Government’s price freeze still leaves poor households facing a painful shock next year

UK Policy Prosperity

Government’s price freeze still leaves poor households facing a painful shock next year

Commentary
Posted on: 8th September 2022
By Multiple Authors
Ian Mulheirn
Executive Director for UK Policy and Chief Economist
Daniel Newport
Head of Net Zero - UK Policy
James Browne
Head of Work, Income and Inequality Analysis

At a likely cost of some £70bn next year for households, the government’s plan to freeze energy bills from October will insulate them from most of the coming energy price shock in the short term.

Freezing the typical bill at £2,500, alongside the £400 flat rate rebate announced by Rishi Sunak in May, the package will mean households are no worse off from energy bills this winter compared to now. But this support will fall away in April, and although benefits will increase by 10% in line with the current inflation rate, this will largely replace the temporary increases in benefits seen this year. The rates of cash benefits and state pensions will not reflect the increase in energy prices from £2,000 to £2,500 until April 2024.

As a result, households will still be worse off in 2023–24 than they are currently, even taking into account today’s announcements and forecast earnings growth. The poorest 10% of households will be 3.6% worse off on average than they are today, and others with below-average incomes about 1.5% or £25 a month worse off. On top of the increases in bills we’ve seen since last year, this will be a painful shock and it’s unclear whether the support provided to the poorest will be enough.

Figure 1: Households still set to be worse off next year

Note: Assumes price cap would have averaged £5,000 in 2023–24 in the absence of intervention. 

Source: TBI calculations using Oxford Economics inflation forecasts, Cornwall Insights energy price cap forecasts, 2019–20 Living Costs and Food Survey and UKMOD version 3.5 run on data from the 2019–20 Family Resources Survey. UKMOD is maintained, developed and managed by the Centre for Microsimulation and Policy Analysis at the Institute for Social and Economic Research (ISER), University of Essex. The results and their interpretation are the sole responsibility of TBI. 

Something that wasn’t announced today, but may be yet to come, is a cut to National Insurance Contributions promised by the Prime Minister during the Conservative leadership campaign. If the government does press ahead with that plan it will not change this picture significantly for the poorest, who will benefit by less than £1 a month on average from this measure.

A bill freeze cannot be the long-term solution

Freezing unit prices will dampen incentives on households to cut energy use as much as they must. In the short term that risks higher-prices or even blackouts this winter. But in the long-term it reduces the urgency, particularly for better-off households, to take action to make homes more energy efficient. This is essential if we are to reduce the exchequer’s fiscal exposure.

For that reason, it would be far better to switch to a rebate scheme along the lines proposed by TBI. Rebates would inevitably be less well-targeted to high energy users than a simple reduction in energy prices. But, as we showed in our report published yesterday, even making relatively simple adjustments to give more to larger families and those living in less fuel-efficient properties, it is possible to address any concerns that some households would be left with unavoidably high bills. Importantly, our proposal would give households strong incentives to act with the urgency we need.

Figure 2: Adjusting support by EPC band and family size reduces variation in bills almost as much as a lower price cap

Note: October price cap level, households with income below median only.

Source: TBI calculations using 2019 English Housing Survey.

Whether funded by a windfall tax or ‘splitting the market’, what matters is how hard a bargain the government wants to drive for consumers

With the enormous fiscal pressure the government’s package implies, the question of how to pay for it is rapidly coming into focus. In the short-term at least, the bulk of these costs will be met through government borrowing. But is it fair, or even sustainable, to use government borrowing to cover the huge windfall profits that are being made by UK producers?

Here the government’s line appears, at best, inconsistent. On the one hand it is windfall taxing UK oil and gas profits at a rate of 65%. On the other, it is maintaining that it would not be right to windfall tax the extraordinary profits being made by low carbon electricity generators.

But total UK-based windfall profits are expected to be in the region of £85 billion next year according to leaked Treasury analysis – around half of which could be related to clean electricity generators. The idea that leaving such unexpected profits on the table, and instead raising general taxation in future to pay for the freeze seems bad economics and worse politics.

There is room for debate as to how the Treasury could get its hands on a slice of these economic rents. Government has said it will tackle the problem through moving generators onto long-term, fixed-price “contracts for difference”. If the price of these contracts was low enough then such an approach could be equivalent to a windfall tax.

But it won’t be equivalent unless government is tough and forces a low price on generators that claws back a significant amount of the economic rents they are now receiving. Any voluntary or auction-based approach would likely result in generators simply offering to swap windfall profits today for windfall profits in future, leaving either billpayers or taxpayers to pick up the tab in the long term.

Whatever mechanism is ultimately preferred, billpayers and taxpayers need to get a good deal. And Liz Truss’s fierce defence of windfall profits suggests a strong ideological view that the government should not intervene to reduce them. That does not bode well for those footing the bill, who want to pay a fair price for their energy in the long term.

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