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IFS response to government cost of living support package

Observation

Paul Johnson, Director of the Institute for Fiscal Studies said:

“Rishi Sunak has announced a genuinely big package of support for households. On average the poorest households will now be approximately compensated for the rising cost of living this year. The flat rate nature of payments to benefit recipients does mean, though, that the package is less generous to poor families with children than to those without. Even so, put these benefit increases alongside the tax rises just implemented, and Mr Sunak is engaging in some serious redistribution from rich to poor - albeit against a backdrop of rising inequality.

While this is coming at substantial fiscal cost, its supposedly temporary nature means he might not be too worried about the impact on the public finances. We will wait to see how the Bank of England responds to a big fiscal loosening in a period of high and rising inflation. If energy prices remain high, or rise even further, it may turn out hard to ensure these changes are genuinely temporary. And there are inevitably going to be families on modest incomes, who are just out of reach of the means tested benefit system, who will feel hard done by relative to the generous treatment of those families not so different from them who are receiving benefits.

The Treasury says the energy profits levy - which takes the tax rate on North Sea profits from 40% to 65% - is expected to raise £5bn this year. This is a reasonable tax to raise under the circumstances, but the chancellor should have been clearer over when and how this additional levy will be phased out as gas and oil prices change”.

Overall size of support for households and impact on government borrowing

The support to households from today’s package is estimated by the Treasury at £15 billion, £5 billion of which is to be covered by this year’s revenue from the new Energy Profits Levy, with the remaining £10 billion adding to borrowing this year.

This is a big package of support. It comes on top of the estimated £22 billion package of household income support from new measures in 2022-23 from announcements already made in the last year, making a gross injection into the economy of £37 billion - a huge sum. Offsetting this there have been substantial tax rises in the current year: the new health and social care levy is forecast to raise £15 billion and the freeze to income tax thresholds a further £3 billion this year (and much much more in later years).

So the overall support package to the economy, net of previously announced tax rises and the proceeds from the new Energy Profits Levy, in the current year is around £14 billion.

A big chunk of this overall policy package can be thought of as a redistribution of resources from the better off to lower income households, who face a higher rate of inflation and are likely to be struggling most with the cost of living. But this is still an injection of around 0.5% of national income into an economy where inflation is already running far above 2% and interest rates are rising.

The direct impact of today’s statement on borrowing beyond this year is modest, given the supposed temporary nature of most of the policies. Borrowing in the following four years, from 2023-24 to 2026-27, will be increased by £1.2 billion a year due to the decision not to make the initial £200 per household energy discount this year repayable over the following four years. This may be more than offset from ongoing revenue from the Energy Profits Levy which is to remain in place until the sooner of when “oil and gas prices return to historically more normal levels” or December 2025.

Carl Emmerson, Deputy Director of the Institute for Fiscal Studies, said:

“Today’s announcement is a big package of support for households this year. But it is not without risks. In particular, if oil and gas prices remain high then the Government will doubtless come under pressure to continue the additional household support for at least a further year. Extending the 5p cut to fuel duties and the £9 billion help with energy bills announced in the March Spring Statement and the £15 billion of additional giveaways for households announced by the Chancellor today for a further 12 months would add a further £26 billion to borrowing in 2023-24.”

Support for households

The government has replaced a previously-announced universal £200 energy discount this year, to be recouped in subsequent years, with a £400 energy discount that will not be recouped. The additional £150 for those in council tax bands A-D remains.

It has also, finally, done something targeted at benefit recipients. This group were set to lose out substantially from the fact that their benefits this year have risen by just 3.1%, despite inflation over the year as a whole now expected to average 8%, because benefits uprating policy uses out-of-date measures of inflation. Hampered by the fact that its computer systems do not allow it to change all benefit rates at short notice, the government has at last found a workaround that allows it to deliver extra support to these households speedily. The 8 million families on means-tested benefits will be paid an additional £650 this year. Pensioners will get another £300, delivered through a higher winter fuel payment, and those on a (non-means-tested non-contributory) disability benefit will get another £150. These are not mutually exclusive.

The need to find a workaround has come at a cost. There is crudeness to the measures. First, the flat rate amounts apply in full to those entitled to very little in benefits, and yet not at all to those whose income is very slightly too high to be entitled, meaning significant inequity in the treatment of very similar families. Second, notwithstanding the extra support for those on disability benefits, these payments do not vary according to how much one is receiving in benefits in the first place, and so they equate to a much bigger percentage increase for some than for others. Had the government instead been able simply to increase benefit rates in line with an updated measure of inflation, these features would have been avoided. Nevertheless, in the absence of that, this workaround does provide significant relief to this group of people.

Living standards

Today’s announcements come against a backdrop of inflation expected to average 8% over the current financial year (and to peak at an even higher level than that in the Autumn), with nominal earnings expected to lag that considerably, growing at 5.75% according to the Bank of England’s May forecast. They also follow measures already announced in recent months which cut taxes for many on low-to-middle earnings while raising them for higher earners. Taking all this together:

  • A worker on median earnings (around £29,000) will now see their real take-home incomes stay approximately the same this year as last. The real-terms fall in their take-home earnings is roughly offset by the flat rate support delivered through the council tax rebate and energy discount.

  • A full-time minimum wage worker (on around £16,200) will now be about £340 better off this year, after adjusting for inflation, than last year. Although the minimum wage will fall in real terms, the £550 of flat rate support easily offsets the impact of that, and they are net beneficiaries from changes to direct taxes due to the rise in the NICs threshold.

  • An out-of-work single parent home-owner with two children will also see their real income stay approximately the same this year as last. This is because the additional flat rate support is broadly equivalent to having increased their benefits in line with the actual expected inflation rate of 8% this year. However, for some families in receipt of more in benefits the flat rate support will not be enough to keep their real incomes constant, while for some in receipt of less in benefits it will mean real increases in income.

Change in take-home income

Notes: First 3 households receive no benefits and have no working partner. The last 2 households are assumed to be lone parent homeowners with 2 children. None of the households are disabled and all are in council tax band A-D properties. ‘With no measures’ incorporates real earnings changes and rates and thresholds by default rising more slowly than expected inflation. Measures incorporate the half-year effect of removing the temporary UC uplift (since it was in place for half of the previous financial year).

Energy profits levy

The new energy profits levy of 25% – much higher than the 10% Labour had proposed – takes the overall tax rate on North Sea oil and gas profits from 40% to 65% from now until December 2025 (or sooner ‘if oil and gas prices return to historically more normal levels’). That is a much higher rate than is paid by onshore companies, but broadly typical of the historical rates of North Sea taxation since the 1970s.
Far from this tax rise discouraging investment in the North Sea, a new ‘super-deduction’ means that North Sea investment will be massively subsidised while the higher tax rate is in place.

Stuart Adam, a Senior Economist at the IFS, said:

“The new super-deduction means that investing £100 in the North Sea will cost companies only £8.75, with the remaining cost paid by the government. So a massively loss-making investment could still be profitable after tax. It is hard to see why the government should provide such huge tax subsidies and thereby incentivise even economically unviable projects.”

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