Fuel tax vs. Road User Charges for Light Diesel Vehicles

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1 THE NEW ZEALAND AUTOMOBILE ASSOCIATION INCORPORATED 26 April 2011 Clerk of the Committee Select Committee Office Transport and Industrial Relations Select Committee Parliament Buildings WELLINGTON Lambton Quay Wellington New Zealand PO Box 1 Wellington New Zealand T F Fuel tax vs. Road User Charges for Light Diesel Vehicles Further to our oral submission to the Transport and Industrial Relations Select Committee on 14 April, the Chair of the committee asked the NZ Automobile Association (AA) to provide further information on diesel tax, particularly implementation, and also on aspects of the transition to e-ruc. This note covers the following issues below: DIESEL TAX Diesel tax Reasons for a diesel tax Practical aspects of implementing diesel tax Inland revenue recovery of off-road use: suggested options Overseas experience Equity of cost recovery of diesel tax and RUC Transition to e-ruc The AA submission on the RUC Bill did not elaborate on our strong support for a diesel tax, as the Bill did not directly cover this, and we had previously detailed our position in the 2008 Independent Review of the NZ Road User Charging System (see Given the Committee s interest and questions on practical aspects of implementing a diesel tax we welcome the opportunity to put this additional information before the Committee. The Cabinet paper argues against moving to a diesel tax because the off-road rebate system would impose compliance costs on off-road users; this is only true if the rebate system is burdensome and does not provide adequate compensation. We consider that the implementation options suggested below address both of these issues and the benefits of moving to the system far outweigh these considerations. RATIONALE FOR DIESEL TAX Cost of the RUC system vs. diesel tax When RUC was introduced, off-road use significantly exceeded on road use (and this was why it was decided to recover the on-road use through RUC). Today the reverse is true, with roughly twice as much diesel used on-road than off-road. RUC became less cost effective than diesel tax many years ago, and this gap will continue to widen. For decades the heavy vehicle

2 Page 2 of 10 fleet has grown faster than GDP and population growth; the proportion of diesel vehicles in the light fleet has also grown steadily. New Zealand would be far better off replacing light RUC with a diesel tax: The RUC system costs Government $120m p.a. to administer (estimate from Road Transport Forum submission). The petrol excise system is extremely cheap to administer; a diesel excise system would likely also have minimal cost. The RUC system has significant levels of avoidance about 10% is lost each year through avoidance; compare to petrol tax, which has no avoidance. RUC requires significant use of scarce enforcement resources; petrol tax has none. Net revenue would be higher even if the off-road refunds (described further below) were generous, which would also more than compensate for the compliance costs to off-road diesel users; and these compliance costs could be designed to be minimal. Net government administrative costs would also be lower, even allowing for a one-off investment in upgrading IRD system capability. The ongoing cost of refunding off-road use would be minor after it is set up, because it can piggy-back on existing IRD GST systems. Diesel tax has zero user compliance costs (it is paid at the pump). RUC compliance costs are high. The owners of 500,000 light diesel vehicles waste hundreds of thousands of hours yearly to purchase paper RUC licences to put in the window of their vehicles. Light diesel vehicles tend to be the workhorses of the light fleet; it is likely RUC is an impost on a productive segment of the population. Transaction fees for light RUC are significant; purchasing 1000km light RUC in person, the transaction fee ($9.60 per transaction) is another 20% on top of the RUC itself (it is more cost effective to buy large amounts of RUC at one time). A diesel tax, even including the off-road rebate system, would result in greater recovery, less avoidance, overall lower costs to government and hence cost to taxpayers, lower compliance costs in total, lower transaction costs and lower costs of enforcement. The light RUC system is thus an unnecessary burden on the New Zealand economy. Distortions in light vehicle fleet The first distortion is that petrol users as a class continue to pay more tax than diesel users. The steady increase in the proportion of diesel vehicles in the light fleet (now 16%) is a symptom of decades of significant tax advantage of diesel over petrol, which distorts choice in the light fleet towards diesel vehicles. The Crown had an opportunity to remove this distortion in 2008 when the petrol tax that went into the Crown account was transferred into the National Land Transport Fund; but has to date failed to put diesel and petrol on the same tax footing; light diesel vehicles as a class pay about 30% less overall than petrol vehicles, with no obvious rationale. The second distortion is that having two different tax structures artificially distorts vehicle choice; identical vehicles except for fuel source pay very different taxes. Compare these identical vehicles: 3-litre Toyota Landcruiser Prado turbo-diesel pays $44/1000km; the petrol equivalent pays $78 (76% more) 1.6 litre Peugeot 307 diesel pays $44/1000km; the petrol equivalent pays $37 (17% less) 1.4 litre Getz diesel pays $44/1000km; the petrol equivalent pays $35 (21% less) This is despite all the diesel vehicles being more fuel efficient, the smaller ones using over 30% less fuel per 100km than the petrol equivalents.

