Chancellor Rishi Sunak has spent the week listening to advice from Conservative MPs on how to steer a course around what Labour has called the cost-of-living “iceberg” looming over British politics.
Whether it is cutting taxes, increasing welfare benefits or suspending “green levies” on energy bills, all of the potential mitigations are expensive and there are no easy fixes.
Sunak has acknowledged something will have to be done as economists warn of the worst squeeze on living standards since the financial crisis. “With Covid, he was not afraid to do the unconventional thing and to go big,” said one ally of the chancellor.
But having just spent £400bn on propping up the economy during the coronavirus pandemic, his room for manoeuvre in dealing with the cost-of-living crunch is heavily constrained.
With inflation above 5 per cent and rising — and with interest rates heading up — the chancellor has told colleagues he will not borrow his way out of the problems, thereby adding to debt servicing costs.
“Nigel Lawson wouldn’t have done that,” Sunak told the cabinet this week, referring to Margaret Thatcher’s chancellor during the 1980s. Tax cuts funded by new public spending reductions are meanwhile deemed politically unpalatable.
The cost-of-living crisis is set to peak in April, when big energy price rises coincide with tax increases that will jointly cost a typical household more than £1,000 a year.
Tory MPs are pressing the chancellor to act ahead of local elections in May, and there are at least four potential options:
Scrapping VAT on energy bills
The freedom to cut value added tax on domestic energy from 5 per cent to zero was once touted by Boris Johnson as a “Brexit dividend”, but the prime minister said this week it would be a “blunt instrument”.
The policy would cost £2bn, according to the Resolution Foundation, a think-tank, and thereby cut energy bills by about £100 per household. But, as Johnson pointed out, the cut would benefit everyone, not just the poor.
In April the energy price cap covering millions of households could rise by up to £700, to almost £2,000 per household, in response to surging wholesale gas and power prices. So a VAT cut alone — backed by some Tory MPs and Labour — would only dent the problem.
Ditching planned tax rises for April
Jacob Rees-Mogg, leader of the House of Commons, this week called for April’s planned £12bn rise in national insurance contributions to be dropped. When challenged by cabinet colleagues, he could not say exactly where he would find the savings to fund the cut.
Sunak is also freezing income tax thresholds in April, sucking more people into higher tax bands. The Daily Telegraph, Johnson’s former employer, asked this week: “Is that really why people vote Tory?”
Sunak cannot afford to reverse the two tax moves, which on a combined basis will cost a typical household £600 a year from April. Downing Street has indicated they will go ahead as planned.
Removing green levies from electricity bills
Some 20 Tory MPs and peers this month called for the suspension of green levies on electricity bills that pay for renewable energy schemes.
But ministers point out the levies are intended to fund Britain’s transition away from gas. Awkwardly, Britain has just chaired the UN COP26 climate change summit.
Torsten Bell, chief executive of the Resolution Foundation, said that shifting £160 of green levies from electricity bills on to general taxation would add £4.5bn to the overall tax bill, which is not an attractive proposition for Sunak.
Increasing support for the vulnerable
Targeted help on energy bills is already available through the warm homes discount, which provides a price rebate of £140 for 2.7m poorer households. Sunak is considering expanding it.
But that scheme is financed through a levy on the energy bills of better-off households. If the scheme were expanded to 8.5m households, with the taxpayer funding a £300 payment, Bell said that would cost up to £2.5bn.
Paul Johnson, director of the Institute for Fiscal Studies, said Sunak could ease the cost-of-living crunch for the poorest households by increasing welfare benefits sharply in April and recouping the cost by freezing them for the following two years — hopefully when inflation has retreated.
But he pointed out the big political issue for Johnson and Sunak are the problems facing millions of people — potentially Tory voters — on low and middle incomes. “If you give 10m people £500, that’s £5bn right there,” said Paul Johnson.