Chapter 1. Introduction and key policy recommendations

This report analyses how tax revenue from road transport in the Republic of Slovenia might evolve as the use of fossil fuels in road transport declines. Reducing the consumption of fossil fuels is a welcome trend, for example from the climate or health perspective and in terms of reduced energy dependence, but may put stress on government budgets. In 2016, revenues collected from excise and carbon taxes on fossil fuels used in road transport represent roughly 14.6% of total tax revenue collected at the central government level in Slovenia.1 A decline of these revenues raises challenges for the central government’s budget.

The aim of this report is to provide an in-depth assessment of the taxation of road transport in Slovenia and to inform about the speed and depth of changes to tax revenue when the vehicle stock shifts towards technologies that rely increasingly less on fossil fuels. It studies different options for tax policy reform that may stabilise tax revenues in the long run.

Several transnational trends have the potential to erode fossil fuel tax bases in the transport sector. These are not restricted to the Slovenian economy. In particular, ongoing improvements in the fuel-efficiency of traditional car technologies allow driving a given distance using less fuel. In addition, alternative fuel vehicles, such as battery electric vehicles, plug-in hybrids or fuel cell electric vehicles, increasingly penetrate the car fleet, also reducing the need for fossil fuels. The appeal of alternative fuel vehicles is rising because of falling production costs, increasing driving ranges and lower charging times, as better-performing batteries are developed. In addition, consumer interest in the specific, and often superior, noise and acceleration characteristics of electric vehicles appears to be rising. Finally, political commitments to fight climate change and air pollution are a further impetus to reduce fossil fuel consumption in the transport sector.

Fossil fuels are not the only tax base in road transport. Governments typically collect tax revenues from three tax bases: energy use, vehicle stock and road use. For example, in Slovenia, purchasing fuel involves paying an excise duty and a carbon tax for each litre of gasoline or diesel. The users of motor vehicles in Slovenia are also subject to a one-off registration tax and an annual motor vehicle tax. When driving on Slovenian motorways, a car needs to carry a vignette, while truck drivers pay tolls per kilometre driven.

The three tax bases in road transport interact and the technological trend towards fuel-efficient and alternative fuel vehicles will affect each of the bases differently. The present analysis informs about the potential changes in the composition of the three tax bases over time under different technology scenarios and estimates the resulting tax revenue implications. It further analyses how tax reform may counteract potential revenue losses from reduced fossil fuel use.

The analysis relies on a simulation tool based on a vehicle turnover model that tracks the evolution of transport tax bases over time. In a first step, it evaluates a range of potential scenarios relating to the development of tax bases, i.e., energy use, vehicle stock and road use, in Slovenia between 2017 and 2050. In a second step, the analysis estimates tax revenues given the current tax system in Slovenia (baseline) and evaluates the development of revenues over time based on the scenarios and outcomes from step one. Finally, it simulates different proposals for tax reform and explores their revenue potential. Tax reform simulations focus on fuel taxes, vehicle taxes and the taxation of road use and account for estimated behavioural responses to changes in tax rates.2

The evolution of tax bases in road transport depends strongly on technology developments that, at present, remain uncertain. For example, the speed at which fuel-efficiency increases and alternative technologies will penetrate the vehicle fleet in the future remain unclear. Therefore, the analysis estimates future tax bases and revenues under specific technology scenarios. The scenarios are chosen based on a review of the literature estimating the penetration of alternative fuel vehicles. The main scenario used in the present analysis applies the International Energy Agency’s 2°C Scenario for Europe (IEA 2DS) to the Slovenian case. A definition of the IEA 2DS is provided in IEA (2017[1]).3 In line with IEA 2DS, it assumes that alternative fuel technologies account for 25% of passenger car purchases in 2030 and 62% in 2050 – compared to a 2% share in 2017.

Consequently, the analysis does not yield tax base or revenue predictions, but derives results from scenario analysis. Scenario analysis intends to provide a plausible narrative about potential future developments and appropriate policy responses, which is useful in the context of technology uncertainty. However, results from the scenario analysis have no predictive intent (see Box 5.1).

The assessment leads to the following conclusions and policy recommendations:

• The tax revenue loss from reduced fossil fuel used in private cars may be substantial in the coming decades. Under the assumption that alternative fuel technologies account for roughly 60% of new passenger car purchases in 2050 (following the IEA 2DS) and fuel-efficiency improves in line with European standards, total tax revenues from fuel used in passenger cars in Slovenia may drop by 56% compared to 2017.

• The picture for trucks is different. The drop in fossil fuel use is likely less important over the horizon considered and for the scenarios covered in the analysis, because of slower take-up of alternative technologies. Furthermore, Slovenia’s current toll system for trucks provides an effective means to raise revenue independently of fuel use.

