Wrong answer

The Labour Party seems very pleased with itself following Sir Keir Starmer’s announcement that, if he were Prime Minister, his Government would freeze energy prices at current (August 2022) levels for six months and pay for it by a further “windfall tax” on energy companies.  Apparently, opinion polls show overwhelming public support for such a measure, which is also endorsed by the LibDems and the SNP.  Of course, it is easy to make such declarations when there is no chance of being able to carry them out.

What Sir Keir did not explain is what would happen next spring when the energy price cap is due to be reviewed again.  Would the freeze be extended ? and if so how would it be paid for?  As the IFS has pointed out, a price freeze would benefit most those who use the most energy – and conversely.  Not a very socialist idea.

What Sir Keir’s crowd-pleasing proposal fails to address is the fact that the recent sharp and probably permanent increase in world commodity prices (including foodstuffs and metals as well as fossil fuels) must inevitably lead to a reduction in the real GDP, and hence in the living standards, of importing countries such as the UK. This unwelcome fact cannot be wished away by subsidising consumption.

The general economic argument against subsidies is that they distort or disguise market signals – in this case, the need to drastically reduce our use of energy.  Under Sir Keir’s plan there would be no incentive, particularly for the well off, to turn down the central heating, switch off unnecessary lights or improve home insulation.  Moreover, at a time when we are supposed to be aiming for net zero CO₂ emissions it is fundamentally wrong to be actually subsidising the burning of fossil fuels.  For the same reason, it is wrong to be reducing fuel duty or abolishing VAT on energy. (It also goes without saying that the proposal to cut taxes generally, as proposed by one of the Conservative leadership candidates, is irrelevant).

The appropriate policy response to the problem of “fuel poverty” (usually defined as spending over 10% of disposable income on home heating) is to increase the income of those in poverty.  As the forecast increase in fuel bills is ca £2000/year per household, this suggests that an immediate temporary increase of £40/week in Universal Credit for the poorest households, together with commensurate increases in other income support payments, would compensate for the higher bills. In the medium term the £40/week could be absorbed into a permanent increase in the rates of benefit payment.

It will be recalled that during the Corona pandemic a £20/week supplement was added to Universal Credit but then abolished last year.  At that time this was obviously considered to be easily affordable, so it should not be difficult to finance the above proposal – if necessary, by increasing the standard and higher rates of  income tax (rather than increasing National Insurance, as proposed by the last Chancellor).

This would represent a far better targeted and more effective policy, especially in the long term, than the half-baked proposal of the Labour Leader.