It’s the year 2050: 99% of the cars and vans in Europe are fully electric; the air is much cleaner; noisy engines are a thing of the past. But if you think that in such a future everybody wins, think again.
The disappearance of petrol and diesel vehicles means that governments will have a funding shortfall of tens of billions of euros (or pounds, krona, krone, koruna, lira, etc) as the tax revenues from fuel duties will be zero.
The drop-off will begin to be felt keenly from 2035 when, in both the EU and the UK, the sale of new liquid petroleum gas, petrol and diesel cars, as well as hybrid vehicles, will be banned.
Last year in the UK, fuel duties raised £24.7bn, or 2.2% of the total annual tax receipts
To illustrate the significance of this drop-off, the UK’s fiscal watchdog the Office for Budget Responsibility estimated that last year alone fuel duties raised £24.7bn, or 2.2% of the total annual tax receipts for the Treasury.
Plans afoot
Waiting until 2050 to find a solution for this upcoming fiscal problem is not an option. However, there is on the horizon a potential permanent fix in the form of a mileage tax for petrol and diesel vehicles, which is about to be introduced in Iceland to replace all their fuel duties.
Subject to an ongoing period of consultation, from 1 January 2025 a per-kilometre tax charge will be introduced on all vehicles in the country. Additional factors – such as if a vehicle's weight exceeds a certain limit – will be taken into consideration to determine the fee payable.
Since the beginning of this year, Iceland has been levying a similar tax on hybrid and electric cars, reflecting the actual usage of the country’s road infrastructure. This charge is currently set at ISK6 (€0.04) per kilometre for electric and hydrogen vehicles, and ISK2 per kilometre for plug-in hybrids.
The way this tax is calculated has similarities to how utility bills are charged
The way this tax is calculated has several similarities to how utility bills for electricity and gas are charged. Car users log their odometer readings regularly, either online or at certified inspection sites. Based on those readings, estimates are made for average driving and billed accordingly until new readings are provided.
Setting the new vehicle mileage tax at ISK6 for all cars, with an upward adjustment for heavier vehicles and the addition of a carbon fee applicable to more polluting cars, may leave a 40% funding gap compared with the current tax revenues from fuel duties. But there is still no precise indication on the level that such a fee will be levied at from January 2025.
Model for others
Nonetheless, it is not surprising that Iceland is at the forefront of this tax reform. The share of electric vehicles in new car registrations was 56% in Iceland in 2022, versus an average of around 23% in the rest of Europe in 2023, according to the European Environmental Agency.
The case for paying in accordance with the use of the road system seems compelling
On its official website Our roads to the future, the Icelandic government has clarified the reasons underpinning the tax overhaul: ‘Oil or gasoline charges are paid for each litre of fuel used by cars. However, this does not reflect the actual use of the roads. The positive trend towards more fuel-efficient cars means that more kilometres can now be covered with fewer litres of fuel, which means that less is paid for the use of the roads despite there being more overall driving.’
The case for a systemic change, where every driver will pay in accordance with the use of the road system, instead of fuel consumption, seems compelling.
And there is little doubt that all governments around Europe – and probably beyond – will be closely looking at the results from this tax experiment in Iceland. We may soon see a vehicle mileage tax across other parts of the world.
