A new study by the Institute for Fiscal Studies (IFS) suggests that green cars may severely reduce the amount of future tax revenue collected from fuel duty and VED. Even though traffic is predicted to grow over the coming decades, the IFS report notes that the £38 billion annual revenue from VED and fuel duty has already began to diminish as more motorists choose lower emission petrol, diesel and plug-in electric cars.

The study, commissioned by the RAC Foundation, suggests that tax revenues from this trend will fall by £13 billion a year by 2029, as the shift to lower emission cars continues. Financial incentives for lower CO2 cars and rising fuel prices are major factors driving this shift. The report has suggested that a "radical overhaul" of the road tax system will be needed to prevent such a significant loss to the Treasury, otherwise a 50% rise in fuel duty would be required to make up the difference.

One way suggested by the IFS would be to introduce a national road charging system based on 'pay-as-you-drive'. This would introduce the option to charge motorists based on when and where they use their vehicles, as well as their individual mileage. Charging higher per mile tariffs in congested areas at peak times would help to tackle urban air pollution, something that cannot be achieved through simply raising the duty at the pumps or the cost of annual VED tax.

Around 65,000 cars were sold last year with exemption from VED road tax due to their CO2 emissions falling below the 100 gCO2/km threshold mark. By charging motorists by mileage rather than vehicle emissions, a long term tax system could be introduced that would guarantee revenue whilst still encouraging lower emissions from private transport by incentivising reduced private mileage.

Professor Stephen Glaister, director of the RAC Foundation, said: "As drivers endure record prices at the pumps they might be surprised to learn that future governments face a 'drought' in motoring tax income. The irony is that while ministers encourage us to buy greener, leaner cars, they are being forced to look at ways of clawing back the money motorists think they will be saving. This isn't scaremongering. The Treasury has already announced a review of VED bands to ensure drivers make a 'fair contribution' to the public finances even as cars become more fuel efficient.

Paul Johnson, the director of the Institute for Fiscal Studies, said: "The current system of motoring taxation suffers from two significant problems. First, petrol taxation does not reflect the fact that the costs I impose on others vary dramatically according to when and where I drive. So many drivers, in rural areas for example, are effectivey over-taxed. But some, in congested urban areas, pay a lot less in tax than they would if they were paying for the costs they impose on other road users.

"Second, as cars become more fuel efficient the revenue from petrol tax will fall – eventually to close to nothing if we are to meet out climate change targets. A national system of charging related to mileage and congestion, largely replacing the current system of fuel taxation, would help solve both those problems."

The RAC Foundation