Credit, Collections & Insolvency News
The analysis shows poorer households tend to spend almost three times as much of their budgets on gas and electricity. This will result in them absorbing a roughly 7% shock to their income this year from inflation.
Rising inflation together with planned tax increases will mean that average take-home pay is likely to fall over the coming year. It also raises specific issues for benefits policy. Those on low incomes will tend to find it hardest to tide themselves over during a period in which their real incomes are eroded, which by default is what happens when inflation increases sharply because the major benefits go up in line with a lagged measure of inflation. In April, benefits are set to rise by the rate of general (CPI) inflation in the year to September 2021, which was 3.1%. But according to the latest Bank of England forecasts, inflation in the year to April 2022 is in fact expected to be around 6%.
The IFS says that a particular contributor to rising prices in April will be energy costs. Wholesale prices of gas and electricity increased dramatically during 2021 as the post-pandemic economic recovery continued to pick up the pace while European markets were struggling with a number of supply-side problems. UK customers have been protected to a large degree from the immediate effects due to tariff caps set by Ofgem, but these caps were increased by 12% in October 2021, and are currently set to increase substantially again in April 2022. The Bank of England expects the caps to increase from their current level by 20% for electricity and 35% for gas, leading to year-on-year energy inflation rates of 31% and 58% respectively in April. Others have predicted even steeper increases.
The IFS says that. this could be an opportune moment to change the way that benefits are uprated over the longer term. The issue of real falls in benefit income when inflation rises (and real increases when inflation falls) occurs because benefits increase with a lagged measure of inflation. An alternative would be to use near-term forecasts for inflation to attempt to increase benefits in line with the actual annual rate of inflation that applies at the point of increase. This is what is already done with the uprating of excise duties. For administrative reasons, Universal Credit has made it easier to change benefit rates at short notice, which also opens up the possibility of simply waiting until nearer to April before confirming the benefit uprating based on the latest inflation outturns available. For a long time now, with low and stable inflation, this would have seemed like a fairly minor technocratic change. But in the current environment, it could make a real difference, and it would reduce the exposure of low-income households to similar problems in future.
Many households on middling incomes, and especially those with particularly high energy costs, will not find it easy to adjust to extra costs upwards of £500 per year. But meaningfully compensating even average-income households for a significant increase in costs would not be cheap, especially if the measure were permanent. The total increase in energy costs in April is likely to be in the region of £14 billion on an annual basis unless and until prices fall back. Therefore any mitigation measure will either be very expensive, or provide very partial compensation, or will need to target only a modest subset of those facing higher bills and provide little or no help to others. For example, abolishing VAT on domestic fuel (from its already reduced rate of 5%) would cost around £2.4 billion per year, but on average would give households back less than a fifth of the annual rise in their energy costs. It would target slightly more compensation on those households with particularly high energy costs, which could be seen as an advantage of the policy from the point of view of helping households hit hardest. The other side of that coin is that the tax system would be further encouraging energy consumption relative to other spending even more than it already does – despite the fact that this is an environmentally damaging activity.
Robert Joyce, Deputy Director said “We have become used to an era of low and stable inflation. But the way in which we increase benefits each April is not fit for the period of high and rising inflation we now face. Benefits are set to rise by 3.1% – last September’s inflation rate. But by April inflation will be about 6%. So the poorest are heading for a 3% year-on-year cut in their real benefit levels and living standards. It would be preferable to raise benefits by the actual inflation rate in April. If that is 6% it would cost an additional £3bn, or £4 ½ bn if the state pension were included. Doing so would compensate benefit recipients on average for higher costs, including energy costs.”
“This need not be a permanent increase. Future uprating can be adjusted once inflation has fallen back. Overall energy bills are likely to rise by £14 billion year on year. That makes compensating more broadly across the population very expensive or only extremely partial. Abolishing VAT on domestic fuel would, quite apart from the environmental downsides, cost £2.4bn per year while only reimbursing households for less than one fifth, on average, of April’s increase in energy costs.”
Average annual rates of inflation to November 2021 and April 2022, by household income decile
