Will today's VAT hike derail the recovery?

Doom-mongers are predicting that hiking VAT to 20% will result in higher inflation, slower sales and job losses. Happy New Year to you, too.

by James Taylor
Last Updated: 19 Aug 2013
Just in case you've been living under a rock for the last few months, or have been afflicted by Christmas excess-induced amnesia, the big news today is that VAT has just gone up from 17.5% to 20%. With prices likely to rise across the board as a result (possibly by more than the extra 2.5%), this is indubitably a bit of a gamble by the Government as it looks to bring down the deficit; chances are that it will hurt retailers and drive up inflation, at least in the short term. Still, on the bright side, the consensus among economists seems to be that the economy is just about strong enough to take it now. Only time will tell...

One potential upside for retailers should have been a last-minute surge in shopping, with punters looking to fill their boots before the prices went up (helped by all the juicy discounts on offer in the sales). And it does look as though some have enjoyed strong footfall since Christmas: John Lewis, for example, said last week that sales on December 27 were 30% higher than its previous biggest ever day. However, most retailers are likely to have been hit by the heavy snow in the run-up to Christmas; we'll know more this week as the first trading updates arrive, but it seems likely that many won't have done as well as they hoped (unless you sell outdoor wear, like Blacks - whose sales were apparently up 10% in December). Our guess is that the usual star turns will have done well, but the laggards may have been exposed even further.

But 2011 could be even tougher for the high street. Although some of the bigger retailers (e.g. John Lewis, M&S and Tesco) have promised not to pass on the VAT hike just yet, others will have to make some tough choices if they want to preserve their margins. They can either put prices up - and some could hike by as much as 8%, according to analysts. Or they can look to slash their own costs - which will probably mean cutting jobs (Labour reckons it could put paid to 250,000 jobs) and squeezing their suppliers until the pips squeak. So there's a good chance the impact of this VAT hike will be particularly hard on small business, who won't have the same capacity to absorb higher costs.

It's a delicate balancing act, though. With consumers already fretting about rising unemployment, falling house prices and the impact of austerity measures, this could be another reason for them not to spend their money - particularly since all these price hikes are likely to drive up inflation, increasing the cost of living in the short term and pushing up interest rates in the medium term. And we need people to keep spending money if the economy is to keep growing.

The Government argues that it's a necessary evil; that we need the £13bn this hike will supposedly raise to chip away at our massive structural deficit (its commitment to which seems to have becalmed international investors). So it will have been cheered the front page of today's FT; in a poll of leading economists polled by the Pink 'Un, the majority claimed that the UK will keep growing, despite the spending cuts and tax hikes. The Government will fervently hope this is true. So do we.

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