The Budget takes place on 17th March 2015 and as always there is much speculation as to what it will and won’t include. One industry that is eagerly awaiting Osborne’s Budget is the North Sea oil and gas industry. Tax cuts and rises may well play a key role in the Budget, but this is one sector where a possibly large tax cut is expected.
The tax paid by this industry is very high compared to others, potentially reaching 80%. The tax rate was increased some years ago and it is now thought that it may come back down. One key factor is oil prices: with such huge decreases in the price of oil relative to when the tax on the industry was increased, the industry is now asking for these tax rises to be reversed. The industry has suggested that a 10% tax cut is a possibility and this would make a big difference for the industry.
Danny Alexander, the chief secretary to the Treasury, said:
“We’ve been very clear that the direction of travel for tax in the North Sea needs to be downwards … And that needs to be even stronger given the low oil price we see at the moment. We want people to have the confidence to invest for the long term future of the North Sea … And so George Osborne and I have been listening very carefully to what the industry has been saying …People will have to wait and see what we say on Wednesday [Budget day], but I hope very much that it will give the North Sea that confidence that we all want to see for one of Britain’s most important industries.”
We may also see further changes for this industry, such as allowances to encourage further investment, as costs of investment are extremely high and this has led to many years of under-investment. These changes are hoped to regenerate this industry. Any change in tax allowances or tax rates will have an impact on tax revenue and it is not necessarily the case that an increase in tax will lead to a rise in revenue or a fall in revenue. The relationship between tax rates and tax revenues can be very complex. The following articles consider this particular issue and what the Budget will do for this industry.
North sea oil groups set for tax breaks in budget Financial Times, Christopher Adams and George Parker (16/3/15)
What does the Budget 2015 mean for the North sea oil industry? The Telegraph, Andrew Critchlow (16/3/15)
Britain needs oil tax cuts to attract North Sea Investment Reuters, Karolin Schaps and Claire Milhench (16/3/15)
Treasury paves way for major tax cut for North sea BBC News, Kamal Ahmed (16/3/15)
Home of Brent Oil benchmark seeks help as investment slumps Bloomberg, Firat Kayakiran (17/3/15)
Questions
- If a tax is imposed on an industry, what type of effect might this have on costs of production? Use a diagram to support your answer.
- In the BBC News article, North Sea Oil is referred to as a cash cow. What does this mean?
- If taxes are cut for the North Sea Oil industry, how will this affect its costs and what might it doe for investment?
- What will happen to tax revenues if taxes are cut? Use the Laffer curve to help your answer.
- How has the North Sea Oil industry been affected by falling oil prices? Does this offer a justification for a tax cut?
Many UK coal mines closed in the 1970s and 80s. Coal extraction was too expensive in the UK to compete with cheap imported coal and many consumers were switching away from coal to cleaner fuels. Today many shale oil producers in the USA are finding that extraction has become unprofitable with oil prices having fallen by some 50% since mid-2014 (see A crude indicator of the economy (Part 2) and The price of oil in 2015 and beyond). So is it a bad idea to invest in fossil fuel production? Could such assets become unusable – what is known as ‘stranded assets‘?
In a speech on 3 March 2015, Confronting the challenges of tomorrow’s world, delivered at an insurance conference, Paul Fisher, Deputy Governor of the Bank of England, warned that a switch to both renewable sources of energy and actions to save energy could hit investors in fossil fuel companies.
‘One live risk right now is of insurers investing in assets that could be left ‘stranded’ by policy changes which limit the use of fossil fuels. As the world increasingly limits carbon emissions, and moves to alternative energy sources, investments in fossil fuels and related technologies – a growing financial market in recent decades – may take a huge hit. There are already a few specific examples of this having happened.
… As the world increasingly limits carbon emissions, and moves to alternative energy sources, investments in fossil fuels and related technologies – a growing financial market in recent decades – may take a huge hit. There are already a few specific examples of this having happened.’
Much of the known reserves of fossil fuels could not be used if climate change targets are to be met. And investment in the search for new reserves would be of little value unless they were very cheap to extract. But will climate change targets be met? 