3 Page 3 of 10 As the Honda NZ submission noted, no one would rationally buy a large petrol vehicle in New Zealand, but they would buy a large diesel. Honda also rightly noted the strong disincentive to buy a light fuel efficient diesel vehicle. Whether we like it or not, the different tax systems (RUC and petrol excise) indisputably have been distorting vehicle choice and hence the makeup of the New Zealand fleet. This is a significant concern. Consider just two factors for example: vehicle emissions and fuel supply. Vehicle emissions Diesel has worse emissions than petrol, in particular has higher particulate emissions which have serious health effects and contribute to the shortening of life expectancy. With a tax system that encourages large diesel vehicles over petrol, New Zealand now has a large number of older, large SUVs that contribute to air pollution in our cities. Fuel supply Light diesel vehicles are now some of the most fuel efficient vehicles in the world. Over the next 10 years, the hybrid diesel is likely to be the most fuel efficient. As Honda noted, a light diesel vehicle won the AA EnergyWise Rally. In Europe fuel efficient, low-emission light diesels are a fast growing segment of the light vehicle market. With fuel supply risks, rising world demand for oil and hence rising prices into the future, it is important that New Zealand is proactive about achieving a future-proof fuel efficient vehicle fleet. This is a hard ask given the length of time vehicles stay in the New Zealand fleet. It is extremely important to remove this distortion between the two tax systems that creates an artificial disincentive to small diesel vehicles, and to do it soon. As an aside, the AA also supports Honda NZ s submission to rearrange the break points for the light RUC classes to more closely reflect the actual range of weights of the New Zealand light vehicle fleet. The difference in the petrol excise and RUC systems also creates issues for example with the recovery of the ACC levy, and vehicle purchase misunderstandings. PRACTICAL IMPLEMENTATION OF DIESEL TAX Implementation issues covered here include: managing refunds for off-road use recovering additional costs (i.e. a top-up over the diesel tax revenue) for heavy vehicles Inland Revenue refunds for off-road use There is already an off-road petrol refund system operated by NZTA, mostly for maritime use, but this is acknowledged as a poor model and the AA would not recommend it be used as a basis for a wider diesel refund system; indeed an advantage of introducing a modern diesel refund system could be to also reduce the administrative costs of the archaic petrol refund system. The AA considers it is regulatory creep that the proposed Bill empowers the Ministry of Transport to recover records, when IRD already has this power and is the more appropriate agency to collect taxes and charges. We recognise that legislation changes would be required to enable IRD to process RUC collection (or in the case of a diesel tax, off-road refunds), however this should not be a reason to pursue the most logical allocation of responsibilities. The issues to address for fairness to off-road users are: the government does not hold onto their money too long

