Burnham Removes VAT on Electricity Bills From October, What It Means and Why Energy Pricing Is Still Unresolved

Andy Burnham used his second day as Prime Minister to cut VAT on domestic electricity bills to zero, a measure that will take effect from 1 October 2026 in time to feed into the next Ofgem quarterly price cap. The move is funded entirely by cancelling the Digital ID programme, which had been budgeted at £1.8 billion over three years. For this financial year alone, the VAT cut is estimated to cost around £850 million.

Households on standard variable tariffs will see roughly £45 knocked off their annual bill at the October price cap, on top of the £150 per household that was removed from bills at the last Budget. All suppliers are expected to pass the reduction on to customers, including those on fixed tariffs, as happened with the previous round of bill relief. Small businesses not registered for VAT, charities, and residential care homes eligible for the reduced rate will also benefit.

The price cap does not set a fixed bill, it limits the unit rate and standing charge suppliers can charge customers on default tariffs. Bills vary with usage. Ofgem reviews the cap quarterly, based primarily on wholesale gas and electricity market prices over the preceding months.

The UK electricity market uses a system called marginal pricing, which ties the price of electricity to the most expensive source required to meet demand at any given moment:

• Marginal pricing: All generators in a given dispatch period are paid the price set by the last, most expensive unit of generation needed typically a gas fired power station
• Effect on renewables: Wind, solar and nuclear generators receive the same price as the marginal gas plant, even though their fuel costs are near zero
• Gas influence: Because gas sets the marginal price for a significant share of dispatch periods, gas market volatility directly raises electricity prices across the whole system
• Scale of the effect: Wholesale energy costs shaped heavily by gas account for roughly 40% of a typical household electricity bill under the Ofgem price cap methodology
• Post Ukraine spike: Russia's invasion of Ukraine in February 2022 sent European gas prices to record highs UK household electricity bills roughly doubled between 2021 and 2023 as a result

The previous Conservative government launched a formal review of the electricity market in 2022 precisely to address this structural issue:

Energy is one part of a cost of living challenge that has persisted across several economic cycles. Successive governments have used a mix of direct payments, bill relief, and minimum wage increases to address household pressures with each approach having distinct effects on inflation and household budgets.

The interaction between wage increases, business costs and consumer prices is a recognised dynamic in economic policy:

The VAT cut is explicitly targeted at electricity rather than gas. The government says this reflects both the structure of the tax and the desire to support the shift towards electrification of heating and transport, areas where household costs are rising as uptake increases. By removing the VAT element rather than increasing subsidies or payments, the measure reduces the bill directly without adding to public borrowing beyond the immediate cost of the policy.

• Timing: The October 2026 price cap is the deadline the government is working to, all suppliers must reflect the VAT change in that cap
• Fixed tariffs: Suppliers are expected to pass the saving to fixed tariff customers as well, consistent with the precedent set at the last Budget
• Longer term measures: The government has said any further action on energy costs including longer term bill relief or market reform will be set out at the next Budget alongside an OBR forecast
• Fiscal rules: The announcement states all further measures will be consistent with the government's fiscal rules, no additional borrowing has been committed beyond the Digital ID cancellation savings
• Iran war surcharge: The government's announcement cites Russia's invasion of Ukraine and the war in Iran as compounding factors in sustained energy price levels

The UK's electricity generation mix has changed substantially since the marginal pricing system was established. Renewables, wind, solar and hydro now consistently account for a large proportion of generation. In several recent quarters, wind alone has provided more than half of UK electricity. Yet because the price is set by the marginal cost of the last generator dispatched, typically a gas plant, those low cost renewable megawatt hours are sold at gas linked prices.

The Structural Gap Between Generation Cost and Bill Price

The REMA process mapped the scale of this divergence between generation cost and consumer price:

The Burnham government has not announced any intention to revisit REMA or change the wholesale electricity market structure. The October VAT cut addresses the tax component of bills, not the wholesale pricing mechanism. Any structural market reform, if it were to happen, would likely require legislation, extended consultation, and a transitional framework for existing contracts, a multi year process. The REMA review documentation remains published on GOV.UK and is part of the public record.

• Budget commitment: Further cost of living measures will be set out at the Budget, alongside an OBR forecast
• No market reform announced: The wholesale electricity pricing structure has not changed as part of this announcement
• CfD mechanism: The existing Contracts for Difference scheme provides price certainty for some renewable generators and feeds through to the Levy Control Framework that affects bills separately
• Ofgem quarterly cap: The cap methodology will reflect the VAT change automatically, no further regulatory action is required for the October adjustment
• NI position: The EU VAT rules that apply in Northern Ireland under the Windsor Framework mean the VAT cut cannot be replicated directly, the NI Executive receives equivalent funding instead

The October price cap will be the first indicator of whether suppliers pass the full VAT saving through to customers. Ofgem has the power to investigate suppliers that do not comply. The previous £150 reduction was passed through in full across the market, which the government cites as the basis for expecting the same outcome here.

The Budget, date not yet confirmed will be the next decision point for further energy cost measures, including any consideration of whether the REMA findings are revisited. The OBR will publish an updated forecast at that point. Any extension of the VAT cut beyond this financial year, or wider measures on the wholesale market, will be set out then.

The VAT cut itself is legislatively straightforward a change to VAT schedule regulations and does not require primary legislation. It takes effect from 1 October 2026.