15 August 2022

Labour’s energy plan may be smart politics, but it has some serious economic flaws


Keir Starmer has now set out Labour’s plan to address what it calls the ‘Tory cost of living crisis’. The plan is not too bad, but it’s not great either.

The main plank is a freeze on energy bills over the winter, keeping the annual cap on the average default tariff at £1,971 until the end of March. Cornwall Insight has forecast that this cap would rise otherwise to £3,582 in October and £4,266 in January (when Ofgem moves to quarterly updates). A six-month freeze could therefore save the average family around £1,000 over this period.

Labour’s plan would be funded in three ways: an expansion of the ‘windfall tax’ on energy companies, cancellation of the planned £400 discount on energy bills (which would no longer be required), and assumed savings on the government’s debt interest bill as a result of lower inflation.

On the plus side, this is a relatively simple proposal which would keep household bills down in a way that is easy to understand, and which should leave no-one behind. It would therefore send a powerful message to consumers (and voters) that the Government has ‘got your back’.

It is also good that Labour is steering clear of Gordon Brown’s proposal to nationalise energy suppliers. This would be both expensive and ineffective, since even a state-owned company would still have to buy energy at global prices.

But there are problems with Labour’s plan, too. First, is it actually necessary to freeze bills at the current level? The Conservatives have already announced a large amount of support on the assumption that bills will rise further this autumn. This support may not now be enough, but the shortfall is probably only a third to a half of the price of Labour’s plan (costed at £29bn).

What’s more, not everyone needs additional support from the government to cover all of the increase in their bills. At least part of the rise could be met from higher nominal incomes, or pandemic savings.

Second, is it even desirable to freeze bills? This would obviously be popular, but global energy prices have jumped because supply and demand are out of balance. Market signals need to be allowed to work properly, increasing the incentives for producers to raise output and for consumers to economise (though some may say that bills are already high enough!).

A better solution would be to allow prices to rise and to focus instead on topping up incomes through a mix of tax cuts and increases in benefits (which is the current government’s policy). In contrast, Labour’s plan to freeze prices would mean that more than half of the help would go to higher-income households. (Poorer families spend proportionately more of their budgets on domestic energy bills, but less in absolute terms.)

Third, this would only be a short-term fix. That may still be enough, of course, if global prices fall early next year. But Cornwall Insight is predicting that default tariffs will jump again in April 2023, to a new high of £4,427. This forecast is speculative – a lot could happen to wholesale prices between now and then.  Many people will also benefit next April from a substantial updating of state benefits. But Labour would presumably need to extend the freeze to avoid another ‘cliff edge’ in the spring.

Precisely how this proposal is funded is less important. If it is indeed a good idea to freeze energy bills (or top up incomes further), then the money could be found in many ways. This might include a increase in long-term government borrowing at historically low interest rates, or some form of state-guaranteed ‘deficit fund’ with commercial banks covering any shortfall between costs and prices (an idea that has been kicking around for a while but now seems to be gaining traction).

Labour’s proposals to expand the windfall tax (raising £8bn of the £29bn cost of its plan) are more problematic. The Liberal Democrats have already suggested an increase in the existing tax from 25% to 30%, and backdating it to last October. Since this is applied on top of the usual headline rate of 40% for North Sea oil and gas producers, this would mean that their profits would be taxed at a punitive 70%.

Labour’s alternative is not much better. Labour would keep the windfall tax at the current level, but also backdate it, and close the ‘loophole’ which allows firms to reduce their liability by increasing investment. North Sea producers might reasonably wonder too whether the windfall tax would be expanded further in the spring, when Labour would presumably want to extend the freeze.

The proposals from both the Lib Dems and Labour would therefore send a terrible signal to any business looking to invest in the UK. Economists are split on the merits of ‘windfall taxes’. A truly ‘one-off’ levy could be a relatively efficient way to raise more revenue, because it would effectively be a tax on past investment rather than on the profits from decisions yet to be taken.

But most would agree that ad hoc and haphazard taxes, especially when applied retrospectively, would increase business uncertainty and lower the expected returns from future investment too. This is exactly the opposite of what is needed now.

However, the biggest component on the funding side is actually the saving of £14bn from scrapping the energy price discount. Some £400 of the reduction in bills that Labour is promising is therefore simply a different way of providing the same support as offered by the Conservatives.

The other element is an assumed saving of £7bn on debt interest payments as a result of lower inflation. Labour’s press release is a little sloppy here (it refers only to the ‘coupon payments’ on inflation index-linked gilts, when it is the RPI uplift on the principal value that realty matters). But it is reasonable to count lower headline inflation as a potential benefit.

In short, Labour’s plan is politically smart and bound to score highly in the opinion polls. For a party in opposition, this may be all that matters. As a serious piece of economic policy, though, it has some major flaws.

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

Julian Jessop is an independent economist.

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