4 Page 4 of 10 the burden is light they are compensated for that burden The AA proposes as an option for off-road diesel refunds that IRD should operate this based around GST returns, which are typically filed two-monthly. This would mean off-road refunds are received promptly. Diesel purchases attract GST and are recorded in the GST system. GST registration is required for turnover of $60,000 or more, so most of New Zealand s 27,000 farmers, for example, will be GST registered (GST registered users would certainly account for most of the dollar value of off-road refund transactions). To reduce the compliance burden for off-road farm use, the AA suggests a one-off piece of work be done so that IRD can deem a percentage of off-road use for a set of typical situations: e.g. farm type, farm size, number and type of vehicles owned. To compensate farmers for the compliance burden we suggest setting this deemed rate so the majority of farmers would be better off accepting the deemed rate. The option to apply for a higher rate should also be available for those that fall outside the deemed rate; these exceptions should only need to be re-established intermittently. This is consistent with other tax rules; for example IRD requires businesses to establish the business share of vehicle running costs by keeping a logbook for three months every three years. Bulk pumps at marinas and other bulk industrial users could be exempt. On-farm pumps could also be exempt provided these are enforced appropriately (enforcement is discussed below) and integrated with any off-road rebate system. Heavy Vehicle Top-up Required Over Tonnes The AA s rough indicative calculation is that income from diesel tax would roughly equal RUC income on RUC type 6 vehicles below tonnes (see the figure below 1 ). Above 12 tonnes the shortfall rises exponentially and would require a separate charging mechanism (e.g. RUC, e-ruc or differential registration fees). Note though there are only 50,000 vehicles over 10 tonnes, and nearly 530,000 RUC paying vehicles under 10 tonnes. Or put another way, less than 10% of vehicles need RUC, but for the other 90%+, RUC represents an inefficient and administratively expensive tax. 1 From the AA submission to the 2008 Road User Charges Review:

5 Page 5 of 10 Minor differences between diesel excise and RUC for the light heavies (i.e. under 10 tonnes) could be easily and cheaply captured by quarterly, bi annual or annual licensing charges. We acknowledge the above diagram is back of the envelope, and encourage you to invite officials to provide their own analysis of this crossover point. We doubt though that refinement of the data will significantly change the general conclusion that the RUC system is needlessly complex and an unnecessary burden on large numbers of people, compared to the relatively manageable number of heavy vehicles for which it is suitable. For the 50,000 heavy vehicles over the tonnes crossover point, the current Bill provides a unique opportunity to allow an exemption to the weight definition to incentivise e-ruc, as this would be the perfect top-up mechanism (discussed below under e-ruc). OVERSEAS EXPERIENCE Australian diesel rebate system In Australia the Australian Tax Office website details how to calculate and claim fuel tax credits; there is an option for receiving an automatic refund every 3 months with GST. The threshold is $300p.a. limit below which no records need be kept: What the AA is proposing, with a generous deemed rate for the vast majority of off-road use, would have considerably lower administrative and compliance costs than the more complex Australian model.

6 Page 6 of 10 We note that Australian officials have investigated the New Zealand RUC regime several times, and each time assessed the $90m p.a. operating cost as far outweighing any benefit of its theoretical elegance. How common is an on-road diesel tax? Officials should be able to access how many countries use diesel tax from the IEA Online Database of Energy Prices and Taxes; the AA does not have access. However anecdotally we have not heard of any countries that do NOT tax on-road diesel; diesel taxes appear the norm in industrialised countries and New Zealand is the exception. In Australia for example the diesel tax is A$ per litre ultra-low sulphur diesel and A$ per litre for conventional diesel. To give a feel for countries that have diesel tax, Wikipedia lists as using diesel dye to distinguish on- and off-road use: European Union, USA, UK, Canada, Australia and Thailand. EQUITY OF COST RECOVERY There were several questions from the Committee that suggested that moving to a diesel tax would be skewing cost recovery; and that petrol tax was also skewed away from true cost recovery. For example, several submitters talked about RUC recovering the costs of road damage and referred to trucks damaging the road a lot more than cars. Ignoring the irony of the skewing effect of the $300 million p.a. under-recovery from diesel vehicles since 2008 (when petrol taxes were dedicated into the NLTF), it seemed to the AA that both the Committee and submitters considered that RUC reflected the true costs this is far from correct. The AA was extremely concerned that the Committee understand that RUC does not embody the true per kilometre costs indeed the final light RUC charges are very ad hoc and bear little or no relation to marginal use let alone marginal damage. There are issues with both how the Cost Allocation Model allocates costs, and then how these costs are translated into charges. In the Cost Allocation Model, a committee has: categories of expenditure (area wide pavement treatments, new road projects, signs and markings, vegetation clearance, public transport, administration) a small set of very broad factors: size (physical space taken up on the road); gross vehicle weight; axle configurations and distance. Joint and Fixed Costs For each cost (e.g. bridges, public transport, passing lanes) a committee of experts judges the weighting for each vehicle factor (per driver, space, weight, axles, distance...). For a road project to relieve urban congestion, a higher proportion of the cost would be allocated to the amount of space a vehicle takes up on the road; for bridges, a higher proportion of the cost would be allocated to vehicle weight and axle configurations. The process is far from exact and further, a large number of items are simply not allocatable to the limited number of factors. For example signs are for people who are going to a place for the first time, such as tourists, but this is not one of the factors considered and there is no mechanism to charge tourists separately. Some costs are joint: the use costs attributable to light vehicles and to heavy vehicles goes nowhere near recovering the total, and there are a wide range of equally fair allocations of the grey area in the middle (economics offers Ramsey pricing as the only guidance for recovering fixed costs.)

