Working to make government more effective

Explainer

Cost of living crisis: reducing energy bill costs 

Energy costs have increased sharply since 2021, largely due to a surge in wholesale gas prices.

What is happening to energy bills? 

Energy costs have increased sharply since 2021, largely due to a surge in wholesale gas prices. Ofgem has announced that from 1 October 2022, a consumer on an average dual fuel default tariff paying by direct debit will see their energy bills rise from £1,971 per year to £3,549.[1] This is well above the figure of £2,800 that former chancellor Rishi Sunak thought would be the level of this cap this autumn when he announced his last package of support in late May 2022.  Recent independent forecasts suggest that the household energy price cap could rise even further, to the equivalent of over £5,000 a year in April 2023, and remain very high for the next few years.

Wholesale gas prices remain extremely high and volatile.

Who will this price rise hit hardest? 

The impact of rising energy prices is being felt by most households. But rising bills will have the biggest impact on lower-income households since the price rises will eat up a greater share of their disposable income (or they may not even have enough to cover the increased cost and have no choice other than not to heat their homes).

The Johnson government therefore came under pressure to help. But it faced trade-offs in deciding how to offer that support, including between how many people it wants to help, how much it wants to help them, and at what cost. 

What did the Johnson government announce? 

As chancellor under Boris Johnson’s government, Rishi Sunak announced a series of packages to help with rising energy costs in February, March and May 2022. This section breaks down the announced measures and then sets the other main options that are available to the new Truss government.

Taken together, the policies announced by the Johnson government between February and May 2022 were sufficient to offset around 90% of the average rise in energy bills in 2022/23 Sunak expected in May. However, since then energy prices have risen even faster than expected and so the package of measures is now only expected to offset around 50% of the increase this financial year.

Broad-based income support

Every household in Great Britain[2] will receive a £400 discount on their energy bills, paid for by the government. This will be automatically applied to energy bills by energy suppliers (pre-payment consumers will have the money applied to their meter or paid via a voucher) and does not need to be paid back.[2]

Those living in homes in Council Tax Bands A-D were also given a rebate of £150 to households, which was delivered by local authorities. This is a broad-based measure, covering 80% of households in England, but excluding those in the highest-value properties (including some low-income households) as well as those who do not pay any council tax (such as students).

Will it work?

Both these measures are very broad based, benefitting households across the income distribution. This makes them costly for the government: the energy bills discount is expected to cost £12bn and the council tax rebate £3bn. It also means that support is not targeted at those who spend most on their energy: even among people with similar levels of income, there is substantial variation in energy consumption. The delivery mechanisms are also imperfect. For example, because the energy bills discount will apply on a household basis and energy suppliers do not know how many homes an individual owns, owners of second homes will receive the grant more than once.

The benefits of the council tax rebate are similar to the energy bills discount in that they are diffused across a large number of recipients. It is however marginally more targeted in that it only applies to those in bands A to D. Due to the delivery mechanism, it is also possible to ensure that second home owners and those who own empty properties do not benefit.

Broad-based measures benefit all households, so are an appealing policy when everyone is facing increased costs. However, their broad nature means that they are expensive and also risk overly stimulating the economy by increasing aggregate demand. The UK economy is currently facing a supply shock: inflation is increasing because demand is exceeding supply. Large-scale spending giveaways of the kind that the government has announced risk being offset by the Bank of England increasing interest rates to dampen aggregate demand and bring inflation under control. This might ultimately negate the boost to household finances that these policies have been designed to do.

Household support for vulnerable

In former chancellor Rishi Sunak's last household support package in late May, support was more targeted at groups who are particularly vulnerable to large increases in energy costs.

Pensioners

The Winter Fuel Payment already exists to support pensioners with energy costs. People who turn 67 before 25 September 2022 will receive an extra tax-free £300 payment this year on top of the regular payment of between £200 and £300.

Recipients of means-tested benefits

The government has provided a one-off tax-free payment of £650 to claimants of the seven main working-age benefits and tax credits, including Universal Credit. Households who were claiming benefits or tax credits before Sunak’s announcement on 26 May will receive this payment in two lump sums in July 2022 and the autumn.

