There has been widespread criticism of the government’s decision to raise VAT from 17.5 to 20 per cent. This is hardly surprising since the increase will hit every household in the country. Indeed, the Adam Smith Institute recently calculated Tax Freedom Day for 2011, and found that Britons would spend an extra three days working for the taxman, rather than earning for themselves, because of the VAT rise. Tax freedom will not come until 30 May as a result.
But raising VAT may hurt more than just our wallets. The Office for Budget Responsibility has revealed that it expects the VAT rise to destroy about £5bn of economic activity in 2011-12. The reason for this is simple: raising VAT will dent consumer confidence and discourage spending. Fewer goods will be sold and lower profits will be recorded. Small firms, which will have little option but to pass on the increase to their customers, may be hardest hit.
Inevitably, this will affect employment, as sellers cut overheads and producers reduce production. The British Retail Consortium has estimated that raising VAT will cost 30,000 jobs next year, and a total of 163,000 jobs by the end of 2014.
We should consider the impact that the rise will have on inflation, already high at 3.3 per cent. Economist David B Smith, a visiting professor at the University of Derby, suggests that inflation in 2011 will be 1.2 per cent higher as a result of the increase, a cruel blow to savers, who have already been hit hard by low interest rates and declining purchasing power.
The enormous budget deficit must be addressed. But as long as the government is ring-fencing wasteful health spending, increasing the foreign aid budget and lavishing costly gimmicks on pensioners in pursuit of the grey vote, the VAT rise will remain a bitter pill to swallow.
Published in Director Magazine.