7 Page 7 of 10 Significant costs are also incurred irrespective of any sort of use, just to have a corridor available, and these cannot be allocated by use as they don t depend on use. Estimates of how much of the road corridor is fixed cost irrespective of use are again very wide, with some experts suggesting that up to 80% of maintenance costs would be incurred if no one travelled on the road just because of weathering. Again very different extreme outcomes could still be considered fair and efficient. Those determining how to allocate the costs have to sometimes make somewhat vexed decisions. The issue for RUC (versus diesel tax) is that for many fixed or joint costs, it boils down to judgement as to whether these should be allocated per vehicle or per kilometre. Many costs allocated per kilometre are not incurred per kilometre, they are only a vague proxy for exposure (for example the more kilometres you travel the more signs you see, but you do not use more resources by seeing more signs). To some extent, allocating per litre would be about as good. It is far from an exact science. In conclusion, the Cost Allocation Model does not provide hard and fast guidance that the exposure/distance costs should be recovered per kilometre or per litre. Vehicle dimension measure Another telling point is that the size measure (vehicle space taken up on the road) used by the Cost Allocation Model is the passenger car unit (PCU). All cars are defined as one car unit, irrespective of size. While this is reasonable for distinguishing rough overall amounts to recover from light vehicles versus heavy vehicles, it is very coarse for over half a million light RUC vehicles. The Cost Allocation Model emphasises the heavy end of the vehicle fleet because small differences there have high cost differences for individual operators. But this leads to large inequities at the car end of the spectrum. A small car takes up half the road space of a large SUV (a factor of two out) and a Smart car a third the size (a factor of three out). According to the model, the three cars shown below all take up the same amount of road space.

8 Page 8 of 10 The model is simply not geared to identify differences in the light fleet; this means light RUC comes out flat, pretty much the same for all light vehicles. 2 These flat charges do not reflect lack of difference in cost of use; they are because the model does not try to distinguish any cost differences in the light fleet. But although the model does not account for it, there are real differences. There are cost savings in having smaller sized vehicles in congested cities, for example. This is significant; it applies to billions of dollars spent on achieving Western Ring Route in Auckland over a decade. Not allowing for differences in the light fleet means artificially flat RUC, which creates the wrong incentives for huge numbers of daily decisions, misallocation of significant resources and a light vehicle fleet with too many old, large diesels. 2 1 and 2 tonne RUC are the same; 3 tonne RUC differs by only a dollar per 1000km.

