Both Liz Truss and Rishi Sunak have promised to cut taxes on energy bills either in the form of green levies or VAT. While it is encouraging to see both candidates attempt to tackle the cost of living crisis and realise that energy bills are the right area on which to focus, such moves would be a mistake.
The first issue is that as an overall percentage of energy bills, both green levies and VAT do not represent a significant proportion of the price paid by consumers. As such, although crapping them might make some small difference, it will still leave consumers facing huge energy bills over the next few months. Therefore, such a move would be ineffective.
It is also a poorly targeted measure. Given that everyone pays the same rate of VAT and energy levies on their bills this would represent a discount to the very wealthy. In fact, as richer households tend to spend more on energy than poorer people, it would represent a substantial giveaway to the very rich.
Such a move would also risk creating a black hole in the public finances. Both green levies and VAT are used by the government to fund public spending – including on essential services. If the Treasury doesn’t raise enough revenue from taxation then it has to borrow the money. There is some debate as to whether or not this would be inflationary – I am not fully convinced of this argument, but higher borrowing does tend to crowd out the private sector leading to lower investment. Regardless, it is generally not a good idea to fund the day to day spending of the government with borrowed money.
Abolishing green levies in particular would be a bad idea. If the UK is to meet its commitment to Net Zero by 2050 (which it absolutely should) then these levies are important as they help to fund investment in renewable energy and nuclear power. The world is facing a climate emergency and there is no time for delay. What is more, a temporary break in payments now just means future pain for future generations who not only will have to face the consequences of our inaction but will also be left footing the bill.
As for VAT, cutting this is also a bad idea. As far as taxes go, VAT has the potential to be one of the better ones. It is an effective revenue raiser for the Treasury while also not being too damaging economically. Unfortunately in the UK the VAT system – just like the rest of the tax system – is poorly designed. There are numerous different rates and exemptions for various goods and services and so adding another one adds further complexity to the system while depriving the public of funds.
Instead of cutting green levies and VAT the government should use the extra revenue raised from increased bills to provide targeted support by redistributing it to those who need it most. This should be done in the form of direct cash transfers to households and should be means tested. It is the very poorest people who are really going to be hurt by the increase in the energy price cap and so it is right that they receive the most support. This should be done on a sliding scale so that other households who are also struggling and may be plunged into financial difficulty receive support as well.
If the next government was feeling particularly bold then it could take this opportunity to fix the VAT system. It should scrap the different rates and exemptions and instead levy VAT on everything (albeit it at a lower rate). This will reduce the burden on businesses and will be less economically distorting and potentially bring in more revenue for the Treasury. This increase in revenue could then be used to provide more generous welfare payments to the very poorest.
There is a cost of living crisis and energy bills are one of the main drivers of this. While it’s encouraging that both Rishi Sunak and Liz Truss understand this, it would be wrong to scrap green levies and VAT on fuel bills. What we need is targeted support for the very poorest and reform of our dysfunctional VAT system.