22 March 2022

Back to the 1970s? Energy, tax and the cost of living crisis

By

As Rishi Sunak prepares his Spring Statement tomorrow, it’s already clear that household budgets are going to soon come under increasing pressure from multiple directions.

Energy is going to remain the biggest concern for most people, taking a big and very visible slice out of their discretionary incomes. Unfortunately, when it comes to volatile international energy markets, there’s not that much the Government can do in the immediate future, beyond properly targeted support for the people who are going to struggle the most.

Leaving aside the importance of supply side reforms we need to make in the future, right now the Chancellor’s focus should be on temporary interventions to shield the poorest from the coming crunch.

Targeted Short-term support

The Government has rejected the suggestion that it should cancel – or at least push back – the damaging increase to National Insurance (NI). We at the Centre for Policy Studies have therefore suggested an alternative plan to blunt the pain.

If the Treasury will not abandon the tax hike, it should at least compensate for its impact by increasing the threshold for paying employee NI. Raising the threshold to £11,284, instead of the planned £9,880, would completely protect low and median earners (those on £27,500 and below), limiting the impact of the tax to the most affluent deciles. The cost would be roughly £4.7bn of the £12bn the Government plans on raising from the tax hike.

This is far from a perfect solution – businesses and high earners would still pay more, damaging growth, and separate measures would be needed to address the impact of higher energy bills on the most vulnerable. But at least it would prevent the Government adding insult to injury.

The Government has already announced measures totalling £9.1bn to allow millions of households to reduce or defer some of the pain specifically from the energy price cap increasing in April. About 80% of households (those in council tax bands A-D) will receive a £150 council tax rebate from April. From October, around 28 million households will also automatically have £200 deferred from their electric bills. This will then be paid back in £40 instalments over five years (effectively functioning like an interest free loan).

However, much of this relief is poorly targeted. Council tax rebates – using bands still pegged to 1991 assessments – will not help all of the those who are least able to cope with the energy squeeze, while perversely, many relatively affluent people who can weather higher energy market prices will be protected. This is another of those policy areas where our Director’s argument that the most important part of modern government, and its most important limitation, is database management, comes into play.

If the Government decides to cushion the blow further this April, or when the energy price cap rises again in October, it needs to consider more targeted interventions. Crucially, these interventions should be ones that don’t risk adding permanently to Government spending – just look at how hard it was to reverse the temporary uplift to Universal Credit (UC) introduced during the pandemic.

A better model would be either a one-off payment to those already in receipt of any means-tested benefit, or the sort of clearly delineated ‘Coronavirus Hardship Payment’ recommended by the Centre for Policy Studies during the pandemic. Such approaches would avoid the distortions caused by using existing schemes, would be wide enough to help millions of people, but would not be throwing cash at those who can get through the next few years of high energy prices without it.

Moreover, to help ease the pressure on the poorest households, we should adjust benefit uprating periods to better mirror the accelerating rise in the cost of living. As things stand, inflation-linked benefits and tax credits will rise by 3.1% from April 2022, in line with the CPI rate of inflation in September 2021. The lag between uprating and price increases is going to leave millions worse off. We therefore suggest that the uprating should be brought forward, with lower increases once inflation has subsided in order to balance the books. As per Centre for Policy Studies recommendations, moving to a system of weekly benefit payments and cutting the waiting time for UC would also help to ease the pressures on those who are going to struggle the most.

To further reduce the pressure on the lowest earners, certain green levies should also be moved on to general taxation, saving another £155 on the average bill. Although part of the rationale of green levies on energy usage is to reduce overall energy consumption, this is a much less relevant consideration given current (and likely persistent) gas and electricity prices. This also makes the levies less distorting economically.

Ministers should also delay, or even write off, the charge of £70 per household being levied to cover the costs of energy companies that collapsed in Q4 2021 (although in the longer term, once energy prices are sustainably moving downwards again, the market-distorting energy price cap needs to be abolished).

In the short term, we should move the energy price cap calculations from a biannual to a quarterly basis, in order to avoid future shocks and allow households to plan better.

And shocks are certainly in store for some, judging by recent polling. According to a survey conducted by Ipsos-Mori on behalf of the Bank of England, the person on the street is expecting inflation of 4.3% this year – well below what most economists expect. A lot of ordinary people are going to be in for a nasty surprise in April, when reality starts to bite. Tomorrow, the Chancellor should help them prepare.

Click here to subscribe to our daily briefing – the best pieces from CapX and across the web.

CapX depends on the generosity of its readers. If you value what we do, please consider making a donation.

Donations via the website are temporarily unavailable

Karl Williams is a Senior Researcher at the Centre for Policy Studies.