The primacy of levy reform: part one
Why we need to cut taxes on energy use
Note: This was largely written before the war in the Middle East broke out. I won’t focus on that here. The fundamental dynamics haven’t changed. They’ve just become more urgent.
The government has a series of levies on energy consumption. It particularly levies electricity, about five to six times more than it levies gas. This is even while it’s paying people to move to electric heating and cars.
The levies obviously add to the cost of electricity directly. But they also cause structural problems, driving up the cost of electricity indirectly too.
Britain needs affordable electricity for lots of reasons, most of all energy security. The levies keep it expensive.
In this piece, I’ll explain what the levies are and four problems they cause. In the next piece, I’ll explain the politics of levy reform and policy options.
What the levies are.
By levies, I am talking about ‘final energy consumption levies’.
Call them a tax and someone will say “actually, according to the Office for National Statistics, they are technically an indirect tax”. But they look like a tax from the bill payer’s perspective. Like taxes, they raise revenues to pay for government policies.
There are currently nine levies altogether, eight on electricity and two on gas. The larger levy on gas also applies to electricity.
In April, the average electricity bill will be £875. £147 of that (17%), will be government energy bill levies. In comparison, an average gas bill will be £766, of which £26 (4%), will be levies.
This is after a big levy cut from the government at the Autumn Budget. Without the cuts, the levies would be more like a quarter of the electricity bill and 8% of a gas bill.
Below is a full list of the levies with their per year cost to the average household that uses electricity and gas, using Ofgem April 2026 price cap figures.
The government cut the Renewables Obligation (the largest levy) by 75%, equal to £67 for the average household. The government also cut the Energy Company Obligation, giving another £60 saving across gas and electricity.
What I’m not including but still matters:
Carbon taxes. Carbon taxes add another ~£50 per year to electricity bills, but unlike final consumption levies are applied upstream A “high use electric storage household” would pay closer to £250 per year in carbon taxes. Fossil gas used in homes is not carbon taxed.
VAT, which stands at 5% of electricity and gas bills.
Levies which are due to hit soon, like carbon capture and hydrogen subsidies or the British Industrial Competitiveness Scheme, all of which will hit electricity.
Taxing something discourages its use. You’d therefore be forgiven for thinking the government really wants you to use fossil gas, not carbon-free electricity.
(A final note before moving on: there’s sometimes a debate about whether to consider Contracts for Difference, the Capacity Market, or the levy for Sizewell C as ‘policy levies’, or simply costs of the system. There is a distinction there, but I call them levies here because they raise cash to support ministers’ policy choices.)
There are four big problems these levies cause:
The levies are pushing us towards a grid death spiral.
The levies hit the poorest the hardest.
The levies punish electrification.
The levies undermine flexibility in demand.
The levies are pushing us towards a grid death spiral.
We are moving towards an electricity grid death spiral. This is when the grid becomes unaffordable for the customers it serves. It looks like this:
Cost rises > people cut back or take action to avoid costs > cost rises per unit to cover fixed costs > people cut back > cost rises > cut back > cost rise > cut back > revenue collapse > government steps in.
With a fossil fuelled grid, supply and demand acts intuitively: ‘consumption goes down, costs go down’ and vice versa, because we use less coal or gas to generate electricity.
But with lots of new renewables, nuclear plants, and more grid upgrades, the economics are turning around. The fuel doesn’t set the price so much, the fixed cost of the kit matters more. If consumption goes down, costs go up instead, to cover more and more fixed cost.
We’re not in the death spiral yet. But we are heading towards one.
Electricity use has fallen by 21% over the last 20 years, for lots of energy and non-energy reasons. To put it into context, we’re in the same league of electricity use drops as countries struck by civil wars and natural disasters.
The government, system operator, and energy regulator are acting as though there’ll be a two-thirds minimum rise in electricity use over the next decade. The government wants x number of people to adopt y technologies by z date. So the system operator plans a grid that can handle that. And the regulator signs off on bill rises to pay for the necessary upgrades. (For more on the forecasts, see Ben Watts’ post.)
