3. The economy, costs and benefits
Introduction and key messages
In this chapter we lay out our approach for considering the economic, fiscal and wider social implications of the transition to Net Zero. This is in line with the Climate Change Act (Chapter 2, Section 2.1).
Our key messages are:
- Our analysis will calculate the whole-economy costs and cost savings over the period 2025 to 2050. We will consider both capital expenditure and operating expenditure of measures to reduce emissions, compared to our baseline.
- We will seek to quantify, where possible, the co-impacts (non-monetary costs and savings) associated with the transition.
- We will make a high-level assessment of the wider macro-economic dynamics of the transition and identify key potential risks and opportunities for the UK economy and to competitiveness in emissions-intensive and trade-exposed sectors.
- The distribution of costs and benefits during the transition will be shaped by policy. We will assume illustrative policy packages for delivering the transition, to assess potential costs and savings across different households and impacts on the Exchequer.
- We will consider potential financial and non-financial impacts on those in fuel poverty and on other groups, including those with protected characteristics (such as sex, age and race).
- We will consider how costs and prices look from the perspective of different actors, including households and businesses.
The rest of this chapter is laid out in two sections:
3.1 Economy and competitiveness
3.2 Distribution of costs, benefits and expenditure
3.1 Economy and competitiveness
The Climate Change Act (the Act) requires consideration of “economic circumstances, and in particular the likely impact of the decision [on the level of the carbon budget] on the economy and the competitiveness of particular sectors of the economy”. Below, we set out our plans for how to consider these questions.
3.1.1 Whole-economy costs and costs savings
The difference in costs between the decarbonisation pathways and the baseline, will be calculated for the economy as a whole (see Chapter 2, Section 2.4 on baselines). We will assess both the additional capital expenditure required for low-carbon technology compared to its high-carbon alternative, and the difference in operating expenditure between the two technologies or practices. Our analysis will consider whole-economy (‘social’) costs in line with the Green Book. This doesn’t include transfers of money from one actor within the economy to another, but just considers what costs will be to the economy as a whole.
The high-carbon technologies and associated costs we assume will be those that are in the baseline. The baseline does not capture the costs of the impacts of climate change due to inaction, as the impacts of climate change on the UK are driven by global, not just UK, emissions.
The methodology will be largely based on the methodology adopted for the advice on the Sixth Carbon Budget, with some minor adjustments.
- As in the Sixth Carbon Budget advice, we will calculate both the in-year change in costs (i.e. what additional capital expenditure is required in a given year) as well as the additional expenditure on a new low-carbon technology spread over its lifetime.
- As in the Sixth Carbon Budget advice, we will calculate the abatement cost (i.e. cost per tonne of abatement) of each abatement measure to identify its cost-effectiveness and compare this to other measures, as well as to the Government’s carbon values (see Chapter 2, Section 2.2 on pathways).
- Where possible we will assess costs in line with the Green Book, including the application of a social discount rate.
- We will adopt a wider range of approaches to testing our cost assumptions, to make them as robust as possible. We will revisit what expenditure falls within scope, including expenditure relating to efficiency upgrades and any costs associated with a reduction in high-carbon goods and services.
The analysis will enable us to determine the set of measures on the path to Net Zero that carry the overall least cost to the economy. It will also help us assess the costs and savings associated with accelerated scrappage. As noted in Chapter 2, minimising costs will be considered alongside a range of other criteria, particularly feasibility. The analysis will also enable us to assess at an economy-wide level what the overall costs to the economy will be, including the additional capital investment needs, and how these will change over time, and the difference in additional cost between our two pathways. We plan to include similar aggregations to those in the Sixth Carbon Budget to summarise this analysis.
We will also estimate the co-impacts (non-monetary benefits and costs) that result from taking up low-carbon measures in areas such as buildings, surface transport, and diet change, including on health. We will review the state of the evidence on other co-impacts that might not be quantifiable.
3.1.3 Wider macroeconomic impacts
Beyond our consideration of whole-economy costs, we will set out a high-level analysis of the main macroeconomic dynamics of the transition. As the trajectory of the economy will be dependent on a huge range of factors, of which efforts to reduce greenhouse gas emissions is just one, we intend to describe the high-level nature and scale, as well as key drivers, of macroeconomic impacts rather than quantitatively modelling expected impacts on employment or gross domestic product (GDP).
For sectors that are emissions-intensive and exposed to international competition, we will consider the potential impacts of competitiveness on our pathways, noting where this is particularly contingent on international progress to decarbonise. We will seek to identify, at a high level, any sectors that will be needed to deliver Net Zero where there may be opportunities to develop or expand domestic industries.
3.2 Distribution of costs, benefits and expenditure
While economy-wide or ‘social’ costs discussed in Section 3.1 are relevant for assessing what is optimal for society as a whole, we also need to consider where these costs could fall (e.g. households, the Exchequer) which is affected by policy.
The Act requires consideration of “fiscal circumstances, and in particular the likely impact of the decision on taxation, public spending and public borrowing” and “social circumstances, and in particular the likely impact of the decision on fuel poverty”.
The Public Sector Equality Duty (PSED) requires those exercising ‘public functions’ to pay due regard to the need to “eliminate unlawful discrimination, harassment and victimisation and other conduct prohibited by the Act; advance equality of opportunity between people who share a protected characteristic and those who do not; and foster good relations between people who share a protected characteristic and those who do not.”
The following sections set out how we plan to fulfil these functions in our Seventh Carbon Budget analysis.
3.2.1 Fiscal circumstances
We will seek to model how the Exchequer will be affected by our pathways. We will consider changes in tax receipts from specific policies – both explicit and implicit carbon taxes – that might be affected by the change in goods and services, as a result of our pathways. However, we do not plan to consider the economy-wide effect of growth and investment resulting from our pathways on tax receipts. We will also consider how public finances would be affected by public expenditure implied by the policy packages mentioned below.
It is for the Government to determine how the costs of the transition are met and the benefits allocated, including what is met by public expenditure or leveraging private spending. However, we are planning a high-level assessment of which abatement measures are most likely to require public or private expenditure. This will indicate the range of possible splits of additional expenditure between the Government, businesses and households.
3.2.2 Distribution of costs, benefits and expenditure
We will assess what costs and cost savings different households could experience under low-carbon technology roll-out and shifts away from high-carbon goods and services in our pathways. This will be based on a range of household archetypes, grouped by characteristics such as income, rural/urban location, vehicle ownership and building type. The impact on household bills of technology roll-out and shifts away from high-carbon goods and services is also affected by policy decisions, such as which costs are passed on through energy bills, general taxation etc. We will therefore postulate several policy packages that are compatible with our pathway and test how policy can redistribute the costs and cost savings across different households. This will consider the impact on low-income households with poor energy efficiency, which we will use as a proxy for those in fuel poverty. Where it is possible to do so, we will consider how the distribution of benefits and costs (discussed in Section 3.1) vary between actors and are dependent on policy.
3.2.3 Impacts on different social groups
We will consider how our pathways will affect and involve different social groups. This will include identifying which aspects of our pathways are most likely to affect groups with protected characteristics or particular communities.
3.2.4 Actors’ incentives
We will consider the respective roles of government, business, financial institutions and households, among others, in delivering our pathways. We plan to identify the key actions that households and businesses would need to take to be in line with our pathways.
We will consider incentives facing households, businesses and investors to determine what prices and other factors would need to be in place for the technology roll-out in our pathways to take place. This is likely to be through case studies, and so will not be comprehensive.