People receiving the seven main disability benefits (including the disability living allowance and personal independence payment) will also receive a one-off payment of £150. Households who claim both means tested and disability benefits will receive both payments.

Will it work?

Focusing support on low-income and vulnerable people is a much more targeted – and effective – form of intervention to support squeezed household budgets.

However, some groups may still fall through the cracks. For example, larger families claiming benefits will not receive any additional support in recognition of their higher energy needs. The nature of one-off payments also means that some households will miss out on support, if they were not claiming benefits before 25 May. There is also a sharp cliff-edge in support between those whose income is just low enough to qualify for means-tested benefits and those just above the necessary level.

Discretionary support – the household support fund

The household support fund is a discretionary pot of money that upper-tier local authorities in England can use to support people in their communities with living costs. The Johnson government provided a total of just over £1bn to deliver support to people who are otherwise ineligible for the other payments.

Providing local authorities with discretionary funding is a potential solution to the problem of some households missing out from support from the other schemes. However, it is unclear whether the household support fund is sufficient to cover all the gaps in other support or if local authorities can effectively channel the money available to those who need it most.

Tax changes – a reduction in fuel duty

At the spring statement Rishi Sunak temporarily reduced fuel duty by 5p a litre for one-year, delivering a net benefit to motorists of £2.4bn. This measure is targeted in that the greatest benefits will go to those that spend the most on fuel. But because higher-income households tend to consume more fuel, this measure is regressive overall – that is, it benefits people on higher incomes most.

What else could the government do?

There were a number of other options available to the government, such as cutting energy-related taxes (which would have channelled financial support to those that spend the most on energy). 

Cutting VAT or green levies to permanently reduce average energy bills for all households

The former chancellor could have reduced taxes or levies on energy bills. This would have directly reduced the price of energy faced by consumers.  

One of the main advantages of intervening in this way is that those who consume the most energy would have received the largest cash benefit. However, this in itself makes the policy poorly targeted, since the greatest benefits would have accrued to higher-income households, who tend to spend more on energy (even though lower income households spend a greater fraction of their income on it). The broad-based nature of such an intervention that reduces price for all households would have made it very costly if it was to offset price rises significantly.  

Consumers’ bills include two tax components (‘VAT’ and ‘Policy costs’ in the above chart) that the former chancellor could remove in order to lower the average unit price paid by households for their energy: 

  • VAT. Fuel is currently subject to a (reduced) VAT rate of 5%. Removing this tax is one easy-to-implement option for reducing households’ energy bills. Doing so would reduce the average price of energy paid by households by just under 5%. This would reduce the average household bill (i.e. a dual fuel customer paying by direct debit and consuming an average amount of energy at the capped price) by just over £90 a year, at a cost of around £2½ bn to the exchequer. 
  • Green levies. Another component of household energy bills that government could seek to reduce or eliminate is the levies on bills that fund green policies – these are what Ofgem calls (shown as ‘Policy costs’ in the chart above). According to Ofgem, these levies make up 15% of total dual fuel bills (though make up a much larger proportion of electricity bills than gas). For a customer on a price capped (at the October 2021 level) average dual fuel tariff paying by direct debit, these social and environmental schemes contribute around £153 to the average annual bill. A temporary (one-year) suspension of these levies, then, could provide substantial relief to households. This would come at a cost of just over £4bn to the exchequer. 

Another downside of these sorts of policies, however, is that – by reducing the average price of energy – it would also encourage its consumption, which would run counter to the government’s net zero objectives. Removing green levies would be even more detrimental to net zero ambitions than cutting VAT if the government did not provide an alternative source of funding for the energy efficiency-enhancing schemes that the levy revenues currently fund.  

How do the chancellor’s policies compare to the other possible options?

The table below summarises the policy options the chancellor could have gone for, including the options he chose. Rishi Sunak has opted for a combination of topping up incomes (via the Council Tax Rebate) and reducing the volatility of prices (via the Energy Bill Discount scheme). When compared with the other options that were available to him, the following features stand out: 

  • The policies do not affect the average price of energy that households will face. This means that support is not targeted at those that consume relatively more energy. However, it does mean that the government is not subsidizing energy consumption, a move that would contradict its net zero objectives. 
     
