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VAT has now risen to 20% in the UK

The rate of Value Added Tax went up at midnight from 17.5% to 20.0%. This move was flagged in advance by the coalition government as being a necessary part of their austerity measures. On the one hand they are slashing spending across most government departments and on the other hand they are trying to raise taxes as well in an attempt to reduce the budget deficit. The chancellor, George Osborne, estimates that the increase in VAT will raise an extra £13bn a year.

This increase is obviously going to hurt families as it is another increase in prices to be added to commodity price increases and increased petrol duty. This is also at a time when most workers will be looking at a standstill in wages this year, which given a CPI index of over 3% will mean a substantial fall in real income. But these are the ‘lucky’ ones as many workers will be losing their jobs this year.

Ed Miliband, the leader of the Labour Party, has suggested that the VAT rise could cost the average family nearly £400 a year and put a quarter of a million jobs at risk.

Will 2011 be worse than last year as a result of the rise in VAT and increases in unemployment?

Theoretically, the increase in VAT should add 2.1% to the price of most products in the market place, but a study by the consultancy KPMG found that 60% of retail managers intended to raise prices above this level. Martin Scott, a partner at KPMG, was reported as saying that most retailers have “….been discounting for so ling it is impossible to see how they can afford not to pass on the VAT increase, and some more. I’d be very surprised if we didn’t see the majority increase prices by far more than the VAT jump.”

The Centre for Retail Research and Kelkoo, the online shopping group, have estimated that retail sales will fall by about £2.2bn in the first quarter of 2011, as a direct result of the rise in VAT. However, there is strong evidence for supporting the view that many consumers have brought their spending forward before the rise in VAT. For example, John Lewis broke their record on Boxing Day for sales on a single day by no less than 30%.

It has also been pointed out that this rise may hit the Olympics next year which has been seen by the government as an opportunity to boost the UK tourist industry. Hotels will particularly suffer from the VAT increase as they must pay the full amount on overnight stays and restaurant meals. This contrasts with countries such as Germany, where there is a special VAT rate on hotel rooms of only 7% and France, where it has been reduced to 5.5%.

However, the UK level of VAT was one of the lowest in the EU before the change and has now moved up towards the EU average.

Finally, there will obviously be an impact on inflation from the coming price rises. With the consumer prices index already at 3.3%, many analysts believe that the VAT increase will push this up towards 4% this year. This will put greater pressure on the monetary policy committee to raise interest rates. If rates go up this will further reduce discretionary consumer spending, as many will face higher mortgage costs. Of course, a rise in interest rates will adversely affect investment plans by firms and could serve to put a brake on growth in aggregate demand.

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Posted in Consumer Price Index, Retailing, taxation, unemployment

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