Policy Background Briefing

1. Context: The Cost of Living Crisis 

The price crisis

Households in the UK are facing a once in a generation fall in living standards as a result of dramatic rises in prices of essential goods and services without equivalent rises in incomes. The Bank of England now estimates that the UK CPI inflation rate will peak at 11% this year, with inflation not predicted by the Bank to fall back to its 2 per cent target until 2024. 

These price rises are driven mainly by external pressures, predominantly the rise in energy prices following Russia’s invasion of Ukraine. However, the UK is set to suffer higher inflation compared to other G7 economies, and is predicted by the IMF to be slowest to return to its 2% target.

The crisis of inequality

For millions of people in the UK, the cost of living crisis did not begin in recent months. It has been a constant and growing pressure on their livelihoods and wellbeing for years.

The last decade has seen a toxic mix of stagnant incomes and an active dismantling of the UK’s social security system which has brought an ever increasing number of people closer to the poverty line (measured as 60% of median household income). Between 2014 and 2019 the number of children living in poverty in the UK increased by 500,000 to 4.3 million, while the number of emergency food parcels distributed by the Trussell Trust charity reached 1.9m in 2019/20 (up from 61,000 in 2010/11).

Successive economic shocks, from the 2008 financial crisis to the Covid-19 pandemic, and the policy choices made by  governments in response to these shocks, have added to the stresses on family budgets, and the most recent price spike is just another step on a journey that has made living in Britain unaffordable for millions of people.

But these crises have not affected everyone equally. The long-running cost of living crisis has corresponded with a boom in incomes at the top and a rise in asset prices, dividend payments, and share buy-backs from large companies. Most obviously, the energy price shock has resulted in multi-billion pound windfall profits for oil and gas producers, which are being used to deliver sky-high pay-outs to shareholders.

The general pattern of recent years is that, through good times and bad, those who have the most wealth have been able to protect their economic position, and even to grow their share of the country’s total wealth, while those who have the least have paid the price through ever declining living standards.   

The solutions

This paper argues that the Government can and should deliver a response which addresses the long-term structural problems with the economy which underpin this cost of living crisis, rather than just offering sticking-plaster solutions. 

We argue that this emergency package must include the following three elements:

1. Guarantee of affordable, clean energy for everyone
2. Ensure everyone has access to a Living Income
3. Reform the tax system with higher taxes on wealth

2. Guarantee affordable, clean energy for everyone 

Context: Energy price hikes and the Energy Price Guarantee

Wholesale energy prices began to increase towards the end of 2021 as demand for energy increased with economies across the world emerging from Covid-19 lockdowns. The year ending April 2022 already accounted for the largest annual price increase on record since 1970. Since then, the Russian invasion of Ukraine has pushed up wholesale energy prices even further as markets have priced in concerns about supply disruptions. 

While rising energy costs have impacted countries across Europe, the UK has seen one of  the sharpest increases in the cost of living – particularly for low income households. This in part reflects a number structural features of the UK labour and energy markets, including low pay, a heavy reliance on imported gas for heating and electricity generation; a fragmented private energy sector; a lack of resilience and storage facilities; and poorly insulated housing stock.

In September 2022, the new Prime Minister Liz Truss announced the introduction of a new ‘Energy Price Guarantee’ scheme in response to soaring energy prices. Under the scheme, a typical household will pay an average of £2,500 a year on their energy bills.  Originally bills were to be frozen until 2024, but Chancellor Jeremy Hunt has since restricted this to April 2023.

The Energy Price Guarantee will provide vital short-term relief, but will still leave energy unaffordable for many. It also does little to address the underlying structural problems that have left the UK so acutely exposed to soaring global gas prices, or to help the UK transition to a more resilient and sustainable energy system.

To really guarantee affordable, clean energy for all in the long term, we need a different approach.

A universal right to affordable energy

Firstly, the valuable breathing space that has been provided by the Energy Price Guarantee should be used to design a more effective and longer lasting energy bill system. This could include the introduction of a form of ‘free basic energy’, taking the form of a rising block tariff where every family receives a free energy allowance, with a rising marginal cost for energy use above this level.

