THE IMPACT OF VAT INTRODUCTION ON UK RESIDENTIAL ENERGY DEMAND - AN INVESTIGATION USING THE COINTEGRATION APPROACH

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 f orced the government to limit VAT on residential fuel to 8%. Using a c ointegration approach, to take account of the non-stationarity fuel co nsumption time series, this paper estimates real energy and fuel speci fic price and income elasticities for the period 1974:1-1994:1. They s uggest that natural gas has a positive real energy price elasticity in dicating that, as real price of energy rises, households scrap ineffic ient heaters and invest in more efficient ones, principally natural ga s. 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 r esult of the additional VAT, although at the expense of other less eff icient fuels. Overall residential energy consumption, however is unlik ely to fall significantly from the tax, suggesting that it is an inapp ropriate way of achieving environmental objectives.