Reports:
Meeting external costs in the aviation industry
Annex B: Financial support to, and taxes on, aviation
B.1 Introduction
1 Financial support to economic sectors may increase their economic activities,
their competitiveness, their profit and the employment they generate. However, there is no such thing as a free lunch. The government finances
the support by raising general taxes, such as income tax. Where these taxes
are raised, they have the opposite effect: they decrease economic activity,
competitiveness, welfare and employment.
Economic theory suggests that the positive effects for the subsidised sector
and the negative effects for those producing the means for the subsidy
generally do not balance. Generally, society as a whole loses welfare. The
reason is that both subsidies and the taxes necessary to produce the means
distort markets. The use of resources becomes inefficient.
3 Economic inefficiency is one reason to rethink financial support. Another
reason is fairness. On the one hand, fairness between economic sectors.
One sector should not have an advantage over the other because of financial
support. On the other hand, fairness to society. Just as the 'polluter pays
principle' states that society should not have to bear the environmental costs
for which it is not responsible, it could be argued that society should not
have to bear the costs of financial support to economic production for which
it is not responsible.
B.2 Direct and indirect financial support
4 The government supports the aviation sector financially, if the public expenditure
is not fully paid for by the aviation sector. In that case costs exist,
which are borne by other parties (the taxpayer) than the aviation sector or
the passengers. There are two types of government expenditures to be distinguished[35]: direct and indirect.
B.2.1 Direct financial support
5 Direct financial support is defined as a government expenditure, which is
directly paid to the economic subject in question without any market-based
return-service of the recipient. It decreases the cost of producing a specific
good or service and thus supports the production sale or purchase of a good
or service.
B.2.1 Indirect financial support
Definition
6 Indirect financial support is considered to be all governmental interventions
and regulations which favour selected economic agents by reducing their
costs or by guaranteeing purchases of their products. For example, these
include tax subsidies, price reducing subsidies, purchase subsidies, regulatory
subsidies and guarantees.
7 In this report, we focus on two areas, where direct and indirect financial
support may exist: airline operation and airports (infrastructure provision).
Criteria for judging fair fiscal treatment
8 In discussions on this topic, there is a lot of confusion about what a 'fair'
level of taxation should be and thus to what extent aviation currently receives
indirect financial support.
9 The strictest, macro-economic, criterion is that fiscal treatment is fair if
similar taxes are levied on similar activities throughout the whole economy.
From this perspective, there is no reason to distinguish domestic air transport
from international air transport, or to tax air transport differently from
road or rail transport.
10 A less strict, sectoral, criterion is that fiscal treatment is fair as long as it
does not distort competition in sectors that compete with each other. In concrete
terms this would imply that exemptions from VAT etc. would not count
as indirect financial support as long as competing modes of transport, such
as high-speed rail transport, or long-distance coach transport, or maritime
transport in case of freight, face the same exemptions.
11 In this report we will follow the first, macro-economic, criterion. The reason
for this is that we take economic efficiency as a starting point. From an
economic efficiency point of view, there is no reason, for example, to tax international
air transport at a lower rate than domestic air transport.
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Financial support to projects outside the air transport sector
12 In many cases governments spend money on projects outside the air
transport sector but closely related to it, such as surface transport links from
and to the airport. We do not take into account these government expenditures:
economic instruments to optimise usage of these investments should
ideally apply to the surface transport link, not to aviation (see also Section
3.1).
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B.3 Financial support to, and taxation of, airlines
13 Financial support to airlines can be split in the following parts:
- fuel tax exemption;
- VAT exemption on international tickets;
- duty free sales on non-EU flights and on board aircraft (excise duty and VAT).
14 Furthermore, there could be direct state aid to airlines. However, in 1994 the EU developed rules aimed at preventing subsidies to commercial aviation.
15 On the other hand, the government levies the Air Passenger Duty (APD), a tax on passengers on flights departing from U.K. airports, at differential
domestic/international rates. We discuss these issues below.
B.3.1 Fuel tax exemption
16 Although other modes of transport have to pay tax on fuel, aviation does
not. It is not straightforward, however, to consider the fuel tax exemption as
an indirect financial support to airlines. This depends upon the purpose of
the existing fuel taxes.
