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Truss will be the UK’s 56th prime minister and has pledged to move swiftly to protect households against soaring energy bills. According to reports, her plan is likely to include a freeze on the energy price cap. Here are some pros and cons of the policy, which had already been touted by the opposition Labour and Liberal Democrat parties.
Advantages
- Clarity
A straight freeze on average annual household energy bills targets the crisis directly. It reassures households that their unit costs will not rise, allowing them to plan family budgets by removing the threat of further financial hardship. The government has already committed £37 billion ($43 billion) of help, with the money targeted more heavily at poorer households. If bills are frozen at the current cap, £1,971 a year, the existing package may be sufficient. If the cap is frozen at the Oct. 1 rate of £3,549, more direct help may be needed.
It is worth bearing in mind that last autumn, the price cap was £1,277. Even a freeze at current levels represents a painful increase for many families.
- Peak inflation
A side-effect of freezing energy bills would be the impact on broader inflation, which is already five times higher than the Bank of England’s 2% target. According to the central bank, energy accounts for “more than half of the overshoot.”
The government could save £30 billion in the first year by pulling down inflation in this way, according to Bloomberg estimates. That is the net saving to the public purse by reducing index-linked debt costs and welfare payments, calculated by extrapolating Bank of America forecasts and using the Office for Budget Responsibility’s “ready reckoners,” which estimate the effect of changes to growth, rates or inflation on government revenue.
Cutting headline inflation would also lower other household bills linked to price-rises, such as mobile phone contracts, and ease pressure on employers to agree to high wage settlements that could lead to a wage-price spiral.
- Buying time
Freezing gas prices would buy the government time to introduce market reforms, such as changing how electricity prices are determined. The existing marginal pricing system uses the highest input cost, currently gas. It could be replaced with a blended cost model, which would reflect cheaper sources of energy such as renewables.
Another reform being discussed in Whitehall is to improve liquidity in wholesale markets, which would help bring the price down.
- Political popularity
According to polling by YouGov, 69% of Britons think freezing energy bills over the winter is a good idea, compared with just 13% who disagree. But doing so would not be risk-free for the incoming prime minister. Just as the windfall tax imposed on energy companies under Boris Johnson was originally a proposal by Labour, so the main opposition party has led the charge for a freezing of energy bills. What that means, essentially, is that on the biggest issue facing Britons in the coming months, it’s Keir Starmer who can claim to be setting the agenda.
Disadvantages
- Enormous cost
Freezing the price cap risks unlimited costs for either energy suppliers or the state. Labour has pledged to subsidize suppliers to cover the difference between the retail cap and the wholesale price. On current estimates, the full-year bill could hit £100 billion — equivalent to around 5% of GDP — or at least as much as the £78 billion spent on the furlough and self-employed income support schemes during the pandemic. That could put the UK’s fiscal position at risk, raising fresh concern among investors and threatening another drop in the pound.
The industry has proposed a deficit fund, with the cost recovered by a levy on future bills over 10 to 15 years. However, the deficit fund may be hard to enforce. As chancellor, Sunak had to switch his initial buy-now-pay-later mechanism into direct income support. An alternative, as proposed by former prime minister Gordon Brown, would be to nationalize energy suppliers as they inevitably went bust. Critics say that would merely add an administrative burden without changing the cost.
- Poorly Targeted
A price freeze would help wealthy households in cash terms more than poor households, as those with larger homes are bigger users of energy.
People on low incomes are, needless to say, far more at risk from soaring bills. For those on energy meters, almost half of their disposable income will go on heating, the Resolution Foundation think tank says. Truss said she would prefer targeted interventions to ensure taxpayer money is spent wisely. For that reason, the price freeze may be tapered or means-tested in some way. She has also proposed broader tax cuts that will disproportionately favor those on high incomes.
- Distorted incentives
Subsidizing bills lowers the incentive for people to cut their energy use. At a time when the UK is potentially facing industry blackouts, it would be useful to encourage households to turn down thermostats. British homes account for a third of national energy consumption.
- Back to business
A household energy price cap does nothing for businesses and may drive their prices higher as suppliers try to recoup any additional costs. Small business groups warn of hundreds of thousands of job losses if they have to close in the face of crippling energy bills, hammering households indirectly even if their bills are frozen. Truss is said to be eyeing a separate business bailout.
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