The impact of VAT introduction on UK residential energy demand: An investigation using the cointegration approach

Abstract

Over a two-year period, which started in April 1994, the real price of energy to UK households was expected to rise by 17.5% as a result of value-added tax (VAT) introduction. The regressive nature of the tax forced the government to limit VAT on residential fuel to 8%. Using a cointegration approach, to take account of the non-stationarity fuel consumption time series, this paper estimates real energy and fuel specific price and income elasticities for the period 1974:1–1994:1. They suggest that natural gas has a positive real energy price elasticity indicating that, as real price of energy rises, households scrap inefficient heaters and invest in more efficient ones, principally natural gas. These estimates enable projections to be made of the impact of the introduction of VAT and imply a rise in natural gas consumption as a result of the additional VAT, although at the expense of other less efficient fuels. Overall residential energy consumption, however, is unlikely to fall significantly from the tax, suggesting that it is an inappropriate way of achieving environmental objectives.