17 If the purpose of the fuel tax is to raise revenues for the Exchequer to
contribute to UK public finances, then the fuel tax exemption for aviation
should be regarded as indirect financial support. Reasons for removing the
tax exemption would then be to ensure a fair fiscal treatment and an economic
level playing field between various modes of transportation. In that
case, removing the fuel tax exemption would come ,em>on top of internalising
external costs. However, if the government would consider removing the fuel
tax exemption for aviation, there would be a case to consider the internalisation
of external costs throughout the UK economy instead of singling out
aviation.
18 However, if the purpose of the fuel tax is to internalise fuel-related external
costs due to transport, then there is only a need to internalise the external
costs due to aviation as discussed in the previous chapters. In that case,
there is no need to remove the fuel tax exemption ,em>on top of internalising external
costs.
19 In different countries different approaches are followed. As an example,
we have calculated the approximate value of fuel tax exemption in the UK if
it is assumed that fuel taxation would be regarded as a means to raise revenues
for the Exchequer.
20 The amount of fuel tax exemption is the product of the number of litres
burnt by an airline and an assumed fuel tax rate per litre. Bunkering of aviation
fuel in the UK is in the order of 12 billion litres per year. Currently, the
average fuel tax paid by European road transport is about Euro 445 per
1,000 litres[36]. However, as the other competitor of aviation, rail transport,
generally pays lower fuel taxes, we choose to work with the current 245 Euros per 1,000 litres legislative minimum fuel tax rate for road diesel in the EU.
On the basis of these figures, the total UK aviation fuel tax exemption is
worth of the order of 3 billion Euros or £2 billion per annum.
B.3.2 VAT exemption on international tickets
21 In the United Kingdom, aviation does not have a competitive advantage
due to VAT exemption, as both international air travel and international rail,
sea and bus transport are exempt from paying VAT (KPMG 1997). From the
point of view of fair competition between the various transport modes there
is no reason to consider the VAT exemption as an indirect support. However,
from the point of view of fair competition between different economic
sectors, the VAT exemption should still be considered as an indirect support.
22 Revenue from tickets for UK airlines originates not only in the UK, but
also in all countries from which these airlines fly. This means that not only
the UK government supports these airlines but governments of countries
from which these airlines fly. Similarly the UK government does not only
support UK airlines but all airline companies that depart from British airports.
23 The amount of VAT exemption on international tickets is a product of the
revenues from international passenger transport subject to VAT and a certain
VAT rate.
24 To estimate the indirect support to British Airways due to VAT exemption,
we estimate that approximately one half on turnover from EU international
air transport is generated with a competitive advantage due to its VAT exemption.
Furthermore, we assume an average 7% VAT rate advantage (CE,
2001). Given the £ 7.1 billion of revenues from passenger transport for BA in
2002 (BA, 2001/2002), we arrive at £ 250 million in indirect support to BA
due to VAT exemption.
B.3.3 Duty free sales on bord aircraft
25 There is presently insufficient information to assess the financial support to UK airlines implicit in tax-free sales on board aircraft[37].
26 Duty-free sales for flights outside the EU at UK airports are treated in Section B.4 because they indirectly support airports rather than airlines.
B.3.4 Air Passenger Duty (APD)
27 In November 1 1994, the Air Passenger Duty (APD) was introduced, a
tax on flights departing from the U.K. The duty ranges from £5 to £40 per
passenger. The total annual revenues are in the order of £800 million.
