icelandic Approach

Iceland's current road financing system relies heavily on excise duties on oil and gasoline. Still, the model needs to be more effective due to the increasing adoption of electric and hybrid vehicles. To address this, Iceland plans to introduce a new per-kilometre charge in early 2024 for electric, plug-in hybrid and hydrogen-fueled passenger or courier vehicles. 

The charge will be set at US$0.04 (6 ISK) per kilometre for electric and hydrogen cars and US$0,01 (2 ISK) per kilometre for plug-in hybrids. By 2025, the aim is to apply a per-kilometre charge to all vehicles, fully replacing the existing oil and gasoline fees with a system that is equitable, transparent and independent of energy sources.

Several factors are driving the change: a significant increase in eco-friendly vehicles, a 50% growth in road usage over the past decade and a 30% decline in revenues from oil and gasoline charges since 2012. 

The new system's design is consistent, equitable, future-focused, transparent and straightforward. Initially, the per-kilometre charge will mainly impact higher-income groups, who are more likely to own electric and plug-in hybrid vehicles. However, even with the new charges, operating an electric car will remain significantly cheaper than a gasoline car due to lower energy costs and the absence of carbon fees.

To further support the transition, the Icelandic government will continue offering incentives for EV purchases, shifting from VAT discounts to direct grants for new EVs. The approach aims to ensure sustainable funding for road infrastructure while adapting to the ongoing energy transition in Iceland's transportation sector.

A balanced approach is needed to ensure adequate infrastructure funding without unfairly burdening EV owners or discouraging EV adoption. Industry experts are urging governments to provide clarity and long-term strategies for replacing fuel duties, acknowledging the unique budgetary challenges of the EV transition.

Given the UK's target date of 2035 for the full transition to EVs, the government has less than a decade to rethink its mobility tax model. Considering that any replacement taxes will need to be legislated and passed through parliament, this process in itself presents a significant challenge. 

As Amy Ford, Executive Director of the Department of Transportation and Infrastructure for the City and County of Denver, highlights: "Road user charges could be a smart way to ensure that everyone who uses the roads pays for their upkeep. But designing these charges is crucial so they're fair, transparent and don't disproportionately impact lower-income drivers."

In conclusion, what are the complexities of new mobility tax models?

Governments worldwide face a complex balancing act: finding ways to cover the costs of maintaining and developing transportation infrastructure without giving the impression of double-charging their citizens. Although this article has used the UK as an example, the challenge is global in scope. The future of transportation funding will depend on innovative solutions that balance fiscal responsibility, fairness and environmental sustainability. 

The path forward may be challenging, as there are currently more questions than answers, but governments must maintain financial stability and the public's trust in the process.

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