Lord Willetts is President of the Resolution Foundation. He is a former Minister for Universities and Science.
I argued for a windfall tax in ConservativeHome earlier in the year, and the case for one is stronger now than it was then. But no Tory wants to raise taxes, and the case for it needs to be made with far more precision than its advocates have mustered so far. Some of the arguments for it miss the point.
A windfall tax is not needed because of a fiscal crisis. The Treasury is forecasting that Government borrowing to fall fast over the next few years – much faster, indeed, than during the days of austerity. One reason is that inflation is good for tax revenues. If allowances are frozen more people pay more income tax and quite possibly at higher rates. As prices rise, so do VAT receipts. So revenues are pretty buoyant. That is why there are pressures on the Chancellor to cut taxes – a decision for a future Budget.
Inflation can also help the Treasury bring down public spending, because the real value of public expenditure programmes falls unless there are cash increases to offset inflation. This effect is particularly striking in the benefits system where there is a dramatic in-year effect.
If inflation is running at 10 per cent and benefits are uprated historically once a year, then by the twelfth month the real value of benefits is down by 10 per cent. This is quite a big cut if you are anyway struggling to make ends meet. It is not a deliberate policy decision to save money – it is just the result of a precipitate increase in inflation and lagged upratings.
The Treasury saves money because benefits are worth less averaged out over the year. So, for example, if inflation is 10 per cent over the year, benefits are on average five per cent lower than they would have been with zero inflation.
This year has seen an uprating for the State Pension and other benefits by 3.1 per cent in April 2022. But over the next twelve months before the next scheduled increase, inflation is forecast by the Bank of England to be 9.5 per cent. That means a real-terms saving on benefit spending for the Government of six per cent – or £15 billion. It’s split between £7 billion off the State Pension, and £8 billion off all other benefits.
That is why at Resolution Foundation we proposed that the Budget should bring forward some of next year’s historic benefits uprating to this year. It was just to help people through a sudden increase in inflation, after which the Treasury could get benefits back to their historic level if they wished.
It would be much better than people going through a real hit to their living standards and then getting a 10 per cent increase next April. There could still be an early increase to Universal Credit, explicitly bringing forward at least half of next April’s increase now ( matching the front end loading of the inflation surge). It is trickier with pensions as their computer system is less able to handle in year increases, but the Winter Fuel payment could be boosted and perhaps also brought forward to, say, the 1st October – the date of the next big increase in the energy price cap.
Disabled people would need special help too. All of these mechanisms are better than trying to turn council tax collection into a distribution mechanism – hoses designed for sucking money off us don’t always work easily when put in reverse.
The Treasury can offset unexpectedly severe falls in the real value of benefits without jeopardising the public finances just be bringing forward some of the next uprating. That would cover the most acutely pressurised families now even without any long term increase in the value of benefits relative to inflation. So where does a windfall tax fit in?
I was in the Treasury in 1981 when Margaret Thatcher, Geoffrey Howe and Nigel Lawson brought in a windfall tax on the banks who were making large profits since interest rates were so high. (And with those three great Tories involved I can’t see how it can be “unconservative”.)
Now it is energy companies which are making windfall profits. The energy price is being pushed up artificially by the immense pressures in the gas market. No energy company has been planning its investment on the basis of such an extraordinary once off bonus, and taxing some of them will not change the economics of their investment plans. The profits are so special that a tax on them will not be seen as an attack on business.
The question is if there is a good credible use for the money. It is a once-off tax, so it would be wrong to use it to finance permanent increase in the real value of benefits, or indeed sustained tax cuts elsewhere. And the smoothing to protect benefits from a real cut caused by high inflation is not an increase in underlying benefit levels and should not require a special tax to finance it.
The best use for the proceeds of a windfall energy tax would be to start tackling the underlying problem which the energy crisis has revealed. We aren’t investing enough to lower the cost of energy, especially for low income families. Poor people spend more of their incomes on heating, but annual bills can be cut by hundreds of pounds if properties are upgraded to an efficiency rating of EPC C – which is actually how the Government wants all homes to perform by 2035.
The homes of poor people used to be better insulated than the average, because of schemes targeted on the less well-off – but these have largely gone. Now it is richer households who are insulating their homes at the quickest rate. The Treasury should devote the proceeds from a windfall tax to revitalising efforts to reduce our energy bills by reducing the amount of energy we need, such as boosting the (bill-payer-funded) Energy Company Obligation with funds from windfall tax receipts. There is an obvious logic for this. It is using a once off tax for a special new initiative. And it is using money from exceptional profits generated from high bills to bring down bills in future.
So we can see the outlines of the package the Chancellor can announce. There should be protection for lower income families from sharp painful falls in their real incomes by protecting the real value of their benefits promptly as inflation surges. In addition the windfall tax funds a longer term package to invest in the future