Table 5: Air Passenger Duty (April 17 2002)
| Type | Destination | Duty |
|---|
| Lowest Class |
European |
£5 |
| Standard/Business/First Class |
European |
£10 |
| Lowest Class |
Other destinations |
£20 |
| Standard/Business/First Class |
Other destinations |
£40 |
28 In the past, Treasury Ministers have justified the introduction of APD as
compensating for the fact that aviation fuel is not subject to Excise duty and
VAT. This is in recognition of the challenges that would be faced in imposing
duty on aviation fuel as a result of the exemptions created by the Chicago
Convention[38]. For example, Treasury Minister Kenneth Clarke justified the
introduction of the APD as follows in his Budget Statement of 1993: "First, air
travel is under-taxed compared to other sectors of the economy. It benefits
not only from a zero rate of VAT; in addition, the fuel used in international air
travel, and nearly all domestic flights, is entirely free of tax. A number of countries have already addressed this anomaly. I propose to levy a small
duty on all air passengers from United Kingdom airports"[39]. In his Budget
Statement of 1996, he made the following remark: "Air travel has also been
undertaxed, because it has proved difficult--still proves difficult--to get international
agreement to tax its fuel. The rates of air passenger duty are to be
increased"[40]. Since the APD in its elaboration seems more related to ticket
price than fuel use, APD may primarily be considered a compensation for
the VAT exemption.
B.4 Financial support to airports
29 Financial support to airports breaks down into two categories: direct and
indirect support to airport infrastructure, and duty-free sales at airports at
flights to non-EU destinations. They are treated separately.
B.4.1 Direct and indirect support to airport infrastructure
30 Direct and indirect financial support to airport infrastructure comprises[41]:
- direct financial support, generally for investments in infrastructure;
- indirect support: corporate tax exemptions;
- indirect support: real estate tax exemptions;
- indirect support: ground costs exemptions.
31 The CE Delft study (CE 2002a) furthermore suggests on the basis of
Dutch and German case studies that direct financial support to finance airport
infrastructure is rather limited, certainly compared with the various forms
of indirect financial support dealt with in the rest of this chapter. There is no
evidence, and we currently have therefore no reason to assume, that this
situation is very different in the UK. As to indirect support, it may be noted
that Schiphol Airport was until recently exempted from corporate taxation as
a provider of public infrastructure. Following investigation by the European
Commission, the Dutch Government was obliged to tax Schiphol's profits.
32 There is insufficient specific information available to make further precise
judgements about the relevance of these kinds of support.
B.4.2 Duty free sales at airports for non-Eu flights
33 Duty free sales at airports (excise duty and VAT) still exist for flights with
destinations outside the EU. IPPR (2003) estimates that duty-free sales
amount to an average of some £ 15 per passenger or £ 400 million annually.
B.5 Conclusion and recommendation
34 The issue of taxation and financial support to aviation is strongly linked to
the issue of external costs, in particular in the case of the fuel tax exemption
and the Air Passenger Duty. Just as in the case of external costs, financial
support to aviation also may imply costs borne by other parties (the taxpayer)
than the aviation sector or airline passengers.
35 In the context of this study, it was not possible to investigate the issue of
financial support in sufficient detail to arrive at specific recommendations
with respect to the various types of subsidies. Therefore, further investigations
on these issues are recommended.
Notes:
35: To evaluate subsidies given to the aviation sector, a broad definition of general subsidies as
well as direct and indirect subsidies is used, which analyses all public interventions aimed at
influencing economic structures. This means that all direct and indirect measures related to
the public budgets at all political levels, e.g. federal, provincial and municipal level, which
lead either to an increase of expenditures or to a decrease of revenues of public budget, are
defined as subsidies. This also means that investments for government owned infrastructure
are included. Furthermore, non-budget measures such as regulatory interventions
should also analysed.
36: Based on a sales weighted average fuel tax level in January 2001 across the EU, calculated
with the database created for the CE study 'Fuel prices and excise duty policies in European
road transport 1980-1999 (CE, Delft, 2000).
37: In the literature, data can be found for KLM in a 2002 study on external costs of aviation
(CE 2002a). Tax losses were calculated as some 64 million Euros, or 1.5% of KLM's passenger
transport turnover.
38: See also Draft Response to CfIT by BAA, 14 February 2003.
39: Rt Hon Kenneth Clarke, Budget Statement, 30 November 1993, col 934.
http://www.parliament.the-stationery-office.co.uk/pa/cm199394/cmhansrd/1993-11-30/Debate-2.html.
40: Rt Hon Kenneth Clarke, Budget Statement, 26 November 1996, col 166.
http://www.parliament.the-stationery-office.co.uk/pa/cm199697/cmhansrd/vo961126/debtext/61126-09.htm.
41: CE (2002).
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