That is hard to predict and depends on international political agreements and implementation, combined with technological developments in fields such as clean-burn technologies, carbon capture and renewable energy. The scale of these developments is uncertain. As Paul Fisher said in his speech:
‘Tomorrow’s world inevitably brings change. Some changes can be forecast, or guessed by extrapolating from what we know today. But there are, inevitably, the unknown unknowns which will help shape the future. … As an ex-forecaster I can tell you confidently that the only thing we can be certain of is that there will be changes that no one will predict.’
The following articles look at the speech and at the financial risks of fossil fuel investment. The Guardian article also provides links to some useful resources.
Articles
Bank of England warns of huge financial risk from fossil fuel investments The Guardian, Damian Carrington (3/3/15)
PRA warns insurers on fossil fuel assets Insurance Asset Risk (3/3/15)
Energy trends changing investment dynamics UPI, Daniel J. Graeber (3/3/15)
Speech
Confronting the challenges of tomorrow’s world Bank of England, Paul Fisher (3/3/15)
Questions
- What factors are taken into account by investors in fossil fuel assets?
- Why might a power station become a ‘stranded asset’?
- How is game theory relevant in understanding the process of climate change negotiations and the outcomes of such negotiations?
- What social functions are filled by insurance?
- Why does climate change impact on insurers on both sides of their balance sheets?
- What is the Prudential Regulation Authority (PRA)? What is its purpose?
- Explain what is meant by ‘unknown unknowns’. How do they differ from ‘known unknowns’?
- How do the arguments in the article and the speech relate to the controversy about investing in fracking in the UK?
- Explain and comment on the statement by World Bank President, Jim Yong Kim, that sooner rather than later, financial regulators must address the systemic risk associated with carbon-intensive activities in their economies.
Economics is about choices. But how can people be persuaded to make healthy choices, or socially responsible or environmentally friendly choices? Behavioural economists have studied how people can be ‘nudged’ into changing their behaviour. One version of nudge theory is ‘fun theory’. This studies how people can be persuaded into doing desirable things by making it fun to do so.
I came across the first video below a couple of days ago. It looks at a highly successful experiment at the Odenplan underground station in Stockholm to persuade people to make the healthy choice of using the stairs rather than the escalator. It made doing so fun. The stairs were turned into a musical keyboard, complete with sound. Each stair plays a piano note corresponding to its piano key each time someone treads on it. As you go up the stairs you play an ascending scale.
After installing the musical staircase, 66% more people than normal chose the stairs over the escalator.
The fun theory initiative is sponsored by Volkswagen. The Fun Theory website is ‘dedicated to the thought that something as simple as fun is the easiest way to change people’s behaviour for the better. Be it for yourself, for the environment, or for something entirely different, the only thing that matters is that it’s change for the better.’
VW held a competition in 2009 to encourage people to invent fun products designed to change people’s behaviour. There were over 700 entries and you can see them listed on the site. The 13 finalists included the musical staircase, traffic lights with quiz questions on the red, a Connect Four beer crate, fun tram tickets (giving entry to an instant-win lottery), a pinball exercise machine, a speed camera lottery where a winner is chosen from those abiding by the speed limit, a jukebox rubbish bin (which plays when people add rubbish), a one-armed vending machine, a fun doormat, car safety belts linked to a car’s entertainment system, car safety belt with a gaming screen which turns on when buckled, a bottle bank arcade system and the world’s deepest bin (or at least one which sounds as if it is). The winner was the speed camera lottery.
The fun theory site
Thefuntheory.com
Fun theory videos
Piano Staircase – Odenplan, Stockholm (on Vimeo)
The Speed Camera Lottery (on VIMP.com, Kevin Richardson)
Garbage Jukebox (on YouTube)
The World’s Deepest Bin (on Vimeo)
Bottle Bank Arcade (on YouTube)
Questions
- Does fun theory rely on rational choices?
- Other than through having fun, how else may people be nudged into changing their behaviour?
- Go through some of the entries to the Fun Theory Award and choose three that you particularly like. Explain why.
- Invent your own fun theory product. You might do this by discussing it groups and perhaps having a group competition.
As we reported in New Build: Foundations for a successful housing policy? the Autumn Statement heralded significant reforms to Stamp Duty – the UK tax on house purchases. The result is the introduction of a graduated system of tax, along the lines of the income tax system. A similar regime will continue to operate in Scotland when the Land and Buildings Transactions Tax replaces Stamp Duty next April. Here we consider the impact on the effective rates of tax following the changes to Stamp Duty.
