Freezing the Energy Price Cap

The policy debate around rising energy bills. Politicians from different parties have proposed freezing the Energy Price Cap at its current level as a way of easing the impact of rising energy bills, which the latest forecasts predict to reach £3,582 on average per year from October and £4,266 a year by January 2024. Labour outlined their £28.9bn plans to freeze the energy price cap for six months, amongst other measures. This followed similar calls from Liberal Democrat leader Ed Davey, the SNP’s Nicola Sturgeon and former Prime Minister Gordon Brown. 

• Inaction will lead to a bleak winter for many. The Bank of England now estimates the UK inflation rate to peak at 13% this year. As a result, households face a once-in-a-generation fall in their real incomes. And inflation is not predicted to fall back to its 2 per cent target until 2024. The latest forecasts show the expected annual real pay will fall by an unprecedented 7.75% in the last quarter of 2022 as inflation erodes disposable incomes. This marks the biggest quarterly fall in real wages for 100 years, which comes after the longest wage squeeze (period of stagnant wages) for 200 years. Analysis carried out for CPAG shows that more than half of British households will be in fuel poverty by October and two-thirds by January; 6m households will be forced to spend an unprecedented 25% of their income on energy. The Resolution Foundation calculated that almost half of annual gas use occurs in the January - March period, where the typical household could find its energy bills rising from £82 a month this summer to over £500 a month. 
• What is the government currently planning? The Times reports that the Treasury under Nadhim Zahawi is planning a government-backed lending scheme to compensate suppliers and enable them to cut an extra £400 off energy bills, costing £9bn. Whether this is adopted or not will depend on who wins the Conservative leadership election; Liz Truss has flip flopped about whether to provide more “handouts” and emphasised her preference for tax cuts over direct payments (read our previous digest on the limitations of using tax cuts to ease the cost of living crisis) and Rishi Sunak proposed scrapping VAT on energy bills and extending the Energy Bill Rebate to provide targeted financial support for pensioners and the most vulnerable. 

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Reducing inflation with fiscal policy. The Bank of England estimates that half of the headline rate of inflation is due to rising energy and food prices. New analysis from IPPR calculates that freezing the Energy Price Cap at its current level could reduce the peak rate of inflation by 3.9% from 13% to 9.1% and save households £2,050 on average in energy bills over the next year, costing £45bn - less than Liz Truss’ £50bn plan for tax cuts and extra spending. If this was funded, at least partially through windfall and/or wealth taxes, inflation could be reduced by a further 0.7%. (IPPR also calculated that reducing the Energy Price Cap to its November 2021 level could reduce the peak rate of inflation by 5.6% from 13% to 7.4% and save households £2,744 on average, costing £60bn. If this was funded, at least partially through windfall and/or wealth taxes, inflation could be reduced by a further 0.9%.) 

• The Bank of England’s contractionary response isn’t working. Criticism is mounting over conventional monetary policy’s failure to tackle inflation properly. The Bank of England is trying to prevent inflation becoming embedded into expectations through ‘second round effects’ of price increases spreading to other goods and services. Earlier this month the Monetary Policy Committee was criticised for the largest interest rate rise since 1995 even though it will have little immediate impact on today’s inflation and is likely to exacerbate the now-forecast recession. The TUC argues this will further erode household incomes through the loss of one million jobs. 
• ‘Fiscal price caps’ are a more effective response to the cost of living crisis. IPPR argue that ‘fiscal price caps’, such as setting an upper limit for the energy price, subsidised through fiscal policy, could reduce inflation straight away, protect households from the increase in bills this winter, and help prevent inflation from becoming embedded by reducing the risk of further snowballing price rises in the future. About half of European economies have some form of price limiting measure in place; e.g. the French government has frozen gas prices and limited electricity increases to 4 per cent, with an estimated cost of €38 billion. 

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Funding the energy price cap freeze.  Labour argues their £28.9bn proposal can be funded by backdating the windfall tax imposed in May to January and closing the investment loophole that grants oil and gas producers a tax break worth up to 91p in every £1, scrapping the £400 Energy Bill Rebate and by making £7bn in savings on debt interest payments by reducing inflation. The IFS’s Paul Johnson called this latter point as an ‘illusion’ because it wouldn’t bring inflation down permanently, however IPPR argues that it could have a significant effect by reanchoring expectations and reducing ‘second round effects’. (A YouGov poll for the Times found that 75% of Conservative voters support “fixing the cap on energy bills even if it means more government borrowing”.)

• Consider other options as revenue-raisers. Windfall and wealth taxes have also been proposed as revenue-raising options to fund proposals to reduce inflation and stabilise energy prices. Tax Justice UK modeled how a 95% tax on excess profits could raise £12.9bn instead of the £5bn in the government's package. (NB The tax rate on oil and gas was 75% in 2015 and 80% in 2014, and the global average is 70%.) Excess profits taxes could also be expanded to other sectors (e.g. commodities companies) that have been reaping windfall profits, as argued here by IPPR’s Carys Roberts. (Read the first report from Unite’s Corporate Profiteering and the Cost of Living Crisis. Private Eye exposes the profits of top companies benefiting from the pandemic, with testing company Randox Laboratories Ltd making £308 million in profit since the pandemic having only made a profit of £12 million before Covid.) The package could also be accompanied by reforms to the UK’s unequal taxation of wealth. Rebalancing taxes on work and wealth has increasing support on the centre-right. 

