A “cost of living premium”? The case for direct cash payments to help struggling households

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Aveek Bhattacharya examines possible policy suggestions that can be used to respond to the growing cost of living crisis. Assessing each, he finally calls on Rishi Sunak’s Treasury to provide direct cash transfers to households to give them the power to decide how best to respond to rising costs.

We are only a few weeks away in 2022, but it is already clear that one of the biggest challenges facing the government this year will be the brewing “cost of living crisis”, which is expected to come to a head in April. The main cause is rising energy bills, with the lifting that month of the price cap that has so far largely shielded consumers from a spike in global gas prices. Analysts to predict this household energy costs could rise by around 50%, from a high of £1,277 to over £1,900 a year. Most households will also start paying higher taxes from April as the health and social care tax, changes to income tax thresholds and potential tax increases. housing will come into effect. This is on top of rising inflation, which is expected to drive up the cost of everyday goods and services up 6%.

The proposed answers are too complicated and accumulate problems for the government

The politicians have explored several ways in which the government could react. It could limit any increase in the price cap and directly support energy companies through grants or taxpayer-funded loans. The Labor Party has call for Energy VAT – currently 5% – will be abolished. Others have suggested scrapping green levies, which cost the average household around £185 a year, from energy bills. One idea that has generated particular interest is the expansion of the Warm Home Discount (WHD). At present, this allows around 2.2 million low-income households to benefit from a reduction of £140 a year on their energy bills, financed by higher bills for better-off households. A ‘hard core’ of poorer pensioners is eligible by right, and energy suppliers have a quota of rebates that they can offer to other low-income households at their discretion. However, to cope with the current crisis, the WHD should be increased in value and extended to more households.

However, these options all share a common drawback. By making gas and electricity cheaper, they encourage energy consumption, which is environmentally undesirable. The Institute for Tax Studies has already questioned the rationality of a system in which carbon emissions from domestic fuel consumption are already “effectively subsidized”. We should try to avoid measures that aggravate this situation.

By focusing narrowly on reducing energy costs, these options are also somewhat limited in their flexibility to deal with other elements of the cost of living crisis. For some households, send food Where Clothes the costs could be as pressing as help with energy bills, especially in light of the unpredictability of future prices. Of course, the money saved on household fuel can be used to pay for other expenses, but this is an indirect way of solving the problem, especially since evidence shows that household spending patterns can be influenced by grant design. The name of the Winter Fuel Payment alone makes people more likely to expend it on energy.

Taking a sectoral approach has other dangers, creating complexity and exposing the government to arguments that other products deserve similar special treatment. Abolition of VAT on energy, in the words of David Gauke, undermines “one of our most effective and best designed taxes”, already subject to too many exemptions. It also risks creating, as he puts it, “a long queue of industry bodies arguing that the answer to a particular problem requires a reduced or zero VAT rate for their particular sector.”

Many of these measures can also prove difficult to unwind, leaving the government liable for an ongoing cost even after the worst of the crisis subsides. As the fierce resistance to the end of the temporary £20-a-week increase in Universal Credit last year shows, people are getting used to and coming to rely on measures that increase their regular income or reduce their regular costs , even though they were only meant to be short-term measures.

Government should focus on cash assistance instead

For all these reasons, the government should prioritize a cash transfer program when it comes to helping people through the cost of living crisis. Such a program could target the most disadvantaged households, for example by paying an additional payment to people benefiting from universal credit or other advantages inherited from the past. The Tony Blair Institute for Global Change estimates that the poorest 10% of households should see their income fall by 4.0% in April, compared to 1.8% for the average household. A cash payment of £300 would reduce this percentage to 2.5%; a larger cash payment (eg £500) would get even more.

Alternatively, the program could be designed to help a wider range of households, perhaps modeled on the US pandemic stimulus payments, which have been paid to all but the highest earners. After all, those in the middle of the income distribution will also face a fairly large drop in their standard of living. It might be possible to do both – a smaller cash payment for most households, complemented by a larger payment for the poorest.

Whatever their design, cash payments would have the advantage of avoiding the distortions and environmental costs of energy subsidies. Instead, they would allow households to decide for themselves how best to adjust their spending in response to changing prices. Cash payments could also more easily be framed as a ‘bonus’, a one-off emergency measure to meet a temporary challenge, limiting the risk of the government incurring recurrent spending that it is struggling to keep going. back.

From a political point of view, giving money directly to people has the great merit of being a very visible demonstration that the government is acting to help cash-strapped families. At least this government has shown real talent for branding programs. It’s not hard to imagine the fun his communications team might have with ‘Boris’s Bill Buster’ or ‘Rishi’s COLA (Cost of Living Assistance)’, filled with photo ops of the chancellor and his trademark can of Coke.

At present, it is unclear how quickly or easily the government could make direct cash payments to millions of households. The experience of the United States shows that such a program is feasible. The US tax authorities made direct payments to individuals’ bank accounts; here, the bonus can be added as an item on people’s payslips under the Pay As You Earn system. Like in the United States, prepaid cards or checks could be delivered to other households with addresses known to HMRC or DWP – the Chancellor might want to steal a move from Donald Trump’s playbook and sign the checks himself (at least we can be sure that he has a automated signature prepared).

If it doesn’t already exist, developing a direct payments infrastructure like this could be invaluable in responding to future economic downturns. Economist Claudia Sahm argued that governments should automatically disburse cash to stabilize demand when key indicators suggest the economy is in recession. Right now, we have a few months to prepare before the worst of the crisis hits – a luxury that typical recessions don’t provide.

A large-scale cash transfer program carries a major risk: that of exacerbating the rise in inflation. This is particularly worrying if payments are made in a single instalment: losing several billion pounds to the economy in a single month could drive up demand very quickly and cause inflation to rise again if supply does not can’t follow. It may therefore be better to split payments into two instalments, perhaps stagger them and delay them as much as possible until later in the year, without putting households in serious financial difficulty. The amount of the payment must also be calibrated so as to be appropriate to the macroeconomic circumstances.

Figure 1: Proposed responses to the cost of living crisis

Source: Tony Blair Institute for Global Change, FT, SMF analysis

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