New grid charges will add £108 per year to bills by 2031. It’s unlikely that these bill rises will deliver all the upgrades they’re for, which means they will not reduce costs elsewhere in the system (see Robert Boswall’s thread for more). Another issue is Ofgem processes have also permitted infrastructure developers to be, in some cases, extremely profligate with bill payer cash, as Ed Hezlet has written about.
But there’s no evidence this demand will turn up. In fact, higher costs could stop it from doing so. Higher electricity costs make it harder for people to move to electric cars and heating. This is how you get the death spiral.
Again, we’re not there yet, but we need electricity consumption to rise lots, fast. We must lower the cost of electricity.
The levies raise the cost of electricity, discouraging consumption. In some cases this is by design. The original impact assessment for the Energy Company Obligation said a pence per kilowatt hour charge would “provide a greater incentive to consumers to conserve energy”. That maybe made sense years ago. Not anymore.
The levies hit the poorest the hardest.
The levies are regressive. They hit people on lower incomes equally to their richer counterparts. Incomes have been stagnant for years. Energy is taking a greater and greater share on strained household budgets. More In Common research last year found a household has to be earning six figures to not be worried about energy bills.
Overall, the government still levies welfare-receiving households more than it supports them with the Warm Homes Discount (£175 levies vs £150 support).
Worse, they’re not even getting the full £150. The government makes them pay for their own support through a levy. It gives households £150 but takes ~£40, leaving a net ~£110. As more people access it, the cost goes up and each recipient gets even less.
Larger households get it even worse. Now that the Warm Homes Discount is funded by use of electricity rather than being an equal fixed cost, the more energy a recipient uses, the less net support they get. Citizen Advice’s Alexander Belsham-Harris has calculated “some higher usage households will now keep only half the cash value of the discount”, so less than £75.
Those on electric heating get hit the hardest because the levies almost exclusively hit electricity. According to government statistics, electricity users are twice as likely to be in fuel poverty. Their fuel poverty gap is nearly 3 times higher, £780 compared to £290. These people usually have old storage heaters or electric boilers, which aren’t as efficient as heat pumps.
Supporting those trapped in fuel poverty is the right thing to do, morally and economically. Making them pay for it themselves is stupid.
It also embitters people who don’t quite qualify for support but are still struggling. In their focus groups, More In Common found that people assume they’re going to get support because they feel hard pressed. When they find out they instead pay for others’, they feel cheated.
It’s also financially unsustainable. Rising electricity costs are forecast over the coming years (see Ben James’ excellent work). Unemployment is rising. More people will need to access the scheme. But the support offered doesn’t automatically rise. Everyone’s bills will rise and the net support of existing recipients will erode more.
The government pays for the Winter Fuel Allowance progressively and fully. It should do that with the Warm Homes Discount.
There is a similar situation going on in the business world. New levies - the ‘Supercharger’ and the British Industrial Competitiveness Scheme - subsidise qualifying businesses with their energy bills. The British Industrial Competitiveness Scheme specifically is a levy that subsidises other levies! See below from the BICS’ consultation.
The support from these schemes is paid for by households and other businesses through levies. Small businesses didn’t get the levy relief announced at the Budget households got. But they are paying for relief for other, usually larger businesses.
We’ve now got a grim situation where ministers prioritise bill cuts for different bits of society. A zero-sum game where interest groups compete for bill cuts. It’s not a sign of a functioning system. It’s not lowering costs. It’s a vicious circle.
A final point here: the government’s Budget levy cuts massively help electricity because electricity is levied far more than gas. It found the sort of households with older electric heaters that are most hurting from the levies were getting the biggest benefit - a £442 bill cut for a high usage household. But the government hasn’t made this very clear. It should. It’s really good news.
The levies punish electrification.
Government encourages households to use electric heating and cars with upfront cost subsidies. Then it punishes them for using those products with its electricity levies. That worsens energy insecurity.