The New Economics Foundation (NEF) has published illustrative modelling of a system that would see the first 8,000 kilowatt hours of gas and 2,000 kilowatt hours of electricity free of charge, irrespective of tariff. Above this, the unit cost of both gas and electricity consumption are set at a higher rate. 

The advantage of such a system would be threefold. Firstly, it would provide all households with a basic amount of energy for free, guaranteeing universal access. The system would also reduce the overall cost of energy for households which tend to consume less energy therefore improving affordability. Finally, the system would provide a strong incentive to use less energy. The NEF modelling found that most households could make significant savings from reduced energy consumption.

NEF estimates that the proposal would require a temporary subsidy to energy retailers of around £14.6bn per year from April 2023 onwards. However, once energy prices come down the amount of free energy available to families could also be reduced to ensure the whole system was fiscally neutral. 

Reforming tariffs in this way could therefore enhance affordability and access, and help reduce the UK’s dependence on fossil fuels. However, this alone will not be sufficient to future-proof Britain’s energy system, unless it is accompanied by wider structural reforms to the way that energy is generated, distributed and sold.

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Reforming the energy market

The UK’s fragmented, privatised energy system has been a significant contributor to the current energy crisis. To move towards a system in the future which provides clean affordable energy for everyone, we need bigger changes to energy generation, distribution and supply. 

Generation

In energy generation, the UK has been left exposed to high gas prices by our reliance on gas for heating our homes and for generating around one third of our electricity. A key priority should therefore be to reduce our reliance on volatile and unsustainable fossil fuels while scaling up domestically-generated low carbon energy.

The private sector has failed to deliver investment in renewable energy at the pace and scale required. One way to boost investment in low-carbon energy generation would be to establish a public  renewables company, learning from successful examples internationally such as Ørsted in Denmark. Such a company could work in strategic partnership with the private sector to scale up domestic renewables capabilities. The company could also benefit from low-cost financing from the UK Infrastructure Bank (UKIB), which has been established with a mission to achieve the government’s net zero emissions target by 2050. Given that the cost of capital is one of the largest cost-drivers of renewable energy projects, borrowing from the UKIB at concessional rates would help to drive down project costs and become more price competitive with international competitors. 

Distribution

Since privatisation, UK energy networks have been owned and managed by a set of privately owned monopolies. Network costs account for over a quarter of gas and electricity bills, and therefore have a significant impact on household bills. The UK’s energy networks also have a vital role to play in accelerating decarbonisation, but this requires significant infrastructure upgrades to harness Britain’s renewable energy potential.

In recent years however, these private monopolies have been criticised for making large profits for their multinational owners and shareholders, and for moving too slowly in supporting the net zero transition. A study undertaken by the Energy and Climate Intelligence Unit estimated that around one-third of electricity distribution network operators’ revenue was being realised as profit, and at least half of this was being paid out to shareholders. 

The UK Government has already set out plans to bring parts of the private energy networks into public ownership. Given the growing pressure on household bills, and the need for large-scale investment and coordination to accelerate decarbonisation, it is important to now consider whether they should go further and bring the rest of the UK’s energy networks into a form of public ownership. There are a variety of forms this could take which would allow strategic changes to energy distribution which deliver greater affordability for households, decarbonisation, and energy security. The profits that are currently paid out as shareholder dividends could be reinvested into upgrading networks, or passed onto customers in the form of lower bills. 

Supply

Problems with the energy retail market have been a feature of the UK political debate for years. The initial problem was that a lack of competition between the ‘Big 6’ energy firms and the difficulty of switching suppliers led to customers overpaying for energy. In 2014 Ofgem reduced the barriers to entry for the energy supply market. While this allowed new players to enter the market, some new entrants embraced high-risk and precarious business models that left them vulnerable to market shocks. In addition, it is questionable whether the level playing field that is required to have effective competition could ever be established in the energy retail market. 

As a result, when wholesale gas prices started to soar in 2021, many smaller retailers experienced financial difficulties, and the Government has already been forced to intervene on a major scale. The UK’s seventh largest energy retailer, Bulb, has been placed under special administration, constituting the largest taxpayer bailout of a private company (£2.7bn) since RBS in 2008.

