VAT rise balanced against threat to inflation and retail sales

24 June 2010

By raising VAT from 17.5 per cent to 20 per cent as of 4 January 2011, the Chancellor will generate an additional £13 billion of government income each year.

That’s the equivalent of 3p in the pound on income tax.

While most business groups had been tacitly expecting some form of increase and while most believed it to the least unacceptable tax hike available to the government, the rise may pose difficulties in the coming months.

There is the threat to inflation that it poses (prices on most purchases will climb by 2.5 per cent).

But it may also have a dampening effect on the willingness of consumers to spend.

Research in the aftermath of the announcement by Kelkoo, the online retail organisation, found that 44 per cent of the 2,000 shoppers polled claimed they would rein in spending once the increase came into effect.

Topping the list of purchases that would be cut were dining out, holidays, computer equipment, mobile phones and adult clothing.

Some calculations put the annual cost to an average earner at £150 a year.

The Chancellor’s wish must be that the rise does not lead to a greater contraction in consumption and consumer confidence as households, already under pressure from rising unemployment, look to reducing their own budget deficits.

Andy Street, the managing director of John Lewis, said that the new rate was “likely to suppress consumer spending, and is therefore bad news for retailers” but added a hope that “it plays its part in restoring Britain’s long-term competitiveness”.