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20% vat still firmly on the agenda: full impact of potential new tax revealed

New study reveals likely VAT increase under next Parliament could cost UK households £11.14bn or £425 each over a 12 month period.

CITY & CORPORATE

20% vat still firmly on the agenda: full impact of potential new tax revealed

New study reveals likely VAT increase under next Parliament could cost UK households £11.14bn or £425 each over a 12 month period.

A new report released today by Kelkoo, the shopping comparison website, assesses the impact on the UK economy should the standard rate of VAT increase to 20%. There is growing speculation among key commentators that a rise in VAT is looming under the next Government, whichever political party wins the general election. With Britain coming under increasing pressure from the EU and international markets to address the record £178 billion black hole in its finances, and with speculation mounting that one of the most viable measures to tackle the deficit is the introduction of a 20% standard rate of VAT, today’s report assesses the full impact it would have on the UK in a 12-month period following its introduction.

According to the study, ‘Raising VAT to 20%: Effects on Consumers, Prices and the Retail Industry’, a VAT increase would raise an additional £11.4bn for the Treasury, bringing total receipts from the tax to £91.29bn. This would cost each household in the country £425, and reduce household spending power by an average 1.25% per annum. In real terms, it would add 2.1% to the price of everyday goods, increasing the cost of petrol by 2.5p per litre, cigarettes by 12p per pack, and a pint of lager by 7p on average. The change would be felt almost immediately, with almost two-thirds (64%) of retailers saying that they would pass on the full increase within the first month, rising to 98% within the first year.

The aim of the report, commissioned by Kelkoo and carried out by the Centre for Retail Research, is to inform public debate. It is non-political in nature and its purpose is simply to lay out the implications for consumers, retailers, and the economy as a whole of an increase in the standard rate of VAT from 17.5% to 20%. The report draws on official data from the Office of National Statistics (ONS), HMRC, materials published by the Treasury, and a telephone survey of 56 major UK retailers, with a combined turnover of £58.6 billion, almost 495,000 employees and 49,980 retail stores.

In the run-up to this week’s Budget and the general election, City experts have warned that it is critical for any Government in power to spell out clear plans to halve the deficit and balance Britain’s books to retain the confidence of international markets and prevent interest rate hikes for consumers. As a result, all major political parties have left the door open for spending cuts and tax increases during the next Parliament. Only last week, Chief Secretary to the Treasury, Liam Byrne, had to do a U-turn on his statement ruling out no new rises in VAT or other taxes, claiming ‘Chancellors reserve the right to come back to tax matters at every budget’1. A recent report from the European Commission also warned that the Government’s plans for reducing debt do not go far enough, and the UK is not on course to cut its deficit in line with EU rules. EU rules say government deficits must be below 3% of GDP, but the UK's deficit is expected to hit £178bn - or 12.6% of GDP - this year2.

The Institute of Fiscal Studies3 has said that further ‘fiscal tightening’ will be required on top of the Government’s current plans for cuts and higher taxes. In addition, there have been claims from leading economists and accounting firms, including KPMG4, Blick Rothenberg3 and Smith & Williamson5, that an increase in the standard rate of VAT cannot be ruled out, given that the UK currently has the fourth lowest rate in Europe, and an increase would simply bring it in line with the rest of the continent, where the average VAT rate is currently just above 20%.

Impact on the Economy

According to the report, the proceeds of VAT in 2008 (£80.7bn) were a major source of revenue for the Government, equivalent to 51.4% of total receipts from Income Tax and Capital Gains tax in that year (£157bn). Total net VAT receipts in 2010 are already estimated to reach £80.15bn, compared to £68.64bn in 2009. However, a 2.5% VAT increase would raise the annual VAT bill for households by 13.9%, generating a further £11.4bn for the Treasury, and raising total receipts to £91.29bn.

There is widespread acceptance of the fact that action must be taken to deal with the UK deficit, and the projected increase in VAT receipts would undoubtedly help to achieve this objective. However, it could also reduce household spending power by 1.25% on average, which could have a negative impact on retail sales volumes, as well as damaging consumer confidence, and ultimately reduce economic growth forecasts.

With the retail sector employing 3 million and providing 24.8% of the UK’s GDP, the performance of the industry is vital to the economy as a whole. The Government’s pre-budget Statement in 2009 forecast growth in real terms of 1.25% in 2010 and 3.5% in 2011. An increase in the proceeds provided by VAT receipts may increase confidence in the general prospects of the UK economy in the long-term, but in the short-medium term, increasing taxes by £11.4bn would make the 2010 forecast unrealistic. If consumers follow a combination of reduced and postponed spending following a rise in VAT, the reduction in GDP could be approximately 0.5% over a 12 month period, cutting economic growth from 1.25% to 0.75%. Furthermore, the impact of higher prices could also lead to an estimated increase in the Consumer Price Index (CPI) of between +0.6% to +0.8%, taking it to 3% from 2009’s average rate of 2.1%.