Overall it is not clear that the improvements to competition in the energy retail market have delivered tangible benefits to customers. The market design has meant that energy retailers have prioritised short-term customer acquisition over energy efficiency and reducing people’s bills. Furthermore, the current system design for this essential service means that while profits in the good times are privatised, the costs and risks of failure are ultimately borne by the state, as the quasi-nationalisation of Bulb shows.

As the Government intervenes heavily in the energy market to protect households from energy prices, they should look more fundamentally at whether this model of energy supply is working for the public, and whether a system which takes energy supply out of the private sector (either wholly, or in part) would deliver greater benefits. These benefits could include faster action on measures such as insulation, as well as the ability to buy energy over a longer period of time and thus keep prices low.

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3. Ensure everyone has access to a Living Income

Context: Stagnant wages and dismantled social safety net

While energy price shocks are the immediate drivers of this crisis, the crisis is fundamentally a crisis of incomes, and it has been a long time coming. Current inflation hikes are rapidly eroding household purchasing power, further impoverishing households on low incomes, creating insecurity and anxiety for middle income households, and threatening a recession in the near future. 

This income shock comes after a ‘lost decade’ of earnings growth, whilst consecutive governments have actively dismantled our social security system to the point where it is no longer capable of preventing people from falling into poverty, even those who have been able to access some form of employment. 

From 1970 until 2007, real wages grew by an average of 33% a decade, but this fell below zero after the financial crisis. Working people lost nearly £20,000 in real earnings between 2008 and 2021, because of pay growth falling below the rate of inflation. The UK is now near the bottom of the OECD ranking for pay growth, meaning the average UK household is £8,800 poorer than their counterparts in France, Germany, Australia, Canada and the Netherlands.

Stagnant wage growth means that work is no longer a guaranteed route out of poverty; in-work poverty rose to 17% of the workforce before the pandemic hit in 2020.

As wages have stagnated, the minimum wage has also seen slow growth in recent years and currently stands at just £9.50 per hour for over 23s. UK trade unions are campaigning for a £15 minimum wage.

Incomes desperately need to recover lost ground to help people cope with soaring living costs and mitigate the severity of the predicted recession. The Bank of England currently predicts a recession that could result in the loss of one million jobs. The Government has argued that wage increases could lead to a wage price spiral, but this claim has been roundly refuted by economists.

Meanwhile, reforms to social security implemented by successive governments over the last decade have resulted in a weak and ineffective income safety net, unable to prevent destitution and prevent the deeply harmful impacts of poverty on individuals, families and society. Political choices to make the poorest in society bear the burden of the 2008 bank bail-outs hit the most vulnerable the hardest. 

The overall level of unemployment benefit has been in steady decline for decades, from around 30% of average wages in 1979 to less than 16% today. This compares poorly to our European neighbours, where unemployment support is typically significantly higher. The social security system in the UK has also been undermined by punitive measures and conditionality, such as the five week wait for universal credit payments, the two child limit, and the benefits cap, which further detract from its ability to act as a social safety net and provide incomes that people can live on.

The social security system is now so weak, that from one crisis to the next the Government is having to intervene with emergency ‘sticking plaster’ income top-ups to get the country through, from the £20 uplift on Universal Credit, to rebates on energy bills and payments by council tax bands. 

Towards a ‘Living Income’ system

We believe that everyone should have access to an income that they can not only survive on but live well.  This means putting in place a safety net that is generous and broad-based enough to give adequate protection to everyone who needs it, and responsive enough by design to deal with shocks and– whether price or income based – so that the government does not need to reinvent the wheel each time we face an economic shock as a country, an inevitability in times of worsening climate change.

Reforms are needed to social security and the minimum wage rate so that they provide a guaranteed income floor, linked to the cost of living, below which nobody can fall.

The current level of the minimum wage does not provide people with an income they can live well on, it should be put on a permanently higher trajectory. One option would be to set a goal to reach £15 per hour as soon as possible. The Progressive Economy Forum suggests this can be achieved by 2024/5, with the extra tax revenue government would receive used to compensate small businesses to ensure that the higher wage remains affordable

The social security system should be significantly more generous, providing much higher standard payments to people that genuinely offer them an income that enables them not only to survive but  live well on. The level of this income would vary based on circumstances and the cost of living, for example Citizen’s Advice recently calculated that a single household needed an income of £960 per month to avoid financial hardship, whereas a family with children would need £1700.