9 Page 9 of 10 This is partly why there is strong public support for a tax system that means smaller vehicles pay less. Other factors, such as environmental, air pollution, safety benefits or reduced fuel dependence, are not included in the Cost Allocation Model (but are not reflected elsewhere either). Our concern is that the Cost Allocation Model is being treated somewhat as infallible (a deus ex machina ) rather than being looked at critically. Certainly there is nothing in the model itself that would prevent a per litre rather than a per kilometre allocation of costs for the light vehicle fleet. Converting Costs into Charges Another critical step is how costs are translated into charges. The Cost Allocation Model s output is to allocate the fair share of total costs to the light and heavy vehicle classes (and as already noted, fair share covers a wide range of plausible possibilities). The government recovers these costs from users three ways: motor vehicle registration fees (MVR), RUC and petrol excise (FED). So you would assume that the costs allocated to distance are covered by RUC and petrol tax, and the fixed costs are the registration fee; but they are not. The registration fee is much lower than the fixed costs, which means the RUC and petrol tax have to be set much higher than the distance-based costs. So we are in effect overly disincentivised by distance. If government were to raise the registration fee to cover the fixed costs, officials consider there would be negative reaction (the public find fixed costs more difficult to pay) and more people would not pay their registration fees. Hence much of the RUC and petrol tax FED should really be recovered by a fixed charge not a distance (use) related charge. To sum up, recovering per kilometre through the current RUC charges is no more morally right, accurate or correct than recovering per litre through petrol. Both are essentially an ad hoc way of recovering a fixed total sum, hence it is not skewing the cost recovery to move to a diesel tax. This credits the RUC system with a greater accuracy than it actually has. The AA concurs with Honda s submission that the wider public would be happier with a per litre recovery; that it would cost a lot less to collect, be less avoidable and remove a very obvious distortion between the diesel and petrol fleets. This is without enumerating the strong environmental advantages of a diesel tax to encourage fuel efficient driving and trip choices (which the Committee considered would be addressed through a carbon charge). TRANSITION TO E-RUC We note also the Committee s interest in transitional arrangements for e-ruc. The Committee asked for the AA s view on a more gradual transition and in particular an optional rather than mandatory transition for heavy vehicles. We reconfirm the AA s support for an evolutionary transition to e-ruc, and refer back to our submission to the Independent Review of the NZ Road User Charging System, where we suggested that an all or nothing e RUC system in one go may not be advisable: Principle determinants of IT project failure are size and volatility (especially policy changes). The larger and more volatile an IT development project the greater the probability that it will fail. There are tremendous potential advantages from e-ruc, including the ability to charge by location (specific road damage) and time of day (congestion), and to replace annual licence fees. As vehicle technology changes, e RUC will ultimately (and progressively) be required for the light vehicle fleet including hybrid, electric and hydrogen vehicles. We see a future,

10 Page 10 of 10 although a long way off yet, where all vehicles will be charged by e-ruc and so we support gradual changes towards this. We note that e-ruc, as implemented then, will look and operate quite differently to the current paper-based RUC system, and should not be used as an excuse to retain the cumbersome paper system rather than move to a diesel tax in the interim, which will save money for decades. Comments were made to the Committee to the effect that e-ruc technology is already low cost for the light vehicle fleet. The Ministry of Transport has advised that, while technology is low cost for the 90% accuracy needed to locate vehicles for mapping, it is still a very high cost for the 99% accuracy needed for charging money. The more vehicles using e-ruc technology, the more e-ruc costs will come down. It is already cost-effective for Toll to have e-ruc for large fleets, and for the heaviest of the heavy vehicle fleet; as costs come down it will be progressively more affordable for lighter heavy vehicles and eventually for the light fleet. The AA supports this transition being incentivised (and particularly, not disincentivised) in order to accelerate the adoption e RUC systems. The change to the weight definition in this Bill provides a unique opportunity to introduce a compelling incentive to accelerate e-ruc. The Committee could allow an exemption to the new weight definition for those companies that can provide the electronic data on actual weights carried. This provides a choice: pay for 100% loading under the new weight definition, or install a compliant (NZTA approved and audited) e RUC system. The clear starting point for e RUC is the electronic vehicle tracking systems companies currently use manage their fleets and payloads (as well as to minimise RUC), and which were eloquently described by the Toll submission. Rather than set up a separate system, the Government should take advantage of existing private sector systems and e-investment. The service delivery agency for e RUC could also be private sector service providers rather than State based. NZTA could just specify, supply constants to, and audit private sector solutions. CONCLUSION We hope the comments are helpful and thank the Committee for the opportunity to provide them. Kind regards Jayne Gale Principal Adviser, Motoring Policy New Zealand Automobile Association