The UK government has promised to make energy bills cheaper, and many of its best efforts have gone towards that end. The progress made on the clean power plan and the benefits we expect from the forthcoming warm homes plan are clear examples. These policies will significantly reduce bills, but because they involve structural changes to our energy system, they will take time to do so. 

The chancellor is apparently eyeing a VAT cut for electricity and gas, which would save the typical dual fuel household £86 per year. This is definitely a quicker change, but it will cost £2.5 billion per year to implement (a commonly cited figure of £1.75 billion is based on energy spending in 2021, before the energy crisis resulting from Russia’s invasion of Ukraine). Cutting VAT is also not a particularly targeted approach, with most of the absolute benefit flowing to the wealthiest households.

So what are the alternatives? How else could the chancellor spend £2.5 billion to make energy cheaper? What would this mean for energy bills, fuel poverty, and carbon emissions? We would suggest that she should consider how to make any change fair, effective and sustainable.

• Focus on electricity bills, rather than splitting the support between electricity and gas. This will ensure that all the benefits are universal and do more for the households that need the most help, such as those using direct electric heating.
• Subsidising bill-funded schemes (such as feed-in tariffs) to the same level as a VAT cut would deliver the same level of benefits, but would only be a temporary expense (rather than a permanent one).
• A one-off debt forgiveness scheme would cost less than two years of the VAT cut, but would reduce the typical household energy bill by £55 for years to come.

VAT is a regressive tax, but so is the distribution of energy costs. The poorest households spend almost 16% of their income on energy, compared to 2% for the richest. And electricity bills are more regressive than gas. The poorest 30% households spend about 40% more on electricity bills than gas bills, while the richest 30% only spend about 20% more. 

This disparity reflects the fact that electricity is too expensive, both in absolute terms and relative to gas. But poorer households are much more likely to have electric heating than gas heating, and some have unavoidable needs for a lot of electricity, such as running medical equipment. This is why households with electrical heating have the highest rates of fuel poverty. 

Any spending on gas only benefits the 87% of households that are on the gas grid. And while many of them are struggling with energy costs, gas-using households are generally better off than those living off the gas grid. Every gas-using home benefits from cheaper electricity. So if the chancellor wants to spend £2.5 billion, spending it all on electricity is a more progressive option than splitting it 60/40 on electricity and gas bills (as would be the case with a VAT cut).

Policy costs (the government levies collected to fund environmental and social programs) currently add over £5.5 billion to electricity bills every year (and another £1.5 billion on gas bills). But some of the biggest costs are due to fall over the next decade. So while a VAT cut imposes an ongoing cost on the government, taking policy costs off bills would deliver similar (or better up-front) benefits, it would also get cheaper over time.

£2.5 billion would cover the entire annual cost of the feed-in tariffs scheme (~£740 million per year), and 45% of the cost of the renewables obligation (~£3.9 billion per year). This would save the typical dual-fuel household around £65 per year. However, the potential savings for households using electric storage heaters (which includes a disproportionate share of many of Britain’s poorest) would be closer to £280 per year. So while the average saving is a bit less than a flat VAT cut, the distribution of the benefit is much fairer.

British households have over £4.2 billion of energy debt, £2 billion of which has been added in just two years, in the wake of the energy crisis. Many of the households in debt have no way to repay it. The number of accounts in arrears has also grown over the past two years, from 1.2 million to almost 2 million. These bad debts - and the costs of managing them - are passed back to billpayers. Debt-related costs currently add £28 to the typical electricity bill and £26 for gas (£55 in total, with rounding). They are also rising, as more households get trapped in cycles of energy debt and fuel poverty.

Debt forgiveness would overwhelmingly benefit the poorest households in Britain. While it is not a lasting solution, it would provide a route out of fuel poverty for millions of households. Fresh debts would undoubtedly start to accrue, but resetting the baseline would make the total cost much more manageable. This one-off cost is less than two years of the VAT cut, and provides a lasting benefit for everyone.