A VAT induced reduction in disposable income could also reduce confidence levels at a sensitive time in the UK’s recovery, particularly if it is associated with a sharp fall in consumer spending and economic activity. The GfK NOP Consumer Confidence Index has improved from -35 (February 2009) to -14 (February 2010). The report states that if VAT were to increase soon after the election, it may come as a shock to the general public, and coupled with January’s revision of the VAT rate to 17.5%, it could take a combined total of £22.14bn or £844 out of every household’s budget. As a result, the GfK NOP Consumer Confidence index could fall to -25 or -27 – the levels last seen in May or June 2009.

The Cost to Consumers

The study reveals that the cost to consumers of increasing the standard rate of VAT to 20% would equate to £425 a year for each of the country’s 26.2 million households, or £181 for every man, woman and child in the UK.

The Treasury has also recently been involved in discussions with major supermarket groups about the possibility of imposing a 5% reduced rate of VAT on food and non-alcoholic drinks, which would bring the UK in line with most other EU countries. While it is highly unlikely that 5% VAT would be introduced on food at the same time as an increase in the standard rate of VAT, if they were to coincide this would add a further £3.55 billion to the Treasury’s coffers, representing an additional £14.69bn in VAT receipts over a full year - resulting in an overall reduction in spending power of £560 per household or 1.66% a year.

The report finds that the impact of any change in VAT would hit lower income groups most severely, given that they tend to pay above average levels of VAT as an indirect tax on spending. During the last fiscal year, the bottom quintile of earners paid 28% of their gross income in indirect taxes, with VAT payments representing more than 12% of their disposable income. This compares to the average household in the UK which paid 14% of their gross income in indirect taxes, and 7.4% on VAT. High income earners paid 10% of their gross income in indirect taxation and VAT represented 5.9% of their disposable income. However, to put this into context, the top quintile still paid 175% more in VAT than the bottom quintile (£6.6bn compared to £2.4bn).

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. Consumers would be left facing an increase in the price of everyday goods at a time when salaries are generally being frozen and the overall tax burden is increasing. The combination of lower disposable incomes, and a reluctance to increase borrowing in the current economic climate is likely to result in lower levels of spending.”

Repercussions for the Retail Industry

56 of the UK’s major retailers were interviewed to assess the impact that a 20% rate of VAT would have on their businesses. While most felt that the Government needed to take action to reduce the budget deficit, many were concerned about how it would affect trade.

 

A VAT rate of 20% would raise £36bn from the retail industry including £4.5bn in additional tax, although it would also cut retail sales growth by 0.64%. Almost 77% of retailers felt that the impact of a 20% VAT rate on their profits and cash-flow would be ‘very negative’ or ‘quite negative’, and 73% thought that it would have a negative impact on overall sales. The proportion of retailers expecting a 1%-5% fall in sales was 41%, while a fifth (21%) expected a fall of 5%-10% and almost 11% expected a fall of 10% or more.

Many retailers expected to slim down their workforce in 2010 and 2011 anyway, but a VAT increase would accelerate their plans. Almost 77% of retailers said that a rise in VAT would probably have a negative effect on employee numbers. If sales volumes were to fall in line with estimates, there would be a reduction of 1.6% in retail staff, equivalent to 47,360 employees. However, half of online retailers expected a VAT rise to have either no effect on employee cutbacks, or even create 1%-5% uplift in staff numbers due to increased sales.

10% of retailers also thought that a VAT increase would result in them having to close 10% or more of their stores. 20% expected a fall in store numbers of between 5%-10%, while 36% thought there would be a slight fall of between 1%-5%. Based on the survey data and the decline in store numbers in 2009, a 20% rate of VAT could result in the closure of around 3% of retail stores nationwide - equivalent to 9,480 shops.

On the other hand, online retailers were less likely to pass on the entire VAT increase and were more positive about the commercial opportunities it presented, with 33% stating that an increase would lift their sales by between 1%-5%. The report estimates that a VAT increase would reduce growth in overall retail sales to a little over 1%, instead of the projected 1.7% this year. E-commerce is forecast to grow by around 12.4% in 2010-11, but this may rise to 15-17% if VAT-induced price increases in traditional stores result in consumers going online.

Bruce Fair, Managing Director of Kelkoo UK, concludes: “While the retail sector is sympathetic to the dilemma that any new Government is going to have to face, raising the level of VAT to 20% is not without its difficulties. It is worth bearing in mind that consumers are much more sensitive to price increases caused by an increased rate of VAT than they are to price reductions when VAT is reduced, and introducing this measure could result in a fall in overall consumer spending.

“We also cannot ignore the fact that the majority of retailers questioned felt that a VAT rise could have a detrimental effect on the industry, adversely affecting sales, and forcing store closures and staff redundancies. However, at the same time online retailers, whose prices are on average 20% lower than the high street, were more positive about the potential benefits of a VAT increase, and thought that it would make customers more likely to seek out goods at lower prices.”

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