The unequal impact of the energy bill crisis

Update 3/​2/​22: See our updated analysis in light of the energy price cap announcement.

As international gas prices soar to record highs, UK households are set to face a painful rise in their energy bills; estimated at £600-£800 on average from April this year – or a total rise in annual UK bills of £14bn. Nearly 3 million households were already behind on their energy bill payments even before the price rise last October. Millions more will add to that soon as those on low incomes and living in poorly insulated homes are set to be hardest hit. Energy bills may rise to 12% of all spending for the poorest 10% of families – three times higher than the proportion for the richest 10% of households.

Protecting vulnerable consumers is a clear priority. Levelling up may remain an obscurity, but it is hard to think of a possible definition that includes allowing the poorest families to get poorer as a result of government inaction. To prevent this from happening, both the quantity and the design of support is crucial. There is a high risk of the government either targeting its measures poorly or else offering inadequate support overall (or both), as has been seen too many times already since the beginning of the pandemic.

In this blog we provide detailed analysis – including new distributional modelling – of some of the possible options for mitigating this crisis over the coming months. The effect of the price cap is often discussed in terms of the average increase on energy bills. But doing so masks the true extent of variation across society, and risks oversimplifying the problem and potential solutions. Using the latest ONS estimates of relative energy spending by families based on the Living Costs and Food survey, we unpack what the average increase in energy costs – such as that estimated by Cornwall Insight – might mean for families at a more granular level.

Figures 1 and 2 below show our estimates for the disaggregated impact of a just under £600 average increase across different family types and levels of income, first in cash terms and then as a proportion of household income (respectively). Two findings jump out. First is the extent of variation across different families. Pensioners and working age adults without children on low incomes might see an increase of between £400 to £500, whereas low-income households with children or unemployed members might see bills rise between £500 to £700 (Figure 1). As a proportion of disposable income, certain types of families are likely to be particularly hard hit, with single parents seeing their bills rise 56% faster than the average (Figure 2). For pensioners and families with one or more disabled people, it will be 43% and 21% respectively.

Second, the impact of higher energy bills is highly regressive. Lower income families of all characteristics see a disproportionately large impact relative to their disposable income. This is because such families have higher gas and electricity needs catering to children or disabled adults, including consumption for specific requirements such as assistive technology equipment. Low energy efficiency is another factor where those living in the least energy efficient housing stock can on average pay 30% more than those living in highly insulated properties. For example, families in the poorest decile would see just under 5% of disposable income wiped out by higher bills, without considering the impact of additional government policies taking effect from April. This proportionate increase in bills is 7.5 times faster than for the 10% highest income families (Figure 2).

Figure 1: There is a high degree of variation in the cost of energy bills for different families

Figure 2: Energy bills of those on lowest incomes could rise 7.5 times faster than those on highest income

The government is yet to make a final decision on the price cap from April 2022, with a decision due on 8 February. There are currently live discussions about which measures would need to be put in place for the cap to be lower than currently projected, including some form of direct subsidy to industry. In general, a direct industry subsidy is undesirable. It does not guarantee that customers will stop getting ripped off on their energy bills as has been the case over the last decade and sets a poor precedent for dealing with such crises where failing incumbent suppliers are propped up by public money. It also only papers over the cracks both in terms of long-term reform to the retail market, and a glaring gap in the country’s energy efficiency strategy that sustains our reliance on volatile natural gas.

Direct support for families, at least to some degree, is preferable to subsidising industry. It is no substitute for addressing the structural drivers of UK dependency on global fossil fuel supply chains rather than domestic renewable energy. But it does help to set a precedent for strengthening the UK safety net to better deal with these sorts of national hits to living standards and addressing the fact that the UK’s safety net is not currently fit for purpose.

In terms of short-term options to support household incomes this spring, three broad approaches have been discussed.

• First, a broad-based approach for all or most families. Here a VAT exemption on energy bills has gained the most traction, which would essentially reduce costs for all 28.5 million households in the UK. Reducing further environmental levies on bills (such as Feed in Tariffs, Renewables Obligation and Contracts for Difference) would also fall into this bucket.[1] Currently levied at nearly 5% on electricity and gas bills, a cut to VAT is expected to save all families £89 a year on average, at a cost of around £2.5bn to the exchequer.
• Second, a ​‘medium targeted’ scenario with a boost for families on lower incomes. This has been proposed either as a temporary uplift to means-tested benefits, supporting incomes for 9.1 million households. Or else significant reform to the Warm Homes Discount (WHD), that would achieve essentially the same outcome. The WHD currently targets state pensioners and a few households on low incomes, totalling 2.1 million households. The target group receives payments of £140 annually between December and March when energy consumptions and bills are typically higher, and the cost is met through higher energy bills elsewhere.
• Finally, ​‘extra targeted’ approaches have been discussed, delivered either through more limited reform of the WHD, or other schemes such as the winter fuel payments. In truth there is no clear way to deliver such a scheme at such short notice in a way that reaches those clearly most in need. We include this scenario in our analysis as an illustration to demonstrate the trade-off between more generous support to fewer households compared to less generous support but across a broader base.

