What is happening to energy bills? 

Energy costs have already increased sharply, largely due to a surge in wholesale gas prices, and will rise even further on 1 April when the energy price cap is raised for approximately 22 million customers. A consumer on an average dual fuel default tariff paying by direct debit will see an increase of £693 from £1,277 to £1,971 per year. Prepayment customers will see an average increase of £708 from £1,309 to £2,017. There is considerable uncertainty about the future path of wholesale energy prices but if they remain high then the cap could stay high or rise even further next winter. [1] 

Who will this price rise hit hardest? 

The impact of rising energy prices will be 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 government has therefore been under pressure to  help. But it has faced a trade-off between how many people it wants to help, how much it wants to help them, and at what cost.  

What has the government announced? 

On Thursday February 3, following Ofgem’s announcement of the rise in the price cap coming on 1 April, the chancellor announced a package of support measures [2] for households, including a £200 discount on all households’ energy bills this year to be paid back in increments and a Council Tax Rebate of £150 for 80% of households in England. It is a large support package, but the benefits are dispersed over a large number of households and do not vary according to how much energy households consume. This explainer describes the announced package and the other options that were available.  

Energy Bill Discount Scheme – intervening in the supply side of the energy market

This measure involves loaning money to energy suppliers to allow them to offer customers energy now at a loss-making price – on the understanding that suppliers will repay these loans when wholesale energy prices fall, with them in turn charging their customers somewhat higher future prices in order to repay the government loans. This policy should have the effect of reducing the volatility of energy prices. This means all households should face the same average price as they would do in the absence of intervention but will be less exposed to the peaks (and troughs) in wholesale prices. This policy will be most beneficial for those households (and businesses) that do not have access to sufficient savings or credit to be able to cope with extreme spikes in prices.  

This type of policy has the benefit of dampening energy price volatility, while not changing the average price that consumers pay for their energy. As a result, it should not affect the incentives that households face to adopt energy-efficiency measures. 

The specific policy that the chancellor has adopted [3] means all domestic energy customers will receive a £200 discount on their bills this Autumn, funded by the government via energy suppliers. Customers will then pay back the discount automatically via their energy bills over a period of five years, starting from financial year 2023/24 when – according to the government – wholesale gas prices are expected to come down. An alternative would have been to allow the energy companies to distribute the funding according to energy usage so that those who pay the highest bills would see the greatest benefit (though this would mean more benefits accrue to higher earners who tend to spend more on energy). 

Will it work? 

In theory, this mechanism entails the government spending money when prices are high and reclaiming it when prices are low such that overall it should cost little or nothing. However, uncertainty over future prices makes such a policy tricky to implement. Wholesale fuel prices are notoriously volatile so it will be difficult to set the price points at which to reduce bills (to mitigate the impact of a spike) and then increase them (to reclaim cash). There is a risk that prices may still be high when consumers are asked to start paying in 2023/24. In that case, it could be politically difficult for the government to stick with its plan of recouping the money – and thus adding to bills – at that point.  

Some questions also remain about how the scheme will be delivered. For example, the government will need to work out how to ensure the scheme is not ‘gamed’ by suppliers, for example, increasing tariffs by more than they would have otherwise while issuing the government-backed ‘discount’. The Department for Business, Energy and Industrial Strategy will need to respond to such concerns when it sets out more detail on the policy in a consultation in the Spring.  

Council Tax Rebate: directly topping up household incomes  

In addition to the support channelled through energy suppliers, the chancellor has also announced a plan to support incomes via a Council Tax Rebate. [4] This measure will deliver a £150 rebate to all households in England in Council Tax Bands A-D in April this year, to be 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). This is expected to cost around £3bn.  

Will it work? 

By targeting the council tax bands for the 80% of properties with the lowest value this policy will channel support to those who are likely, when controlling for differences in prices between regions, to live in smaller properties and therefore face lower energy bills. Households that receive the benefit will receive the same amount of support, regardless of how much energy they use. This means 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. Because this policy applies to 80% of all households, its benefits are also diffused across a large number of recipients. In order to support households most in need, the chancellor could have opted to expand a more targeted welfare policy. 

What else could the chancellor have done? 

There were a number of other options available to the government, including expansion of other benefit schemes (which could have meant a greater benefit for those on lower incomes) or cutting energy-related taxes (which would have channelled financial support to those that spend the most on energy). 

  • Support households incomes via a more targeted policy 

The chancellor could have introduced more targeted support for household incomes via the expansion of other welfare policies, focusing on those most likely to face the greatest financial pressure from high energy prices.  

There are several ways the government could have delivered more targeted income support through existing schemes – including cold weather payments, the warm homes discount (both of which are offered to those on pension credit or on low incomes), winter fuel payments (currently awarded to those aged 66 and over), or via an increase in Universal Credit.  

If the same amount of money that is to be spent on the council tax rebates had instead been spent on increasing the amount allocated to recipients of the Warm Homes Discount (which is expanding this year to cover three million people), then each of those households would receive around an extra £1,000. Delivering the benefit via Universal Credit would be an in-between option, covering 4.9m households [5] who would all get around an extra £600 on average.   

  • Cutting VAT to permanently reduce average energy bills for all households 

The chancellor could have reduced taxes energy bills, directly reducing the price of energy faced by consumers. Those who consume the most energy would have received the largest cash benefit, but 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 chancellor could remove in order to lower the average unit price paid by households for their energy. 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. 

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

 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.  

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 
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.
Universal Credit
One-off payment (e.g. Council Tax rebate, cheques to households) 
Update date: 
Friday, February 4, 2022

Original source – The Institute for Government

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