4 January 2022

A token VAT cut would do little to stave off Britain’s energy crisis


Energy bills are set to soar in the coming months, increasing the cost of living for millions of households. According to both Labour and a number of Tory backbenchers, the way to head those price rises off is to remove VAT from energy bills.

Although it’s certainly welcome to see both main parties talk about cutting taxes, removing VAT from energy bills is lazy economic thinking which will achieve very little and make practically no difference to the poorest people in the country.

Our VAT system is already complex and convoluted with different rates and exemptions, many of which make very little sense. Creating yet another exemption would undoubtedly be popular, but it would simply add even greater complexity to the tax code and reduce government revenue into the bargain.

Nor would the practical effect of this cut be particularly pronounced anyway. VAT on energy bills is only 5% as it is, so taking it away would produce a very modest saving at best.

None of that is to say we should stand idly by, however. We need some sensible and effective solutions in both the short and long term. So, what should the Government do?

In the short term, ministers should look at redistributing some of the revenue raised from existing taxes on energy. Labour is right to point out that the Treasury is set to see a windfall as bills go up, money which could be transferred to those in need to help with their bills. They could also consider increasing Universal Credit payments, though that looks rather unlikely given that Rishi Sunak stuck to his guns on removing the £20 Covid uplift last year.

In the long term, we need to think about our energy security by increasing supply in a way which protects consumers and the planet while also ensuring we are not reliant on increasingly hostile states such as Russia. That means one thing: more nuclear power. For all the scary-sounding rhetoric about ‘nuclear waste’ and the abiding shadow of Chernobyl, nuclear power is one of the safest and cleanest sources of energy

There is an old proverb which goes ‘The best time to plant a tree was 20 years ago. The second best time is now’. So it is with nuclear power plants. They take several years to build so we better get a move on so that we can enjoy the benefits as soon as possible. This will be a huge task, but it will bring energy security to our country with the added benefit of helping to level up the UK by creating thousands of high quality and well paid jobs in every region. We certainly should not follow the bizarre example of Germany, which is currently in the process of closing down its remaining nuclear power stations. 

We also need to rethink green taxes. Rather than the plethora of taxes and regulations designed to reduce carbon emissions, a single tax on carbon should be introduced. There is a great deal of evidence to suggest that carbon taxes work, and they enjoy support from some of the world’s leading economists. Not only would a carbon tax be effective, it would also be simpler thereby making it easier for businesses to comply with it and so will bring down costs.

Of course, emissions in the UK are tiny compared to countries such as China and so a carbon tax would make very little difference to global emissions while also making us less competitive than other countries. This is a fair criticism, and is why any carbon tax should be border adjusted. ‘Border adjustments’ place a carbon price on imports that originate from countries without a carbon tax. Border adjustment would ensure that energy intensive industries in carbon-taxing nations are not unduly punished, and incentivise other countries to introduce a carbon tax of their own.

Any revenue raised by the border-adjusted carbon tax could then be redistributed to poorer households in the form of dividends. This would ensure that not only would those on the lowest incomes are not left in financial hardship by our push to Net Zero, they could potentially actually be better off.

So, there are plenty of things we can and should be doing to get to grips with both the cost and availabiliy of energy – a tokenistic VAT cut is not one of them.

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Ben Ramanauskas is a Research Economist at Oxford University and a former adviser to a government minister.

Columns are the author's own opinion and do not necessarily reflect the views of CapX.