What the new chancellor should do to help struggling households
Like a couple of ageing rockers, Liz Truss and Rishi Sunak have spent the summer traveling the country, banging out their greatest hits. Truss opened and closed with tax cuts as the solution to the cost of living crisis, and given that she’s the front runner, this could end up being the government’s headline response.
However, it’s not the only option on the table, and when campaigning rhetoric meets stark reality, the scale of the damage being done to people’s financial resilience means there may well be other priorities she has to consider first.
Targeted support for vulnerable people
A huge part of Truss’s campaign has been built on tax cuts, including dropping VAT to 15%, cutting national insurance and removing green levies on energy bills. This will mean people lose less of their income to these taxes, but it’s not particularly well targeted towards those who need the most help.
Those on higher incomes tend to spend the most, so pay the most VAT. They also earn the most so stand to gain the most from lower national insurance.
Meanwhile, those on the lowest incomes pay less of all of these taxes, so gain the least.
Read more: New PM’s term in office to be marked by deepest living standards squeeze in a century
Even if a rise in the personal allowance was considered, it wouldn’t help those who earn less than the threshold already, and it would still support higher earners making up to £125,140.
The problem with less-effectively-targeted help is that there’s a risk it could feed even more inflation.
Truss has also suggested that there may be more targeted support for vulnerable people, who need help the most. This is absolutely essential.
It’s hard to overstate the horrible scale of the challenges facing people whose finances have been stretched beyond breaking point. The Resolution Foundation forecasts that the number of people in absolute poverty will rise by 3 million by April 2024, with 21% of people in poverty — and 30% of children.
People cannot be left to struggle alone, so whatever else happens, this is the first priority.
This could mean bringing in new subsidised tariffs for those facing the biggest financial challenges.
Alternatively it could mean additional payments for those on the very lowest incomes, or more support through the universal credit system. Benefits only rose 3.1% in April, which means an entire year of impossible struggle, so improving uprating of benefits needs to be considered.
Watch: What is a recession and how do we spot one?
More widespread support
Energy price rises are so profound that, in addition to causing enormous problems for those who are already struggling, it will throw huge numbers of people further up the income scale into financial difficulties.
The Resolution Foundation found that without any policy changes, real household income is expected to fall 10% in the next two years — the biggest two-year drop in the last century — and equivalent to a £2,800 cut.
The majority of households are going to reel from that kind of hit. It means the government may need to offer more widespread support, and at that point it faces the challenge that it can’t afford to do this at the same time as cutting taxes.
If the government offers more support, it could come in a number of ways. There could be more helicopter payments, following the £400 payment for all bill payers and the additional payments for those on low incomes and pensioners.
Read more: Energy inefficient homes face £6,600 bills from October
There are a couple of issues with this. The first is that a universal payment is very poorly targeted — reaching people on high incomes with no need for the extra money.
In addition, the Office for National Statistics has said that it considers these payments to be a rise in income rather than a fall in spending, so it won’t do anything to bring down inflation. It means it doesn’t help avoid more interest rate hikes, which threaten to make the economic slowdown even more painful.
The targeted payments are likely to do more immediate good for those who receive them. However, they’re not flawless. Unless this cash goes directly into energy accounts, because we’re human and are driven by more than maths, it’s not all going to be spent in the most economically efficient way. It means there’s a risk this won’t cover people’s additional costs and could fuel inflation again.
Freeze the energy price cap
These problems could be avoided with an alternative approach — a freeze in the energy price cap.
However, if this is unfunded it would mean energy companies going under, so it raises the question of how to pay for it.
Among those who have proposed a freeze, potential ways of paying for a price cap freeze have varied widely.
Scottish Power proposed a commercial loan, backed by the government, and repaid by consumers through higher prices for 15 years — spreading the cost.
Ovo proposed a variation on this, using the loans to subsidise bills specifically for those on lower incomes.
Read more: UK energy bills discount will not lower inflation, says ONS
Other potential suggestions include a windfall tax on energy companies or a redistribution of the £400 being paid to every household.
During the campaign, Truss was dismissive of plans for a freeze, but that doesn’t make it impossible — not every campaigning pledge makes it to the statute books.
Support for businesses
It’s not just domestic consumers facing horrible challenges. Rising energy prices have had a big impact on businesses, which don’t benefit from the price cap.
While many of them have tried to absorb at least some of the extra costs, the rest is being passed on to consumers through higher prices. Those businesses who don’t have the pricing power to do so, risk going under.
Truss has suggested that cuts in corporation tax will help offset rising energy costs.
If she continues down the tax cut road, she could do something with business rates too.
Read more: Food prices rising at fastest rate since 2008 as inflation surges
This would fit with the ideology that over the short term tax cuts will help offset costs and over the long term it could help businesses reinvest and grow.
However, the effectiveness of this depends on how much of the extra costs are offset. If it’s just another drop in the ocean, it might be more effective in the short term to consider whether there’s a role for a price cap, particularly for smaller and more vulnerable businesses.
All of these potential solutions would help address the short-term squeeze on prices. However, the government needs longer-term solutions too.
This includes ensuring that the transition to sustainable energy sources is as quick and effective as possible, and that the country sees a revolution in insulation.
As ever, the devil will be in the detail. But a freeze in the domestic energy price cap, along with support for businesses, help for the most vulnerable, and step change in our approach to insulation has a number of benefits.
For some politicians, the answer is tax cuts regardless of what the question is, but the new chancellor needs to think long and hard before taking this path, to ensure we get a solution that’s as radical as the price rises have been.
Watch: Public offer views on Truss or Sunak
Sarah Coles is a personal finance analyst at Hargreaves Lansdown and co-presents Switch Your Money On podcast.