A gradual reform of the tax system starting now may allow a smooth adaptation to the technological change in the vehicle fleet. Technological changes take time to percolate through the entire car fleet. Therefore, fuel tax revenues erode only gradually over time, which leaves some leeway to adapt tax policy. However, tax reform implementation also takes time and requires preparation and discussion with stakeholders. Early preparation and a gradual approach will reduce the risk of disruption and create room for developing and implementing the necessary accompanying measures.

Comprehensive transport tax reform to stabilise revenues includes finding the right mix of taxing distances driven, vehicles and fuel. Tax reform simulations show that the revenue potential in the sector is constrained by behavioural responses to tax increases, tax competition and existing regulations. Some of the main findings are as follows:

• Tax reform that increases fuel or carbon taxes and regularly adjusts nominal rates to inflation will effectively raise revenue in the short to medium run in Slovenia. In the longer run, once the low-carbon transformation is on its way, the revenue potential from fuel taxes is limited in the passenger car segment of the market. Setting unilaterally high fuel taxes may trigger fuel tourism and erode tax bases from international drivers, in particular as regards trucks. Higher European Union (EU) minimum rates on fuel excise could help reduce the pressure from fuel tourism.

• Revenues can be sustained in the long run by gradually increasing fuel or carbon taxes that cover the external costs closely related with fossil fuel use in vehicles and by phasing-in distance-based charges for cars to reflect external costs closely related with distances driven. In addition, the existing distance-based charges for trucks could be differentiated further to align better with external costs. Such a tax system would gradually shift revenues to an alternative and likely more stable tax base, road use, while further reducing distortions.

• A more efficient distance-based system for passenger cars would set as a base the amount of kilometres driven. This requires phasing out the current vignette system for cars and adopting a driving based system, as currently applies to trucks. Using the modern electronic toll infrastructure, which is in place on all motorways in Slovenia, will help contain costs of implementing distance-based charges for cars.

• The current distance-based charging systems for trucks could raise revenue and manage external costs more efficiently, in particular congestion as well as air and noise pollution, by differentiating rates along time and place to account for congested nodes in the network and population exposure to pollution.

• Currently, the revenue potential from distance-based charges is limited by regulation. For example, within the EU, current legislation allows rates to vary in line with some environmental objectives (air pollution and noise) and traffic management (congestion), setting maximum values for these external costs. A co-ordinated approach across countries to support a revision of the maximum values to reflect the full driving-related external costs could make the system more efficient.

• Finally, vehicle taxes may also be part of the tax reform package. An advantage of vehicle taxes is their lower administrative burden compared to distance-based charges. However, if they were to cover the shortfall in revenues from fuel excise over time, they would need to increase substantially over time and gradually cover alternative fuel vehicles too. Their limited ability in managing external costs from driving reduces their appeal from a transport and broader mobility perspective.

Designing efficient tax policy requires considerations beyond pure revenue raising concerns. The potential to raise revenue fairly and efficiently depends on design features that relate to revenue stability, external cost management, administrative costs as well as fairness and equity concerns. Table 1.1 shows that fuel, vehicle and distance-related taxes contribute differently to the aspects to long-run revenue stability, which deserves consideration in the discussion of transport tax reform.

Fiscal objectives can provide an impetus for tax policy reform when fuel efficiency improves and alternative fuel vehicles increasingly penetrate the fleet. In the longer run, decarbonisation of transport is necessary to contain the risks of climate change. Policy instruments, including tax policy and carbon pricing, play an important role in this process.

Finally, careful design and tailored communication is essential for the success of comprehensive tax reform in the road sector, given the involvement of numerous stakeholders. In particular, it will be necessary to communicate the benefits of the reform (e.g. in terms of the provision of public services through tax revenue, improved environmental outcomes) and to underline that the reform implies a shift in the composition of the tax burden, but not necessarily in the size of the burden.

However, to gain support for tax reform, it is necessary to develop a good understanding of the potential negative consequences (e.g. how changes in tax liability from reform are distributed along income and spatial dimensions) and to design appropriate policy responses. For example, accompanying policy measures may encourage the development of alternative travel modes (e.g., public transport) in the long run or support those households that are affected disproportionally by the reform in the short run, but cannot easily adapt to the reform due to budget constraints.

The report starts by describing the conceptual framework for the analysis (Chapter 2). Chapter 3 provides information on the current tax system in road transport in Slovenia and Chapter 4 on the data sources that were available for the analysis. Chapter 5 introduces the modelling tool and presents the estimated development of tax revenues over time in the baseline scenario. Chapter 6 simulates and analyses potential tax reforms that may stabilise revenues in the long run.