One option would be to enrol everyone on the system, with the state automatically ‘topping up’ people when they fall below an agreed minimum income floor, just as it taxes people when their income exceeds certain thresholds. 

This system could be combined with supplementary payments covering additional needs such as disability, and children, to ensure that the support people recieve is tailored to their needs. Such a system would remove arbitrary and punitive measures such as the benefits cap, two child limit, and the minimum wait for payments, and would be more responsive to people’s changing circumstances than the current model. It would also increase incentives to work by reducing marginal tax rates.

Interim measures to protect household incomes while these bigger reforms are being developed and implemented could include 

• A universal payment of £750 per household which would kick in after the temporary freeze in energy prices had expired. This would be delivered through the universal credit system, and would require mass enrollment which would pave the way for a future living income system. 
• Taking energy support outside the standard Universal Credit system (similar to child and disability payments) and delivered in a separate payment worth £1020 per year for the poorest 9 million households.

A package of support along these lines, in addition to the measures mentioned in section 2 would shield the most vulnerable from the spiralling cost of living in the short term while building the foundations for a new system for the future, based on the principle of a Living Income for everyone.

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4. Reform the tax system with higher taxes on wealth

Context: An unfair and regressive tax system

The unfair and regressive nature of the UK’s tax system is contributing to the cost of living crisis by driving inequalities in income and wealth. Fixing it must be part of the solution. 

The current tax system disproportionately taxes income from work whilst people who are already wealthy from investments, rent and inheritances are taxed relatively lightly. Not only does this entrench inequality, but it is bad for the economy too. A tax system which disincentivises work relative to other forms of income damages productivity.

Wealth has risen from three to eight times national income since the 1980s. Whilst, as outlined above, household income has undergone the largest squeeze since the Napoleonic wars, wealth increased from £8.9 trillion in 2008/10 by £6 trillion to £15.2 trillion in 2018/20, with more than half of the gain in wealth accruing to the top ten per cent of individuals. Since the pandemic, the richest 10% of households gained £50,000 in wealth per adult. The top 10% of households now hold 43% of all wealth in the UK, while the bottom half hold 9%.

The under-taxation of wealth directly contributes to increasing inequality in the UK and ensures that the very richest do not pay fair taxes on their income compared to the majority who earn all their income from work.

This under-taxation manifests itself in a number of ways, from lower tax rates on income from wealth such as dividends and high tax free allowances that benefit those who already have wealth, through to a complicated maze of tax breaks and loopholes which can be exploited by the wealthy to minimise the total amount of tax they pay.

The government’s new agenda focuses heavily on tax cuts for the very richest, arguing that these will boost economic growth. This argument has been roundly refuted by economists who argue that there is little relationship between tax cuts and economic growth. The reality is that the majority of the benefit from these tax cuts go to those at the top of the income distribution, while cuts to the rate of corporation tax will lead to higher dividend payments, again benefitting the already wealthy. Tilting our tax system even further in the favour of the wealthy will not solve this crisis. Instead we need to tilt it the other way, with fairer taxation of wealth, especially unearned wealth such as income from assets which accumulate in value , with the receipts used to help those lower down the income ladder. 

Wealth tax reforms

Redressing imbalances in the tax system by taxing wealth fairly is long overdue and would raise substantial government revenue that could be used to fund cost of living support measures and the climate transition now and in the future. This agenda has support across the political spectrum, and from major global financial institutions such as the IMF, and the time for action has come. 

There are a range of specific reforms that could be undertaken ranging from simpler measures aimed at equalising taxation of income from wealth with income from work, through to an annual wealth tax aimed at reducing inequality in the long term.

Options include:

• Equalising rates of capital gains tax (CGT) with income tax so that income from wealth is taxed at the same level as income from work (raises £16bn per year).
• Removing loopholes and reliefs from inheritance tax (£2.7bn per year).
• Applying National Insurance more consistently across all forms of income (could raise up to £30bn per year depending on the scope of the reform).
• Introducing an annual tax on stocks of wealth (would raise around £10bn per year if wealth above £10m was taxed at 1%).

Taken together, a package of wealth tax reforms could raise a substantial sum of money which could be used to fund cost of living support in the short term and provide essential public goods like a strong social safety net and clean affordable energy provision in the future.