Under the old system any house purchase involving a property whose value was £125,000 or less incurred no Stamp Duty liability. Thereafter, one of five tax rates applied: 1% above £125,000 to £250,000, 3% above £250,000 to £500,000, 4% above £500,000 to £1m, 5% above £1m to £2m and 7 per cent for properties over £2m. The important point was that the whole of the purchase price was subject to one of these five progressively higher tax rates.
The new system sees the introduction of a graduated system of tax which means that the amount paid by house purchasers will be dependent upon the proportion of the value of the property that falls in each of the tax bands. Again, for properties up to £125,000 there will be no liability. There will then be four bands: 1% above £125,000 to £250,000, 5% above £250,000 up to £925,000, 10% above £925,000 up to £150,000 and 12% above £150,000.
One significant impact of the changes is that the liability will be more proportionate to the value of the property. To see this we can compare the average rate of tax under the new and old tax system. The average rate of tax is simply the amount of the tax liability relative to the price of the property.
From Chart 1 we can see how the new average rate of tax under rises progressively with the price of the property. (Click here to download a PowerPoint of the chart). Under the old system, the profile of the average rate of tax looks like a series of steps with a slab at each tax rate. Unsurprisingly, the system was sometimes referred as the ‘slab system’.
A second significant change will be the removal of the significant spikes in the marginal rate of tax around each of the tax bands. For example, the tax liability on a property costing £125,001 was £1,250.01 compared with a zero liability on a property costing £125,000. Therefore, a £1 rise in the price of property was accompanied by a £1,250.01 rise in the purchase tax. In percentage terms this is a marginal rate of tax of 125,001. Chart 1 shows how the marginal rates now match the progressively higher tax rates that become payable between each threshold.
The principle of removing the significant distortions to pricing created by the old system of Stamp Duty is likely to receive general approval. However, there may be some unease around the short-term implications for house prices of the bands and rates under the new system. This is largely because nobody purchasing a property at £937,000 or less will see their tax liability rise. The reduction in the liability raises concerns about a potential boost to house prices.
Chart 2 show the percentage change in the Stamp Duty liability for properties of up to £2.5 million. (Click here to download a PowerPoint of the chart.) The average UK house price, excluding London, is currently £235,000. The stamp duty saving in this case is £150 or 6.4 per cent.
But there are more significant savings than this from the reforms, including in London where inflationary pressures in the housing market have been more significant. Here annual price inflation ran at close to 20 per cent in the second and third quarters of the year. Given that the average house price in London is currently £510,000, this means a Stamp Duty saving of £4,900 or 24 per cent. Of course, for premium London markets (and other similar markets elsewhere) a quite different effect could arise. The liability on a £2m property rises by 53.75 per cent. Nonetheless, for most markets it is the boost to prices that is most concerning.
In the East Midlands, which is a good barometer of the market in the rest of the country, there will be a saving of £610 or 32 per cent on the current average property purchase of £189,000. Therefore, even in markets where house price inflation is more subdued there is the potential that the changes to the Stamp Duty system will, in the short term at least, boost housing demand and fuel house price growth.
Stamp Duty/Land and Buildings Transactions Tax
Rates and allowances: Stamp Duty Land Tax Gov.UKLand and Buildings Transaction Tax Revenue Scotland
Autumn Statement
Autumn Statement: documents Gov.UK
Articles
The home owners cashing in on stamp duty reforms Telegraph, Dan Hyde (2/12/14)
Christmas comes early for estate agents after stamp duty changes Guardian, Nigel Bunyan (7/12/14)
Stamp duty: House price boom and mansion bust Telegraph, Anna White (6/12/14)
£200m house deal stampede by wealthy to beat stamp duty hike: Reforms spark one of busiest periods for estate agents in 25 years Daily Mail Online, Louise Eccles and Ruth Lythe (5/12/14)
Stamp duty changes boost housing market and push up prices Guardian, Hilary Osborne (5/12/14)
Stamp Duty revamp blow to SNP property tax reforms Scotsman, Tom Peterkin and Jane Bradley (4/12/14)
Autumn Statement: What do stamp duty changes mean? BBC News, (3/12/14)
Data
House Price Indices: Data Tables Office for National Statistics
Questions
- What is the tax base of Stamp Duty and the Land and Buildings Transaction Tax?
