How to tackle the UK cost of living crisis – the main economic ideas

B oris Johnson has said he will not introduce any new measures to deal with the cost of living crisis. Big spending decisions are being delayed until his successor as prime minister is in post. However, the result of the Conservative leadership election will not be announced until 5 September.

In the meantime, a major increase in the regulated energy price cap, which puts a ceiling on gas and electricity bills, is due to be announced this Friday. It is forecast to rise from just under £2,000, to £3,600 a year for the average household. While the nation waits to hear whether any further help is coming, the Treasury is working on a menu of options.

Here we outline the main ideas, and assess the political and economic impact of each one. Targeted help for the most vulnerable The most limited option for the Treasury is to direct additional help for households to those on the lowest incomes, many of whom are already in fuel poverty and struggling even before the bill increases come in this winter. More than half of British households, 54%, will be in fuel poverty by October and more still in January.

The most targeted way of getting money to the most vulnerable is via increases in universal credit and pension credit. Truss has also promised to reverse the national insurance rise – though many poorer households were not affected by that because the last cost of living intervention by Rishi Sunak as chancellor. Jessica Elgot: This is the most likely level of support Truss is prepared to offer, citing the cost of the package from Sunak announced earlier this year and with the need to fund her promised tax cuts.

She has called it “Gordon Brown economics” to have a high tax burden and then high amounts of state help. But such a route would mean starting her premiership with tax cuts that benefit the wealthy and some additional aid for the poorest – meaning the majority of working people get very little. MPs are worried that is not a sound electoral strategy.

Richard Partington: Charities are calling for the existing £1,200 energy support payment for 8m households on means-tested benefits to be doubled. There is a strong economic case for such targeted support because poor families spend more of their budget on essentials – such as energy and food – than richer households, leaving them the most exposed to the inflation shock. The Resolution Foundation estimates a “cost of living” inflation rate for the poorest of 1.

5 percentage points higher than for the richest. Double the fuel discount from £400 to £800 Sunak announced earlier this year that eligible UK households would receive a £400 discount to help with energy bills from October . Officials have been looking at the potential for people to receive additional support, perhaps up to £800, because forecasts for price rises are now considerably higher.

The discount is easier to administer but somewhat of a blunt instrument because of more well-off households will benefit from the discount. Jessica Elgot: This looks more like the kind of package Sunak would back but Truss has said that she favours giving targeted support rather than increasing the £400 grant for every household, and her allies including the chief secretary to the Treasury, Simon Clarke, have been disparaging about the entire £400 scheme – though have said they would not cancel it. Richard Partington: The case against universal support is that many wealthier households saved money during the pandemic while working from home, with the Bank of England estimating about £180bn of “excess savings”.

With inflation the result of demand outstripping supply, some economists say putting more money in the pockets of those who can afford to keep spending will pour fuel on the inflationary fire. However, others say the scale of the energy shock requires more people than usual to receive support. Scrapping VAT on energy bills This measure, which was first proposed by Labour , is another option being worked on to reduce bills.

VAT on domestic energy is charged at a rate of 5% and it would save a typical consumer £154 over the year, and cost the exchequer about £4. 3bn initially. Removing VAT would help those who face the biggest rise in their energy bills, those who consume the most.

Jessica Elgot: Sunak rejected this as chancellor but has made it a key part of his policy offer as a Conservative leadership candidate. This was widely pilloried by the Truss campaign as a screeching U-turn, making it difficult for her to adopt it in No 10 without losing face. But it has the advantage of being able for a new PM to talk up the measure as a “Brexit freedom ”.

Richard Partington: One consequence of higher energy bills is that the Treasury will rake in more than expected from the VAT charged on them. Giving some of this back to struggling families therefore makes sense. However, Sunak had previously worried that it would be difficult to put the tax back on again in future, which could cause trouble for the government’s budget deficit amid weaker economic growth and rising spending pressures.

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A windfall tax on oil and gas companies is more likely if Sunak wins the leadership contest. Photograph: Jane Barlow/PA A new windfall tax Nadhim Zahawi as chancellor has been candid with energy firms about the option for an expansion of the windfall tax on oil and gas companies announced by Sunak in May. Truss has said she is opposed to windfall taxes though Sunak has not ruled it out if he wins – though that seems unlikely.

Extending the levy could raise £4bn, providing some much needed leeway for the government to help with energy bills. Labour has said the existing windfall tax could be tightened to remove the option for energy firms to claim tax relief on more than 90% of the levy if the money is reinvested. Jessica Elgot: There were raised eyebrows in both leadership camps when Zahawi started talking up the potential for a windfall tax.

Truss and her likely future chancellor, Kwasi Kwarteng, are staunchly opposed to the tax, believing it makes Britain an unpredictable place for investment. Truss has also said profit is “not a dirty word ”. But there is mass public anger about extraordinary profits, which Zahawi has alluded to, so it may be an unpopular stance to defend them.

Richard Partington: Continued high energy prices have helped the world’s five biggest oil companies to bumper profits of nearly £50bn, lining shareholders’ pockets at the expense of consumers. This shows a clear case for a bigger windfall tax. However, chopping and changing the plan could undermine the argument that the policy is a one-off, potentially leading firms to reassess their investment plans.

Scrapping the price rise and absorbing the costs This is the plan that is gaining momentum, backed by Labour and the Lib Dems, so it would be unusual if the Treasury was not beginning some preliminary work on the possibility. It would involve freezing the energy price cap at its current level of just under £2,000 a year rather than allowing it to rise in line with global wholesale gas prices. Labour says the plan would cost just under £30bn, although that’s on the assumption that it would apply only for the next six months – so it may cost much more in the long term.

Jessica Elgot: Both candidates have ruled this out, despite overwhelming public support for the measure, which is backed by 85% of Tory voters. However, given past experience of the Tories dismissing and then adopting popular cost of living policies, it is not impossible this one could seem appealing in the cold light of day in September. Richard Partington: There are clear pros and cons.

A universal cap could halt headline inflation from rising further, potentially saving the government money on inflation-linked borrowing. However, it would have a hefty price tag and need to be in place for a year (inflation is based on the 12 -month change in consumer prices). Free-market economists argue it would destroy price signals; incentivising energy use, rather than lower consumption and investment in insulation.

It would also benefit rich and poor alike. Sign up to the daily Business Today email or follow Guardian Business on Twitter at @BusinessDesk Deficit fund for suppliers to cover fuel price rise The idea has been suggested by the boss of ScottishPower that the government could set up a deficit fund to cover the difference between what people pay and how much it costs to supply their homes with gas and electricity. The fund could be underwritten by the government, or a willing financial institution, and repaid over a 10 to 15 year period to smooth out the costs.

Suppliers would be expected to use the period the scheme was in place to focus on investments in green energy while policymakers delink electricity prices from gas. Jessica Elgot: This could be a way for Truss to U-turn on freezing prices while claiming it is a way to boost investment and get better value for taxpayers’ money. But it would still require vast sums which she has said she is not prepared to spend – and that would be on top of additional billions of spending commitment she has made on tax cuts and defence.

Richard Partington: Spreading energy bills over a longer time frame would ease some of the pain today, helping the economic outlook in the short-term. However, it would build up costs for the future, and would ultimately be a cost ultimately borne by consumers rather than the state. If prices stay high, it would mean higher bills for households in future.

However, it could help smooth the transition, rather than having cliff-edge moments each time the Ofgem price cap is updated. .