Spring of Bills: the chancellor’s options to tackle the cost of living

The Russian invasion of Ukraine is wreaking terrible destruction on both the country and its people. The economic fallout here in the UK pales in comparison, but its impact on living standards is very real nonetheless. The increase in energy costs to hit household energy bills in April now appears to be not a brief spike in energy costs, as we might have hoped at the turn of the year, but only the first of two major price rises this year. Indeed, higher gas prices than those we have been used to seem to be on the cards for the foreseeable future. This, combined with disruption to Ukrainian agriculture, is raising the cost of other goods, particularly food. What should the government do about the higher cost of living for households at the Spring Statement next week?

Combining the latest inflation forecasts from Oxford Economics and energy price projections from Cornwall Insights, we estimate that overall inflation is set to be 8.2% in 2022–23. But since poorer households spend a greater share of their budget on domestic fuel, they will be hardest hit, facing inflation rates of around 10%.

As a result, households are now set to see a 5% reduction in their spending power in the next financial year, with the biggest losses felt by the poorest. This compares to our estimate back in January of just under 3% – a very sharp deterioration in the outlook.

The support measures announced in February – a £150 reduction in council tax bills for most properties and loans to smooth over what was initially seen as a temporary increase in fuel bills – will do little to ease these pressures. Moreover, there are some groups of households that will see particularly large reductions in their living standards. Looking at households with less than median (middle) income, workless families with children look set for a reduction in their spending power of more than £1,600 per year.

In the longer run, the only way around the problem of high prices for natural gas is to shift towards lower-cost renewables and nuclear energy, as we outlined last week. This will be necessary to reach our net zero target in any case, but high prices and reliance on what has become a hostile foreign power for our energy needs adds urgency to the situation. There is, however, relatively little that can be done to switch away from gas in time for next winter.

The looming squeeze on living standards therefore demands further fiscal measures to support households. With high gas prices now looking more permanent, the rationale for loans to suppliers or households to cover a ‘temporary’ rise in energy costs looks weaker. But should the Ukraine crisis abate, at least some of the high prices to be expected next year will be transitory. This context suggests a strong case for two measures:

• First, benefits should be increased in line with expected actual inflation in April (around 8%) rather than last September’s CPI figure of 3.1%. The average Universal Credit payment would increase by £425 per year. Right now it is hard to justify the usual 7-month lag in inflation data, which would mean the real value of benefits would be 5% lower this April compared to last April because of accelerating inflation in the interim.

• Second, ‘policy costs’ – which fund a combination of environmental and social levies, both current and past programmes – should be removed from electricity bills in the short-run. This could reduce energy bills by around £150 a year on average, and would send an important signal that the carbon price is the same for electricity and gas. This in turn would encourage households to make the switch from gas boilers to heat pumps, a move that the Ukraine crisis has made all the more urgent.  While borrowing should take the strain of this measure while the confrontation with Russia rages, in the medium term the government should flesh out its plans to phase in a carbon tax or emissions trading to replace the lost revenue, as gas prices hopefully recede.

The [blue] line in Fig. 3 shows how these policies would do a lot to cushion the cost-of-living shock ahead. They would ease the pressure across the board – households’ spending power would reduce by an average of £1,250 next year rather than £2,000 – and provide greater protection for the most vulnerable: the lowest-income 30% would see the fall limited to about 1½%.

But most households would still face a significant squeeze. To some extent this is inevitable: the cost of higher energy will ultimately have to be borne by households in some form either through higher energy bills or higher taxes. But should more be done to help those on the lowest incomes?

To eliminate the living standards shock to the poorest households completely, the Chancellor would need to increase minimum-income benefits by a further £10 per week, which would see the lowest-income third of households just about breaking even. This would not be cheap: benefit expenditure would increase by £4.4 billion a year. But this is what is required to protect the most vulnerable: a group who have already lost out from the expiry of the temporary increase in benefits last October.

What appeared to be a bad outlook for living standards just two months ago is now set to be a severe shock. Whether the Chancellor chooses to act in next week’s Spring Statement or not, at some point the government will have to act.