VAT rise looms as coalition deal adds estimated £10bn to debt

King of Capital: Sandy Weill and the Making of CitigroupPlans raise fears of blow to already fragile consumer confidence and more upward pressure on inflation

There were warnings tonight that the government will be forced to hit consumers with a VAT hike to 20% if it is to reduce the country's gaping budget deficit and retain the confidence of jittery financial markets.


Such a rise could cost every household in Britain £425, but the government may have little choice given the state of the public finances, economists warned. The coalition's plans outlined so far on the deficit quickly came under City scrutiny, with one institution warning that in their current state they would actually worsen the country's budget position.

Credit Suisse said the measures announced would add close to £10bn per year to the deficit, contrasting with the incoming government's emphasis on the need for "a significantly accelerated reduction".

The easiest solution would be a VAT rise, Credit Suisse added, echoing other economists but raising fears of a blow to already fragile consumer confidence and more upward pressure on inflation.



"In our view, one way to get the numbers to add up would be an increase in VAT, up to around 20%," said economist Neville Hill. "Raising VAT is the quickest and easiest measure and relatively effective in terms of raising the sums involved."

It was also one measure that both parties could introduce without being seen to violate any pre-election pledges, he added.

VAT is currently at 17.5%. It has already risen once this year, as an emergency recession-related cut by the Labour government was reversed in January. The increase has been blamed for slower economic growth seen at the start of the year.

"You don't want to raise it twice in one year. If I were George Osborne, I would be thinking about half a percentage point rise each year for five years," said Hill.

Analysts at Citigroup see VAT as the most likely tax to rise, but are not worried it would derail the economic recovery given that the Bank of England is likely to keep interest rates at their record low for some time, giving some support to households.

"We believe any such tax hikes will occur as soon as possible, as part of a 'kitchen sink strategy' to absorb the pain, while the coalition is still in a political honeymoon and the previous government can be blamed," says Citigroup's Ann O'Kelly.

The Institute for Fiscal Studies also noted the new government has left the door open to a VAT hike in Osborne's June budget, and it will set its own thoughts on how to tackle the deficit on Monday.

Sainsbury's chief executive, Justin King, urged the government to get the timing of any VAT hike right and give retailers plenty of notice. A rise in VAT on non-food items looks "more likely than not," he added, but imposing VAT on food would be "bizarre" and "regressive" as it would hit poorer families the most.

Although retailers are widely expected to absorb at least some of any VAT increase initially, they will eventually pass it on in full to customers, King warned.

A rise in VAT to 20% would cost each household in the country £425, according to a report by Kelkoo, the shopping comparison website. It estimates that in real terms the hike would add 2.1% to the price of everyday goods, increasing the cost of petrol by 3p per litre, cigarettes by 12p per pack, and a pint of lager by 7p on average. Carried out by the Centre for Retail Research, the report also predicted the change would be felt almost immediately, with almost two-thirds of retailers saying that they would pass on the full increase within the first month, rising to 98% within the first year.

Bruce Fair, managing director of Kelkoo UK, said: "While it is widely recognised that urgent action is required to plug the hole in the UK's finances, it is imperative to avoid a sharp drop in consumer spending, as it could derail the country's fragile recovery from the recession. An increase in VAT would increase government revenues significantly, but it could also have serious repercussions for consumers, retailers and the economy."

Whatever the risks to consumer spending, in the end, economists believe, VAT or other tax measures will have to be introduced as spending cuts alone will not get the deficit down sufficiently.

With Greece rattled by a financial crisis and riots over austerity measures, the new government will be aware of the spiral that can ensue if a country's deficit is not tackled soon enough.

"At the end of the day this is an exercise in keeping market confidence in you, because we have seen what happens if markets lose confidence in you – it's very bad," said Hill.

sourced from The Guardian