Should VAT on gas and electricity be cut?

Households have been warned that they face an energy bill ‘double whammy’ this year. The expected big rise in April and October, has raised the question, should VAT on gas and electricity be cut?

 

Prices rising

In December, Dame Clare Moriarty, Citizens Advice Chief Executive, said: “Energy customers are facing a multibillion-pound bill, in large part because Ofgem missed multiple opportunities to tackle rule-breaking by suppliers.”

Rising energy bills have raised concerns over the cost of living.

Only last week, Centrica CEO Chris O’Shea said there was "no reason" to expect gas prices would come down "any time soon".

"The market suggests the high gas prices will be here for the next 18 months to two years"

 

How much money would cutting VAT to zero save consumers?

VAT on domestic energy bills in the UK is currently charged at 5%.

Household savings would depend on energy usage, tariff type and energy provider.

Energy regulator, Ofgem, states that the average energy bill for a customer on a standard variable tariff, is £1,277 a year. Therefore, the VAT and possible saving of more than £60 a year.

 

The downside to cutting VAT to zero

Reducing VAT on energy bills to zero does not target the most vulnerable households and those facing fuel poverty. Any saving would be worth more to affluent households, who have bigger homes and spend more on energy bills.

Analysis by charity The Joseph Rowntree Foundation, claims the poorest families will be hit disproportionately hard when the price cap rises in April this year. They say some of those earning the least could end up spending 54% of their household income on energy bills, leaving them unable to cope and pushed into fuel poverty.

Additionally, making fossil fuels, such as natural gas, cheaper will not help the UK achieve environmental targets. This would require the government to reconsider its environmental agenda, months after hosting a global climate summit.

Although there does appear to be some cross-party agreement, according to HMRC, cutting VAT to zero would cost the government £1.7bn.

As a political judgement, cutting VAT to zero on gas and electricity may well prove to be all too tempting. However, would it prove to be a sensible response to rising energy prices or a temporary fix to an industry in need of reform?

 

Other Option - Government payments

Only yesterday, the Financial Times reported that the UK is exploring a radical intervention, under which the government would make payments to energy suppliers when wholesale gas prices rise sharply.

Energy suppliers would receive government payments when wholesale gas prices exceed a certain threshold, in essence, stopping them passing the increase on to the consumer.

  

Other option - Government loans to energy suppliers

Energy chiefs reportedly requested £20bn during talks with Business secretary Kwasi Kwarteng last year, to help energy suppliers spread the cost of high prices over time.

How feasible the loan deal is would depend on whether the unprecedented wholesale gas price rise is temporary. It could also set an unwanted pattern for subsidies to other businesses who are dependent on product prices.

Investment bank, Goldman Sachs, expects the government to provide some support, but said: “We think the government will step in with some support, but this is more likely to be a few billions, rather than tens of billions.”

  

Other option – Warm Home Discount

The current  Warm Homes Discount scheme provides a £140 saving to more than 2m UK households.

The discount could rise from £140 to £240 and the coverage could be expanded to 8.5m low income households throughout the UK.

Sir Ed Davey, leader of the Liberal Democrats, has proposed increasing that payment to £300 as well as widening the number of eligible households.

 

Other option – Green levy

The Energy Company Obligation (ECO) or green levy, adds £29 to the average annual energy bill for consumers who are not improving the energy efficiency of their homes.

It covers the cost of insulation for low-income households and the £1bn scheme could be cut to reduce the rising energy costs.

However, as the scheme is subject to a binding contract, the government would still have to pay, even if it was taken off consumer bills.

 

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