It is obviously a bit harsh to judge anyone’s premiership by just one announcement on the first day, but a token cut in VAT on domestic electricity bills does not bode well.
In case you missed it, the new government has announced that the rate of VAT charged on domestic electricity bills will be cut from 5% to 0% from October this year. The official statement is vague on how long this will last, but the framing (“to give millions of households breathing space this winter”) implies that this is intended to be a temporary measure until next April.
On the plus side, cutting VAT on electricity bills is a quick and easy win for Andy Burnham and John Healey. Other political parties had also called for this change, so it is hard for them to criticise it.
Nonetheless, it is not a very effective way to tackle the cost of living.
For a start, cutting VAT on electricity bills will only make a tiny difference to most households. The official statement says the move is expected to take around £45 off the annual Ofgem price cap in October. But assuming the cut lasts just six months, it would only save the average household about £25 (electricity use is slightly higher between October and April than in the rest of the year).
This measure is also not well targeted. Poorer people do typically spend proportionately more of their income on domestic energy (you can find the data here), but most of the benefits in cash terms will go to richer people whose bills are generally higher.
Nor will this policy do anything to tackle the underlying reasons why UK electricity prices are so high (especially for businesses), or to help with gas bills.
The reduction in the cost of electricity should reduce headline inflation in October, but by just 0.1 percentage points, and this fall will only be temporary. The Bank of England’s Monetary Policy Committee will therefore give it very little weight, if any, when setting interest rates.
The cost to the Treasury might be relatively small (estimated at £850 million for the six months from October to April), but this reflects the fact that VAT on electricity is currently just 5%. This is already low enough to provide a substantial tax subsidy for the consumption of energy (compared to spending on other goods and services), which is not obviously a “good thing”.
The government has said this measure will be funded by the savings from scrapping digital ID cards. But as Keir Starmer’s close ally Darren Jones has (pointedly) pointed out, there was no budget for digital ID cards in the first place. It is also hard to see this “temporary” cut being reversed any time soon.
It was not possible to cut VAT on electricity bills to zero in Northern Ireland because of EU rules, so the NI Executive will have to be given extra money to support households in other ways.
The upshot is that this policy could quickly morph into another £2 billion each year that the new Chancellor will have to find from somewhere else. Realistically, the reduction in energy bills will be offset by higher taxes. There might still be some distributional benefits, but these will be uneven and unreliable.
More such announcements are expected in the coming days.
The next is likely to be the return of the £2 cap on bus fares in England. But just like the reduction in VAT on electricity, someone will still have to pick up the bill. In this case, bus operators will have to be compensated by an increase in government grants. Moreover, even the official impact assessments show that bus fare caps are poor value for the taxpayer’s money.
It would still be surprising – and worrying – if these announcement amount to anything more substantial. There are good reasons why calls with big fiscal implications are left to the Budget, including the risk of unsettling the markets with large unfunded commitments. Parliament is also just about to break up for the summer.
The scope for big announcements between Budgets is now limited too by the “fiscal lock” introduced by Rachel Reeves. This kicks in if the government announces permanent measures which together cost more than 1% of GDP (say, £30 billion) and triggers a full OBR assessment.
Nonetheless, it has not gone unnoticed that the new administration is already starting to splash the cash. Burnham and Healey may hope to use the limited flexibility within the current fiscal rules to increase borrowing. But market appetite for even more bond issuance is already exhausted. In the meantime, another summer of pre-Budget speculation is likely to dampen business and consumer confidence again.
Worse still, this is all pretty pointless. Inflation happens when too much money chases too few goods and services. This means that tinkering with a handful of prices or subsidising demand will not fix the cost-of-living crisis, especially if funded by growth-killing tax increases. What’s needed instead is sound money and fundamental reforms to boost supply.
Unfortunately, Burnham seems to be continuing where Starmer left off. A token VAT cut and a pound off bus fares might deliver a few positive headlines, but they will barely make a dent in the underlying problems.
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