As we saw above, the levies effectively subsidise gas. Well installed, good heat pumps can still give a saving even with the levies on electricity, because they’re so efficient. Without levies, an smartly run Octopus (the company I work for) heat pump would save the user about £600 per year. But because electricity is hit with far more taxes than gas, too many heat pumps still struggle to give a big saving.
Importantly, higher running costs push up the upfront cost too. The higher the running cost, which the levies add to, the more home retrofit work that needs doing.
This is an affordability absurdity. It makes cutting carbon from heating, the second largest source of carbon after transport, harder than it needs to be.
And, most importantly, it hurts energy security.
Regardless of the politics of oil and gas production, one fact is indisputable: Britain has a gas-hungry system that we have not been able to feed by ourselves for 20 years. Imports are growing.
From 2000 to 2024, domestic gas production declined by 73%. Demand fell by just 39%. Imports now comprise about half our gas. The steepest production decline was before the Climate Change Act in 2008. We had a policy of ‘maximum economic recovery’ for most the 2010s. So it is not simply down to green policy that we have far less (finite) oil and gas than we once did. Again: a simple fact we need to live with. Certainly not an anti-production point.
You can read more about the position this is putting Britain in my report for the Council on Geostrategy. In summary:
We cannot depend on America to keep prices low,
Nor will we always affordably outcompete Asia for Middle Eastern gas and Europe for Norwegian gas, and
The Exchequer is exposed to paying for crippling price shocks.
(I don’t need to get into what’s happening in the Middle East here. The risks from Qatar, the producer of a fifth of the world’s liquified natural gas, shutting down production are obvious. The above bullets were structural realities before of the war.)
Personally, I prioritise energy security first, affordability second, sustainability third. That’s why I think Britain’s energy priority should be to find a way to economise oil and gas use without keeping the energy services (light, heat, movement) provided to the end user affordable.
That means electrification because electricity is simply the most efficient general-purpose energy vector. Most things most people use energy for are most efficiently done with electricity. Max supply, sure. But be lean in consumption with electrification. That way, you have more supply.
The levies actively discourage electrification. They need reform.
The levies undermine demand flexibility, raising costly waste.
The levies undermine the economics of demand flexibility, or “flex”. The result is the energy system operator wastes cheap power, raising bills rather than cutting them.
Flex is often portrayed as some new idea to pay people to boil their kettles at night time because the wind is blowing, including (bizarrely, given the economics of renewables) by renewable CEOs. This is a bad take.
Flex goes way back and isn’t just for renewables. In 1978, the Electricity Council introduced lower night time electricity prices for electric storage heaters. This allowed more nuclear-generated electricity to be sold to produce and store heat up at night for use in the day, shifting the original demand from day to night to match nuclear’s inflexible supply.
Economy 7 advert, 1983
Good flex is moulding demand, increasing efficiency, and lowering cost to improve overall final service. A great example is a “V2G” (vehicle-to-grid) car charger automatically buying low and selling high out of your electric car’s battery, allowing you to fuel your car from home and drive for free.
But the levies make the efficient flow of electrons harder.
When there is abundant renewable generation in an area, the levies make it artificially too expensive for the system operator to cut costs locally to promote use or storage. Instead it pays wind farms to switch off, raising everyone’s bills.
The levies double tax people for ‘banking’ electrons in their home batteries or cars to sell on later. (This has been fixed for grid scale batteries but not for households.)
The way the Contracts for Difference levy works financially will punish suppliers for doing renewable flex, even though it saves all bill payers money. It also prevents the drop in wholesale prices from renewables doing anything to final bills.
The value of renewable energy is not getting through to bill payers because the levies jam up flex. Without levy reform, system waste will continue to rise, raising collective bills by billions each year.
Levy reform is necessary.
That’s it for now. In the next piece, I’ll get into the tricky politics and options for levy reform. Until then, I hope now I’ve provided a clear picture of the problems these levies are causing. They’re unsustainable, unfair, pro-pollution, and directly and indirectly raising bills.
