Protecting vulnerable from £700 hike in energy bills means hard choices now | Nils Pratley

It’s choose your poison time for a government that must know allowing low-income households to suffer the full blast of the scheduled rise in energy bills in April is a political non starter.

After six months of high gas prices in the wholesale market, the regulator Ofgem’s price-setting formula is likely to spit out a figure close to £2,000 on average for an annual dual-fuel bill, or a year-on-year increase of roughly £700. That is simply unaffordable for many. And the implied £20bn-ish hit to discretionary consumer spending will do little to encourage a whoosh of post-Omicron activity the Treasury is relying on in other areas of the economy. Some form of subsidy or smoothing mechanism for bills must be found.

From where the chancellor sits, though, you can see why he may not fancy cutting VAT. It’s charged at 5% on energy bills, so even a temporary removal would only reduce a £2,000 bill by £100. Nor would it be targeted: all bill payers would benefit. On that score, Boris Johnson is correct to describe it as “a blunt instrument”.

Rishi Sunak’s real worry, though, may be whether an intended temporary measure could become semi-permanent. The Treasury, remember, is trusting that VAT receipts from electricity will rise over time as fuel duties from petrol and diesel decline when we plug in our electric cars. It needs VAT to be seen as fixed.

A windfall tax on North Sea gas producers? That will be tempting, but the design would be key. Some of the producers who are enjoying current conditions are also hooked into government-backed carbon capture projects, so a windfall tax risks complaints about jeopardising long-term incentives and investment. Should nuclear generators, or energy trading firms, also be included since they are also beneficiaries of high wholesale prices? Determining who should pay, and defining a “windfall” profit while wholesale prices are still volatile, can quickly become a messy business.

Back in 1997, the beauty of the then chancellor Gordon Brown’s windfall tax on privatised utilities was its simplicity: it was levied on the grounds that the companies had been sold off too cheaply, which was almost unarguable. Definitions were clear and boardroom grumbling could be ignored.

Boosting the size and availability of the warm homes discount available to vulnerable households is a far simpler idea. There is at least an established mechanism for payments and the benefits, unlike with a VAT removal, would be targeted. How much would it cost to make a meaningful difference? A case can be made for any number as high as £10bn, which would upset the Treasury’s spending arithmetic for the next financial year. And, again, Sunak may fret about an exit given that analysts expect next autumn’s price cap to be set even higher than April’s.

Thus you can see the political temptation to grant a £20bn multi-year loan to energy supply companies to make them manage the headache. The government would avoid the appearance of setting energy bills and consumers would pay over time.

It’s hardly a pain-free or risk-free option, however. It means telling consumers their bills won’t fall even when wholesale prices do. And underwriting loans to a sector where two dozen companies have gone bust in the last three months would be a brave move. The government has already nationalised Bulb and probably does not want to add to its collection of failed suppliers.

It is hard to predict where ministers will land among this range of unattractive choices, but a massively expanded warm homes scheme gets the vote here. It would be targeted, which is an essential requirement, and would confront the problem head-on instead of putting the bill on the never-never. The hardest part would be expanding the definition of “vulnerable” consumers: the whole point about a £700 hike to the default tariff is that newly vulnerable households will be created, which is the penny that is dropping only belatedly among ministers.

Meetings with supply companies, as on Wednesday, don’t change the basic fact that a political choice has to be made about how much money to throw at easing the price shock. Doing nothing is not plausible. Ofgem sets the price cap in early February and any support scheme for low-income households needs to be announced simultaneously. Ministers need to hurry up.