VAT hike to cost UK £5bn (hence Ireland's tough stance on corporation tax?)

Why is Ireland playing hardball on corporation tax? One clue comes from the first official estimate of how much the VAT hike will cost UK plc...

by James Taylor
Last Updated: 19 Aug 2013
The Office for Budget Responsibility suggested today that increasing VAT to 20% could wipe almost £5bn off the UK's national output next year - equivalent to 0.3% of GDP - as shoppers cut back on their spending. That's a lot of money, particularly at a time when growth is likely to be pretty feeble, and it's prompted calls for Chancellor George Osborne to reverse his plans. We can't see that happening. But it's a reminder that tax hikes can ultimately be self-defeating - an argument that's clearly popular in Ireland, where ministers are still insisting that they won't give up their 12.5% corporation tax rate to appease their prospective European paymasters...

The Chancellor hopes that putting VAT up to 20% (as of January) will raise around £13bn to help plug the hole in the public finances. But the OBR reckons this will actually lop 0.3% off next year's GDP figure, currently forecast to be an optimistic-sounding 2.3%. Official figures out today showed that retail sales grew by 0.5% in October after two months of decline - but that's not much to shout about, given that shoppers have a big incentive to buy before January. Naturally, the Opposition has seized on this as evidence that the VAT hike is not only regressive, but will also kill jobs and growth.

The Organisation for Economic Co-operation and Development goes even further: it has just slashed its UK growth forecast for next year from 2.5% to 1.7%, partly because of the VAT hike. The good news for the Chancellor is that the OECD also praised the UK's cuts programme; the 'ambitious medium-term plan has significantly reduced fiscal risks', it said, causing it to revise its growth forecast for this year up from 1.3% to 1.7%. And although it thinks the UK will perform worse than previously expected next year, it seemed to suggest that this was a necessary evil.

Speaking of tax hikes, it sounds like Ireland's ultra-low corporation tax rate remains the big obstacle to any EU/ IMF bailout package. Ireland argues that the only way it can recover from its current position is if it continues to attract multinationals to come and do business there - but the EU countries likely to fund the bailout want Ireland to increase its rate (officially so it can raise more cash, but removing a source of competitive advantage presumably has a lot to do with it too). You can see their point - but if Ireland does have to normalise its rate, and ends up losing business as a result, it may take a lot longer for it to get its finances back on an even keel. So they may end up cutting off their nose to spite their face.

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