Target Practice: Can Government Really Target Its Energy Price Guarantee by April?

UK Policy

Target Practice: Can Government Really Target Its Energy Price Guarantee by April?

Commentary
Posted on: 18th October 2022
By Multiple Authors
Daniel Newport
Head of Net Zero - UK Policy
James Browne
Head of Work, Income and Inequality Analysis

Yesterday the Chancellor announced a Treasury-led review of the Energy Price Guarantee (EPG). With such clear need for the government to demonstrate a return to fiscal discipline, the estimated £58 billion cost of the EPG in 2023–24 was always likely to come under scrutiny.

But imperfect as it is, the price freeze was introduced to protect against the twin risks of devastation caused by unaffordable bills for households and the crushing economic recession that would inevitably follow.

These risks will not have gone away by next April. Bills of between £3,500 and £4,500 are estimated for next year. But they could be much higher: next winter is likely to be harder than this winter as Europe’s ability to refill its reserves depends on the unknowns of geopolitics, weather and demand.

So the objective of the review – to “design a new approach that will cost the taxpayer significantly less than planned whilst ensuring enough support for those in need” – is no mean feat.

Many have called for more targeting of support to reduce the costs. Broadly, targeting means providing financial support in a more restricted way, based on delivering more to those who need it than those who don’t. This is a worthy aim, and a blanket price freeze scores badly: everyone is supported and higher-income households tend to receive more financial support than poorer households.

But in practice it will be hard to more efficiently target households in need for two reasons. First, if energy prices stay around or above current projections most households will continue to require support. Providing support to only the approximately 8 million households who receive means-tested benefits would be completely inadequate.

Second, the need for support is at a household rather than individual. But it’s not possible to target high-income households directly through the individualised income tax system. This is a major stumbling block: consider the difference in need between a household of four middle-income earners and a household with one middle-income earner with three dependants.

Many proposals for better targeting breeze over these constraints. Government will not be able to do likewise. Having failed to find a way of squaring this circle over summer, policymakers will now be sent out again to scrape the barrel for further options. Those options remain seriously limited:

  • Council tax. This is the only recurrent household-based tax in the UK, which is why the then Chancellor Rishi Sunak used it to target the first £150 energy rebate. In theory, council-tax bands could be used to reduce support for higher-income households by increasing tax rates for properties in higher council-tax bands. But this would mean support was less well-targeted relative to need as larger properties typically have higher energy costs and property size is only loosely related to household income. Moreover, this is not a good way to target higher-income households: around 640,000 households in England in the lowest three income deciles live in property bands B and E and above, and more than half of the richest tenth of households live in homes of band D or below.
  • Rising block tariffs. This idea, which has been employed in some European countries, is to give all households a certain amount of very cheap energy and then charge a high price for energy use beyond that. Although this would limit the amount of support given to high energy-using households, that rather misses the point. High energy users are not necessarily wealthy: as we showed in our previous report there are drivers of high energy use across the income distribution. While there are good arguments in favour of rising block tariffs, they are really around maintaining incentives to reduce consumption, rather than better targeting of support.
  • Means-testing by suppliers. One approach that has been mooted is to allow households with income below a certain threshold to access support (such as a preferential tariff) through their energy supplier. That would require energy suppliers to know and verify household income before deciding what tariff or support to offer. Privacy issues aside, energy suppliers are not used to assessing benefit entitlements, and certainly not on this scale. They would incur significant costs in setting up new systems for means-testing. Even if an “opt-in” system were used and the burden of proof sat with the household, the problems persist: how would energy suppliers manage fraud, compliance or appeals? This is the work of HMRC, not private companies.
  • Means-testing by HMRC. Instead it might be tempting to design a new system for providing means-tested energy-bill support to households through HMRC. This would need to overcome missing data – HMRC doesn’t currently know where everyone lives, for instance. So households would have to jointly declare their income, which would be used to calculate their entitlement to support. This would be costly both for households and administrators. Furthermore, as with most benefits, some households needing support with their energy costs would slip through the “opt-in” net. It is far from clear that it is proportionate or effective to set up an entirely new system from scratch and ask the majority of households to undergo a joint means test – effectively moving away from individual taxation – in response to a temporary policy challenge. Few are calling for a return to joint taxation.
  • Rebate and tax-back. It would be far simpler for the government to provide universal support and then use income taxes to claw some of it back. This still has the drawback that individual taxation would be used to claw back household-level subsidies, which would lead to some unfairness. But it has the virtue of being immediately viable and at least reasonably fair.
  • High-income clawback. One final option would be to use the income-tax system to claw back support from households with higher incomes, similar to the High-Income Child Benefit Charge (HICBC) system used to withdraw Child Benefit. Under HICBC, families with someone earning more than £50,000 see their award gradually withdrawn. The higher-income parent has to fill in a tax return declaring the child benefit their family has received. We estimate that replicating this could save on energy bill support for around 15 per cent of relatively well-off households, and might save around £6 billion from the exchequer cost assuming a £5,000 price cap. However, there are serious problems with this approach. It would require millions of people to fill in a tax return, possibly for the first time. This compliance hurdle would be exacerbated by the need for people to know the incomes of other people in their household – not at all easy, for example, in shared houses with multiple renters. The net result would be a compliance headache, as we’ve seen with the HICBC, leading to many thousands of families being penalised by HMRC. Using an individual-based system to assess entitlement to a household-based benefit would also damage work incentives and create unfairness. A couple with one earner on £60,000 would get no more support than a couple where both earned that amount.

Given the six-month window to implement a new approach, it seems likely that in asking the same question, government will receive the same answer: there are no real options for targeting households beyond the existing benefits and tax systems. Which means unless prices fall dramatically, to the point that only supporting benefits recipients is acceptable, some universal support will need to remain. A better question to ask might be about the relative levels of support offered.

In our report, Staying Power, we propose using rebates as an alternative to a price freeze. While the ability to target based on income is limited due to the scale of price increases and the lack of levers, it would be possible to reduce support for households not receiving benefits to 75 per cent of the full amount. By further varying payments by Energy Performance Certificate (EPC) rating and household size (both easily verified by available data), this would allow support to be better targeted towards those most in need and limit the extent of over- or under-compensation. Moreover, it would give less support to high-income, high-consumption households.

Such an approach would reduce the cost of financial support compared to a universal price freeze by £10 billion against a £4,500 price cap. No panacea, but a helpful start.

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