£12 Billion Needed If Government Wants To Maintain Value Of Household Support Package

17th August 2022

The government would need to find £12 billion simply to achieve what it was aiming to do with the £24 billion package announced in May. That's largely because in May energy prices were expected to rise by 95% in 2022/23, and are now expected to rise by 141%.

This is a new finding from analysis by the Institute for Fiscal Studies, funded by the Nuffield Foundation as part of the forthcoming IFS Green Budget.

Given expectations in May, out-of-work benefit recipients looked set to be broadly protected from rising prices. But under the latest inflation forecasts, out of work working-age benefit claimants are now on course to see a fall in their real income of £620 over the course of the year. Doubling the current £650 grant to those on benefits would protect them on average, as well as helping low income pensioners and families in work, at a cost of roughly £5½ billion.

Similarly, back in May it looked like the £400 energy discount and £150 council tax rebate would cover around half of the increase in energy costs for a typical family over the year. If the government wants to continue to cover half the cost of increased bills support would need to be increased by a further £260 at a cost of around another £7bn.

There is a difficult judgment here. Extra spending of this magnitude, funded by further borrowing, could add to the inflationary pressures in the economy. With energy prices and inflation set to remain high next year it seems almost inevitable that at least some of the extra spending will be maintained beyond this fiscal year.

Other findings include:

Because poorer households tend to spend more of their budgets on energy, the inflation rates they are experiencing are accelerating even faster than those faced by other households. The poorest fifth will face an eye-watering 18% inflation rate in October, compared to 11% for the richest fifth.

The new energy price cap takes effect in October. Because benefits are increased each April in line with inflation the previous September, benefits are set once again to fail to keep up with actual increases in the cost of living. The government should permanently change the way that it compensates benefit recipients for inflation such that benefits rise by the expected April rate rather than rate from previous September that is used at present. Otherwise in April, the real value of benefits will be 7% lower than they were pre-pandemic.

Paul Johnson, IFS Director, said, "The government is still playing catch up as inflation and the cost of energy continue to spiral upwards. Just achieving what they wanted to achieve back in May will cost an additional £12 billion, and a package on that scale will still leave many households much worse off. Given the costs there are genuine and difficult trade-offs here. For both households managing their budgets and the government managing the economy's finances some clarity on strategy is urgently needed."

Alex Beer, Welfare Programme Head at the Nuffield Foundation said, "As prices of essentials including food, heating and fuel continue to rise, families on low-incomes are facing more uncertainty and pressures. Many of these families were struggling to get by even before the current crisis and are not helped by the rollercoaster real value of Universal Credit payments, and short-term fixes to help benefit claimants. The government needs to make clear the actions it will take to help these families, by providing them not only with more security now, but greater certainty in the medium term."

The existing package of support
Back in May, the government updated their one-off package of support for households, which now totals £24 billion and comprised five main strands:

£400 to all households labelled as an "energy discount" that will be subtracted from energy bills.
£150 for all households in council tax bands A-D (around 80% of households).
£650 for any family on means-tested benefits.
£300 for pensioners.
£150 for those on a disability benefit.
None of these strands of support are mutually exclusive. For example, if you are a low-income disabled pensioner in Council Tax Band B you can get all of the above, worth £1,650.

A worsening outlook
These measures came in response to an expectation, at the time, that the cost of living would on average be 9.5% higher in 2022-23 than 2021-22, with an expected peak of inflation of 10.2% in the fourth quarter of this year, and with the energy price cap expected to reach £2,800 for a typical household in October 2022 and to remain at a similar level in January 2023.

Had everything played out as was expected in May, the net effect of all this would have been for the real incomes of low-income households being broadly maintained on average this year, though with significant variation around this. Middle- and high-earners, while benefiting from at least £400 of support and typically £550, were nevertheless still set to see significant falls in real income.

Unfortunately, the outlook has got worse once again since May. The cost of living is now expected to be 11.3% higher this financial year, 2022/23, than last, with inflation peaking in the last quarter of this year at 13.1%. The energy price cap is expected to reach £3,600 for a typical household in October and £4,300 in January.

This means both that inflation expectations overall are higher, and - because much of the recent change in the outlook is due to energy prices - that the pattern of inflation is even more unfavourable towards poorer households, who tend to spend more of their budgets on energy. Figure 1 shows how inflation is expected to vary across income quintiles in October of this year, accounting for the different budgets of different income groups. The fact that poorer households devote more of their spending to energy, means that the inflation rate the poorest quintile will experience is expected to rise to an eye-watering 18% in October, compared to 11% for the richest quintile.