17 Dec 2010 | Capital Hill

Capital Hill on... the VAT Increase 

It’s not unusual for shop tills to be ringing at this time of year as people splash the cash. Retailers could be in line for an even bigger bonanza than usual thanks to the government’s drive to balance the country’s books.

The standard rate of value added tax (VAT) will rise from 17.5% to 20% on 4 January 2011 – leading many people to snap up big-ticket items ahead of the change. More than 13.8 million British adults say they plan to go on a shopping spree in advance of the increase, according to a poll of more than 2,000 people by Opinium Research for Santander Insurance UK.

They will collectively splurge £8.9 billion, or £650 each, with electronic items (such as iPods, iPads, mobile phones and TVs) the most popular items for a pre-VAT hike spending spree. Clothing, alcohol, furniture and white goods are also on people’s shopping lists.

While retailers might enjoy a short-term boost, what are the longer-term consequences? Will the increase hamper consumers’ financial wellbeing, causing them to rein in their purse strings, and hit retailers’ profits – and their share prices?

Such an increase couldn’t come at a worse time: not only is January the month of festive financial hangovers, but Britain is poised for a wave of public sector job cuts, pay freezes, lower social benefit payments and higher taxes.

It’s important to remember, though, that this rise won’t push up the cost of everything. VAT, at the full rate, is charged only on non-essential goods. Essentials – so things like food, children’s clothing, books, newspapers and public transport – are not subject to VAT, and many other items carry a reduced rate of 5%. These include gas and electricity, sanitary hygiene products and children’s car seats.

Few people felt flush overnight when the Labour government cut VAT from 17.5% to 15% on 1 December 2008 – a temporary reprieve that lasted until 1 January 2010. Equally, few people will suddenly feel impoverished on the back of the increase.

Say, for example, you bought a something costing £10 at the current standard VAT rate. With the new rate at 20%, the price will theoretically increase to £10.21 – pretty negligible.

However, on big-ticket purchases it will make a sizeable difference. An extra 2.5% VAT will add £425 to a new £20,000 car, £106 to a £5,000 kitchen and £16 to a £750 TV.

The British Retail Consortium (BRC), a trade body which represents 80-90% of stores, warns that the move will knock demand for goods and services and erode companies’ profits. Ultimately, it will lead to cost-cutting, redundancies and a freeze on recruitment.

It will yield £11.3 billion in the first year for the government, but it will also lead to 30,000 job cuts across all sectors, the study conducted for the BRC by the Centre for Economic and Business Research said.

Against that backdrop, many retailers plan to use the VAT rise to “mask” more extensive price increases, a survey by accountancy group KPMG has found.

It showed that 60% of retailers and consumer product manufacturers plan to increase their prices over and above the VAT rise to 20%. Across all industries, 40% of firms will do the same.

Whether that materialises remains to be seen. One thing that appears certain, though, is that companies exposed to consumer spending – much like the economy – face a rocky road.

Author: Jennifer Hill
Jennifer is an award-winning British financial journalist. She recently left The Sunday Times, where she was deputy Money editor, to set up her own company, Media Hill Ltd. She is a previous personal finance correspondent of Reuters, the global news service, and personal finance editor of The Scotsman newspaper.

She has won or been shortlisted for six Headlinemoney awards, the ‘Oscars’ of personal finance journalism in the UK. She has also scooped or been nominated for accolades from the Association of Investment Companies, Ignis Asset Management, the Association of British Insurers and the British Insurance Brokers’ Association.