Pelosi wants a VAT Tax

VAT rise will mean months of stagflation

Households must brace themselves for a painful period of stagflation-lite in the opening months of 2010 as the VAT cut comes to an end and squeezes incomes across the country, experts have warned.

By Edmund Conway, Economics Editor
Published: 6:00AM GMT 26 Dec 2009


Last year sales were given a boost by a reduction in VAT. The CEBR fears the increase to 17.5pc on January 1 will hit this year's sales.

Inflation will rise significantly above the Bank of England's 2pc target and consumer spending will drop by 0.7pc in the opening months of next year, in the first taste for British households of the period of austerity that is an inevitable consequence as the Government puts its books in order in the coming years, according to the Centre for Economics and Business Research.

It said that the increase in VAT from 15pc to 17.5pc that kicks in on January 1 "has the potential of stalling an emerging recovery."

The warning will be a blow for retailers. Although they are expecting healthy takings ahead of New Year, they are steeling themselves for one of the most disappointing sale periods in recent history.

The Chancellor refused at the pre-Budget report earlier this month to respond to pleas to defer the date at which the tax increases to later in the year, arguing that to do so would be too expensive for the public finances. However, in fresh research, the CEBR found that the VAT rise would depress consumer spending by 0.7pc in the early part of 2010, and then a further 0.2pc in the rest of the year. It said that the consumer price inflation, which is currently just below target, would rise to 3pc, potentially triggering a letter of explanation from the Bank of England Governor, Mervyn King, to Alistair Darling.

The combination of these two effects will be to erode household income for some months, said the CEBR's Jörg Radeke.

He added: "Additionally, while some companies may decide not to pass the increase on, shrinking margins at a time of falling profitability will be the result. All told, reversing the cut in January is likely to wipe out most of the benefits it was meant to create in the first place. Expect a tough Spring for retailers and other industries dependent on consumer spending."

The news comes amid heightened worries for the British economy, with both the record fiscal deficit and the relative weakness of economic output coming under scrutiny. On Christmas Eve, the interest rate on the benchmark 10-year gilt rose above the 4pc mark for the first time since June. At these levels, the Government's cost of borrowing is now higher than Spain's, and is almost equal to Italy's, sparking fears that international investors are considering abandoning the UK. Traders are concerned by the fact that the pre-Budget report failed to map out a more ambitious plan to cut the deficit than previous Treasury statements, despite warnings from ratings agencies and the International Monetary Fund about the worrying state of Britain's public finances.

The CEBR said that the VAT cut had helped support retail sales throughout the year, helping push sales volumes up by 2.7pc in the year to October, compared with a 1.9pc over the same period in the eurozone. It said that the cut equated to an extra £300 of disposable income, a boost of around 1.2pc. This helped increase consumer spending by a significant £6.8bn in the past year, and overall GDP growth by 0.5pc – some way short of the 1pc hoped for by the Chancellor, the CEBR said.

However, this came at quite a cost. Mr Radeke said that the gross cost for the Treasury is likely, all told, to have been around £10.7bn. But when the additional tax revenues from increased consumer spending and higher economic activity are borne in mind, the net cost is likely to have been only around £4.3bn. This is significantly lower than the £7.8bn originally projected by the Treasury. Amid the fiscal worries, it will come as welcome tidings for the Chancellor this Christmas.

http://www.telegraph.co.uk/finance/econ ... ation.html