- How does Stamp Duty distort choices?
- Under the old Stamp Duty system, why might a seller be reluctant to put their property on the market at £251,000?
- What is meant by the average and marginal rates of tax?
- What is meant by a progressive tax?
- What is the connection between the average rate of tax and how progressive a tax is?
- Calculate the marginal rates of tax (in percentage terms) under the old Stamp Duty system following a £1 rise which results in a property’s value moving into the next tax band (start with a £1 rise from £125,000 to £125,001).
- Using a demand-supply diagram show the effect of the Stamp Duty reforms on house prices in most UK housing markets. What characteristics of supply would make the change in price particularly large?
- Are there any housing markets where demand could fall following the introduction of the reforms to Stamp Duty? Illustrate the possible effects using a demand-supply diagram.
- How might an economist go about evaluating the Stamp Duty reforms? What factors will affect the judgement formed?
The typical UK high street is changing. Some analysts have been arguing for some time that high streets are dying, with shops unable to face the competition from large supermarkets and out-of-town malls. But it’s not all bad news for the high street: while some types of shop are disappearing, others are growing in number.
Part of the reason for this is the rise in online shopping; part is the longer-term effects of the recession. One consequence of this has been a shift in demand from large supermarkets (see the blog, Supermarket wars: a pricing race to the bottom). Many people are using local shops more, especially the deep discounters, but also the convenience stores of the big supermarket chains, such as Tesco Express and Sainsbury’s Local. Increasingly such stores are opening in shops and pubs that have closed down. As The Guardian article states:
The major supermarket chains are racing to open high street outlets as shoppers move away from the big weekly trek to out-of-town supermarkets to buying little, local and often.
Some types of shop are disappearing, such as video rental stores, photographic stores and travel agents. But other types of businesses are on the increase. In addition to convenience stores, these include cafés, coffee shops, bars, restaurants and takeaways; betting shops, gyms, hairdressers, phone shops and tattoo parlours. It seems that people are increasingly seeing their high streets as social places.
Then, reflecting the widening gap between rich and poor and the general desire of people to make their money go further, there has been a phenomenal rise in charity shops and discount stores, such as Poundland and Poundworld.
So what is the explanation? Part of it is a change in tastes and fashions, often reflecting changes in technology, such as the rise in the Internet, digital media, digital photography and smart phones. Part of it is a reflection of changes in incomes and income distribution. Part of it is a rise in highly competitive businesses, which challenge the previous incumbents.
But despite the health of some high streets, many others continue to struggle and the total number of high street stores across the UK is still declining.
What is clear is that the high street is likely to see many more changes. Some may die altogether, but others are likely to thrive if new businesses are sufficiently attracted to them or existing ones adapt to the changing market.
How the rise of tattoo parlours shows changing face of Britain’s high streets The Guardian, Zoe Wood and Sarah Butler (7/10/14)
The changing face of the British High Street: Tattoo parlours and convenience stores up, but video rental shops and travel agents down Mail Online, Dan Bloom (8/10/14)
High Street footfall struggles in August Fresh Business Thinking, Jonathan Davies (15/9/14)
Ghost town Britain: Internet shopping boom sees 16 high street stores close every day Mail Online, Sean Poulter (8/10/14)
Questions
- Which of the types of high street store are likely to have a high income elasticity of demand? How will this affect their future?
- What factors other than the types of shops and other businesses affect the viability of high streets?
- What advice would you give your local council if it was keen for high streets in its area to thrive?
- Why are many large superstores suffering a decline in sales? Are these causes likely to be temporary or long term?
- How are technological developments affecting high street sales?
- What significant changes in tastes/fashions are affecting the high street?
- Are you optimistic or pessimistic about the future of high streets? Explain.
The Budget takes place on 17th March 2015 and as always there is much speculation as to what it will and won’t include. One industry that is eagerly awaiting Osborne’s Budget is the North Sea oil and gas industry. Tax cuts and rises may well play a key role in the Budget, but this is one sector where a possibly large tax cut is expected.
