Switch to Variable Energy Price Cap Could Solve the Cost-of-Living Crisis, and Save the Treasury Billions says NIESR

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The National Institute of Economic and Social Research says it has arrived at a solution to solve the country's cost-of-living crisis, and best of all it won't cost the new government billions of pounds.

The NIESR says the solution comes in transforming the current single point Energy Price Cap into a variable (or sliding) price cap.

This would see the price per unit of energy used increases with usage.

The proposal would reduce the energy bills of the poorest households from nearly £3,000 to around £1,000 per year, a 70% reduction, according to the NIESR.

Energy bills in the UK are due to jump 80% from October to £3,548 a year for the average household.

The NIESR's plan would be financed by raising the cost of energy for those who use it most, which are richer households that can afford this rise in energy bills, says the NIESR.

The effect of such a variable price cap would be to reduce energy bills for lower-income households in the country while higher earners, who consume more energy, would bear a commensurate share of the higher costs.

"The scale of the energy crisis mandates us to think big in how we respond to it. Freezing all energy bills is one idea, but the extraordinary cost – and for an unknown period – would place enormous pressure on public finances. We instead propose a reform to the energy price cap that would be as effective in reducing the energy bills for the poorest but would likely require no further fiscal resources to fund it," says Max Mosley, an Economist at NIESR.

The NIESR's proposal comes amidst reports the new Prime Minister Liz Truss intends to help households and businesses by capping annual energy bills at £2,500.

The cost could however be enormous, with figures of £100BN to £130BN regularly cited, but any open-ended cap could cost around £190BN over the next two years.

Richer households would see their energy bills rise from about 2% to just 3% of their income, according to the research.

The NIESR says their plan could in fact be 'revenue neutral' for the Treasury, which would not require further fiscal support such as extra borrowing and which would therefore represent a substantially more cost effective and sustainable alternative to freezing all energy bills.

The plan could also be combined with more fiscal spending to help reduce the energy bills of both lower- and higher-income households.

The NIESR's research finds energy use is strongly correlated with household income and making units of energy more expensive for those who use it most affects higher-income households while cutting costs for lower-income households who tend to consume less.

When compared to other policy proposals - specifically freezing all energy bills – the NIESR says their proposal has two advantages.

1) It is more cost effective than freezing energy bills, which could cost around £100BN over the winter period.

"While this high cost could be absorbed in the short-run, such a policy likely becomes unaffordable in the longer-run if current price levels persist. Therefore, a more cost-effective alternative, like our proposal, presents a more sustainable option," says a statement from the NIESR.

2) freezing energy bills detaches the price signal mechanism from the purchase of energy, which would have the effect of locking in energy demand at its current level. This proposal not just leave this in place but allows for stronger incentives to bring energy consumption down.

"Our proposal for a variable energy price cap would reduce the bills of both the poorest and lower-income households by increasing the contribution from top earners who consume more energy. It can be combined with further targeted support for low-income households who live in poorly insulated homes or have more dependents. Faced with a once-in-a-generation shock, our proposed policy is more cost effective and more socially equitable than freezing everyone’s energy bills," says Professor Adrian Pabst, Deputy Director for Public Policy at NIESR.