  • The newly announced policies are not targeted at the lowest income households, who are likely to suffer most as a result of increased energy prices. The Energy Bill Discount Scheme affects all households in Great Britain, while the benefits of the Council Tax Rebate accrue to 80% of households in England (though Devolved Administrations may choose to follow a different approach with £715m they will receive through the Barnett formula). While the chancellor has announced a £144m discretionary fund for local authorities to allocate to these households, it is not clear that this is sufficient to provide an equivalent £150 payment to all those that do not qualify (those that do not live in Band A-D properties and some people who are exempt, such as students).  
     
  • Although the government is spending £9.1bn this financial year on these schemes, over half of this is through the Energy Bill Discount scheme, which the government aims to reclaim over five years from 2023/24. This means the policy package has a lower lifetime cost than if the money was concentrated through welfare payments or tax cuts that would not be repaid.  

Summary of key factors

Policy

 

Target: average energy prices, energy price volatility, or household incomes?

Impact on incentives to consume energy

Temporary or permanent

Cost

Tax Reduce VAT Average energy prices Increase consumption  Either – politically difficult to maintain  ~£2.5bn p/a 
Tax Reduce green levies Average energy prices Increase consumption  Either – politically difficult to maintain  Up to ~£4bn p/a  
Market intervention Supplier loan scheme Energy price volatility  Negligible impact Either – but announced scheme is temporary (paid in 2022/23, paid back from 2023/24)  Zero lifetime cost in principle, but may be costs due to (i) delivery of payments and (ii) risk of non-repayment 
Welfare Cold weather payments / Warm homes discount / Winter fuel payment  Household incomes. The choice should be determined by the extent to which government wants to target support. The Council Tax rebate covers 80% of households, others such as the Warm Homes Discount target a much smaller group.  Negligible impact Either – politically difficult to reverse except for one-off payments, which are more credibly temporary. Dependent on size of increase/expansion – Council Tax Rebate estimated to cost just under £3bn.
Welfare Universal Credit Household incomes. The choice should be determined by the extent to which government wants to target support. The Council Tax rebate covers 80% of households, others such as the Warm Homes Discount target a much smaller group.  Negligible impact Either – politically difficult to reverse except for one-off payments, which are more credibly temporary. Dependent on size of increase/expansion – Council Tax Rebate estimated to cost just under £3bn.
Welfare One-off payment (e.g. Council Tax rebate, cheques to households)  Household incomes. The choice should be determined by the extent to which government wants to target support. The Council Tax rebate covers 80% of households, others such as the Warm Homes Discount target a much smaller group.  Negligible impact Either – politically difficult to reverse except for one-off payments, which are more credibly temporary. Dependent on size of increase/expansion – Council Tax Rebate estimated to cost just under £3bn.

 

 


  1. www.ofgem.gov.uk/publications/default-tariff-cap-level-1-october-2022-31-december-2022
  2. www.gov.uk/government/news/400-energy-bills-discount-to-support-households-this-winter
  3. Brewer and others, A chilling crisis, Resolution Foundation, August 2022, retrieved 30 August 2022, www.resolutionfoundation.org/publications/a-chilling-crisis/
  4. National policies to shield consumers from rising energy prices (bruegel.org)
  5. Figures taken from Brewer and others, A chilling crisis, Resolution Foundation, August 2022, retrieved 30 August 2022, www.resolutionfoundation.org/publications/a-chilling-crisis/
Administration
Johnson government
Publisher
Institute for Government

Related content

03 DEC 2020 Report

Evidence in energy policy making

The government needs to change how it shapes energy policy – or risk hindering efforts to reach its 2050 net zero target.

16 FEB 2024 Podcast

Rishi Sunak's double by-election trouble

Chris Cook of the Financial Times joins the podcast team to explore just how much trouble the PM is in – and what he can do to turn things around.