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VAT rise inconvenient but not the darkest cloud on the horizon

The latest white paper from the KPMG/Synovate Retail Think Tank which was published this week looked at the effect of the VAT rise on the retail sector. By Helen Dickinson

GENERAL MERCHANDISE

VAT rise inconvenient but not the darkest cloud on the horizon

At first glance, the RTT’s conclusion – that it will have minimal impact on the sector – might seem a little surprising.  After all, the rise in VAT to 20 percent in January 2011 is far from welcome news for the retail sector, which has been at the sharp-end of the economic downturn for the past two years.

Let’s face it, changing the rate of VAT is an unwelcome task for retailers at any time – altering product tags, shelf prices and systems and processes to ensure the appropriate declarations and payments is a logistical nightmare – and happening at the busiest time of year creates a real headache.  It’s also things like dealing with refunds of sales made before the VAT change, which will be particularly complex.

At the same time, many retailers have a freeze on IT projects over December and January to minimise the risk of disruption to the business over the most crucial trading period of the year.
 
And research undertaken by the BRC indicates that making such a change cost the sector a particularly unwelcome £60m last time, while making errors in the VAT return carries additional risks and penalties with HMRC.

But while this is certainly an inconvenience and will have a short term impact on staff productivity, the RTT believes that the retail sector is particularly adept at handling these types of pressures.

The RTT looked at the how the VAT increase will be handled from the point of view of pricing.  With rising logistics costs following capacity cuts, Asian wage inflation, oil prices, ongoing weakness of the pound we will see shop prices rising slowly over the latter part of this year as they try to build it into the pricing structure early, giving some short term relief to margin. 

The most likely scenario is that retailers, consumers and suppliers will all share part of the pain of the VAT rise either through margins being squeezed or, in the case of consumers, through lower disposable income, reduced volumes or quality of products consumed.  The RTT believes that retailers have no choice but to pass more than half of the cost to consumers and, due to the highly competitive nature of the industry, absorb the remainder themselves or share it with suppliers.

The real question is the extent to which higher VAT means lower demand for goods and services.  This is debatable but as prices go up and companies' margins are hit, the theory is that retailers cut costs to protect profits so employ fewer people or hold-back on job creation.  Research by CEBR on behalf of the BRC estimates that by the end of 2011 there would be a £1.6bn (0.25 percent) hit to consumer spending and 30,000 fewer jobs in the UK (across all employment sectors).  After four years these figures would be £3.6bn less spending and 163,000 fewer jobs.

My perspective is that we will see some short term blips in retail spending – ensuring Christmas trading is positive is a plus, while January 2011 will be challenging – the longer term direct impact of the VAT change in isolation will be less significant.  After all, how beneficial was the cut to 15 percent?

The broader, and much more worrying, impact on spending will come from the contraction in disposable income from the other fiscal measures and changes.  The VAT increase could actually contribute to this, should the MPC decide to increase the base rate before the end of the year – a possibility if headline inflation stays above the target figures.  My view is that the risk is all on the downside.

Helen Dickinson is Head of Retail at KPMG

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