The big advantage is that it will also reduce headline inflation, which with energy bills frozen and, as promised, VAT removed from energy costs, will soon start to exceed the Bank of England’s dire forecasts.
The Liberal Democrats have already proposed just such a course of action, and former Prime Minister Gordon Brown something similar. Depending on where the price cap is set, however, the costs will be out of scale.
The Liberal Democrats have estimated the cost of capping energy bills at the current average of around £2,000 per household at an eye-watering £42 billion in the first year. Assuming wholesale gas prices stay where they are, that sounds about right. But with more than half of that spent on vacation, it’s one heck of an expense. How much longer can public finances absorb these crisis-induced support schemes?
The thinking in the Truss camp, however, is surprisingly calm on such matters. Soaring inflation leaves tax revenues in much better shape than usually expected. As reported by the Telegraph last week, high inflation is fueling so-called “fiscal drag” linked to the tax relief freeze until 2026, which is likely to result in an extra £30bn in tax as more and more people are drawn of higher income tax brackets, or four times the amount originally projected by the Office for Budget Responsibility. Higher inflation also puts rocket boosters on VAT revenue.
The extra borrowing needed to cut Mrs Truss’s taxes and fund the mooted price controls on energy bills may not be as worrying in such circumstances as it seems.
Historically, bouts of runaway inflation have benefited public finances, allowing successive governments to “inflate” much of the World War II debt. That would be the gamble anyway. What are the chances of it working?
I’m not saying there isn’t, but we have to be careful about citing historical experience; may not be much of a landmark this time.
And that’s not just because higher inflation raises the cost of servicing the government’s mountain of debt—instantly through index-linked hog stocks, now a quarter of the total, and through higher interest rates, then slowly but relentlessly through central bank reserves which, thanks to quantitative easing, now amount to almost a quarter of GDP.
Higher inflation also means higher costs, at least in nominal terms. A good view is that it is easier to cut taxes than to cancel government spending commitments.
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