Using the IPPR tax and benefit micro simulation model we created illustrative forecast scenarios to inform thinking on all of these three options and compared the outcomes for each in terms of distributional implications. Our baseline comparator for all policy options is what we think will happen if no further action is taken at all: in other words, the current expected change in incomes between March and April 2022. To do this, we constructed a core scenario for April 2022 based on the latest economic forecasts and the policy changes currently expected to take affect that month. This includes higher National Insurance for both employee and employer contributions of 1.25%, uprating of benefit payments to match inflation last September and the increase in the national living wage of 6.6% — as well as the expected higher price cap itself.

To compare our three options on a like-for-like basis, we set each one at a broadly comparable cost to the VAT exemption (around £2.5bn). For our ​‘medium targeted’ scenario, this allows for an increase in the main payment of key means-tested benefits – pension credit, universal credit, and legacy benefits – by £270 per household, boosting incomes for 9.1 million families. To illustrate an ​‘extra targeted’ approach, we boost all disposable incomes for the 5.6 million poorest 20% of families by £440. This is an entirely counterfactual scenario to demonstrate what a ​‘perfectly’ targeted outcome might look like, based on equivalised household income.

The results of this modelling are presented in figure 3, distributed across income deciles for three broad family types – working age families with children, working age families without children and single or coupled households claiming pensions. Other household types presented in figures 1 and 2 above were not possible for new policy modelling due to data limitations.

The main takeaway from the analysis is that £2.5bn of support is not enough. If it is distributed to all families, such as through a VAT cut, then lower income families are still left largely exposed while some higher income families get support where they probably didn’t need it. If £2.5bn is targeted at all those in receipt of means-tested benefits, then the funding is better spent than a VAT cut, but the poorest families are still left even poorer this April than they were before. If ​‘levelling up’ is to mean anything, it surely must preclude the poorest getting any poorer. Finally, our stylised ​‘extra targeted’ scenario shows that £2.5bn would be enough to largely avoid average falls in income for the poorest 20% of families, but in practice such precision targeting doesn’t exist – and even if it did, it would still leave lower to middle-income families without any support at all.

Figure 3 – £2.5bn is not going to be enough to provide adequate support to all that need it

Much more support is needed than £2.5bn. The two most obvious approaches to achieving this would be to either combine different options, or else lift the level of payments to all those in receipt of means-tested benefits to a level that offers more meaningful protection – potentially as a first step to a Living Income. To illustrate this, we set out two further scenarios in Figure 4 below. The first is a Labour party policy that includes the VAT exemption, smoothing out the costs of supplier insolvency and a £400 payment to all those on means-tested benefits through the WHD. We cost this package at £6.6bn. The second scenario models a boost to means-tested benefits of £800 – effectively restoring 80% of the pandemic uplift to universal credit but extending this boost to legacy benefits as well at a total cost of £7.8bn.

Both approaches are highly progressive and broadly adequate overall. We view a boost delivered through welfare alone as preferable overall as it is more likely to prevent the very poorest households from becoming poorer this April. Any boost to low incomes on top of this is much needed since it will just offset some of the increased costs that have already been seen this year. For example, the average overnight rise in incomes of £285 for the poorest 10% that this policy would imply would cover the £2350 average rise in energy bills already seen since 2019 when the price cap was at £1,040.

Figure 4 – An £800 boost to benefits will prevent the poorest from getting poorer

Our analysis further highlights that emergency government support is best delivered through the existing means-tested benefits system, allowing for a boost in incomes for around 9 million families. Our illustrative £800 boost would offset 60% of the expected £14bn increase in domestic energy bills, with the rest of the cost passed through primarily to higher income families.

Expanding the WHD scheme could be an alternative route to a similar outcome, however the scheme’s current design has severe limitations. Reforming the scheme so that costs are not redistributed back onto energy bills is a case in point. A report from Citizens Advice also indicates that the necessary changes to the scheme, which expires in March for customers to apply for rebates, can only take effect for the winter of 2022/​23, making it a less ideal policy mechanism to deliver emergency support for households this April.

However, the existing welfare system also has big gaps. According to the Committee on Fuel Poverty 40 – 46% of households in fuel poverty are not receiving any benefits. We argue that in addition to the support via the benefits system, the government’s Household Support Scheme, currently resourced with £500m, needs to be scaled up. This would ensure those in fuel poverty who do not access benefits or those still at risk of falling through the cracks, can access finance from their local authorities. We estimate that support could capture an additional 1.2 million households, costing £700m.

The government must take urgent measures that shield households from the April bill rise while not losing sight of the necessary medium- to long-term actions. As families move from one cost of living crisis to another, piece meal solutions need to be replaced by systematic ones. This should include a Living Income for families as advocated by NEF, and a Great Homes Upgrade that retrofits millions of homes and slashes our dependence on natural gas.

Image: iStock

[1] Civil society groups and industry bodies have also advocated for a temporary or permanent shift of environmental levies on to general taxation which is progressive and will have a direct material impact on slashing energy bills to the tune of £170. However, specific policies such as the Energy Company Obligation, which fund retrofit measures for fuel poor households, need to be ring fenced and protected from the vagaries of short-term tax decisions in the future, as was evidenced in the recent media story about the chancellor considering slashing the ECO programme.