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Criticism and counterarguments. The proposal has come under fire for a variety of reasons, detailed below. One free market counterargument was given by IEA fellow Julian Jessop, who argued that price caps distort price signals such as “increasing the incentives for producers to raise output and for consumers to economise”. IPPR provides a rebuttal to this, arguing that a 73% increase in energy prices since last year is enough of a strong incentive to transition to lower carbon homes, and freezing the energy price cap at its current level should always come in combination with another package of support to increase investment in clean energy and energy efficiency upgrades, such as Labour’s ‘energy efficiency revolution’.

• Why not target support at those that need it most? Labour’s plan has also been criticised by economists, such as Tax Research Network’s Richard Murphy, on the basis that it “delivers a significant gain to the best off households”. However Resolution Foundation Chief Economist Mike Brewer argues that the higher prices go, the more justification there is for a universal intervention while the FT’s Stephen Bush points out that even among the richest fifth of households, median income is £62,700, so there is a case for intervening high up the income distribution. (A YouGov poll for the Times shows voters slightly favouring support applied equally to all households (47%) than means tested (40%).)

• What about other types of support? IPPR have argued that, though gas prices could remain well above their 2021 levels until 2025, freezing the price cap in place for an extended period has “significant costs”. They argue that “Instead, it could be better to use the time provided by a one-year freeze to put in place a ‘social-tariff’, a measure designed to cap or reduce energy bills for those on the lowest incomes, and accelerate a programme of clean energy and reducing energy demand through home retrofit (though the benefits of the latter two policies will take time to come to fruition).” Retrofitting proposals, such as NEF’s Great Homes Upgrade, and income support proposals such as a Living Income could be seen as complimentary packages and not mutually exclusive. The TUC’s Kate Bell argues that the price cap freeze should come alongside other measures such as increases to social security and minimum wage “at least in line with inflation to October”, funding decent public sector pay rises, fair pay agreements and replacing Universal Credit with a decent system paid at 80% of minimum wage.
• What about businesses? The FSB has been calling for more support as the Energy Price Cap and cost of living packages of support have so far failed to protect businesses from rising costs, some of which are facing five-fold increases in their energy bills. Commenting on the FSB’s Small Business Index, the FT’s Oliver Barnes predicts that “many SMEs, which together employ around three-fifths of the UK’s workforce, will probably collapse without government intervention”. IPPR’s paper suggests that the energy price cap could be broadened to cover all or some businesses, which could further reduce the headline rate of inflation as high energy costs are likely to be feeding into non-energy price rises. (The Mirror’s Dan Bloom also reports that some schools are considering shutting at least one day a week to protect already stretched budgets from rising heating bills. NHS trusts are also struggling with rising energy costs.)

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Public ownership for bankrupted suppliers. So far, Ofgem’s logic in increasing the energy price cap has been to prevent energy suppliers making losses and eventually going bankrupt, which in turn would force consumers to absorb additional costs. (Martin Lewis has argued that “at every turn, in these desperate times where lives are at risk, [Ofgem] has ignored all asks for consumers and instead kowtowed to the industry”.) Bulb was bailed out by the taxpayer when it collapsed last winter, but campaigners such as We Own It want to see it nationalised on a more permanent basis.

• Prioritising protecting households over shareholders. Even energy companies have suggested freezing the level of the energy price cap, but their proposal still involves funds flowing to the shareholders of energy companies as the government might provide loans (up to £50bn to cover 22 million households) repaid over 10 to 15 years, “either by suppliers adding a small surcharge to customers’ bills, or through adding the cost to general taxation.” While Gordon Brown proposed temporary renationalisation of failed energy suppliers in his intervention, Starmer steered clear of committing to nationalisation of energy companies, arguing that all funds should go to compensating households rather than shareholders. (This article explores how much compensation a future Labour government might have to pay foreign energy investors if their 2019 manifesto proposals to nationalise energy were implemented.) However, Common Wealth argues that “unless the energy market is transformed, substantial parts of the £29bn package risks flowing to shareholders. A simpler, practical approach is public ownership: removing rent extraction and to deliver value for money.” 
• Nationalisation is affordable, popular and can reduce bills. The TUC calculates that energy retail company bailouts have so far cost £2.7bn, and taking the Big Five energy retail firms into public ownership would cost just £2.85bn, reduce bills, speed up energy efficiency improvements to homes and cut carbon emissions faster. New polling from We Own It found that 66% of voters support energy being in the public sector. Evidence from 15 Western European countries over the last 30 years has shown that energy prices are 20-30% lower in systems that have publicly owned energy suppliers. ‍
• Paradigm shift towards public ownership? PEF’s James Meadway argues that the “crucial point with the price cap freeze” is that “it has now been tacitly accepted that government *can* interfere in the price mechanism to help deal with inflation. [This is a] major breach in the neoliberal theology that inflation is something *only* the central bank and interest rates can deal with.” Tom Collinge, Progressive Britain’s Head of Policy and Comms, suggested that energy security “clearly cannot be left to the market” and that while not providing a short term solution to price rises, nationalisation “is a long term, structural, solution to long term, structural problems.” The Mail on Sunday’s Dan Hodges argued that “if the major private utilities are unable to provide basic services to their customers at a price that is affordable they should be brought under public control. Not handed subsidies… If the market fails, the state should step in and replace it.”