As speculation mounts that VAT will rise to 20% in line with the rest of Europe following the emergency Budget, Kelkoo study reveals the true impact on consumers, retailers and the economy

Monday 21st June 2010 : A report released today by Kelkoo, the shopping comparison website, assesses the impact on the UK economy and consumers in the 12-month period following its introduction, should the standard rate of VAT increase to 20% following tomorrow’s emergency Budget.

Last week, as the Office of Budget Responsibility (OBR) slashed Britain’s growth forecast from 3.5% to 2.6% for 2011, George Osborne was left looking to fill a £12bn gap next year, £2.4bn of which will be funded through higher taxation2. According to key commentators, the introduction of a 20% standard rate of VAT appears an increasingly likely option given that the proceeds from the tax represent the third largest source of revenue for the Treasury, equivalent to 51.4% of total receipts from Income Tax and Capital Gains tax in 2008 (£157bn). In addition, an increase would simply bring the UK in line with the rest of the continent, where the average VAT rate is now 21.3%.
At 17.5% the UK currently has the lowest standard rate of VAT and the only 0% rate on food of any major EU member state. The announcement in tomorrow’s Budget would follow the recent European trend for VAT rises, with Greece having ramped up its rate from 19% to 23%, Portugal from 20% to 21%, and Spain set to mirror Portugal’s rate from July 2010. In countries like Norway, Denmark, Sweden and Hungary VAT already stands at 25%.

Today’s report was commissioned by Kelkoo and carried out by the Centre for Retail Research. 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 £1.16 per day or £425 a year, 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. However, the impact on big ticket items would of course be more substantial with the cost of a Ford Focus increasing by £382.23. 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 Treasury has also recently been involved in discussions with major supermarket groups about the possibility of introducing a 5% reduced rate of VAT on food and non-alcoholic drinks, which would see the UK align itself with most other EU countries and move away from its position as the only major EU member with 0% VAT on food. 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. This would result in an overall reduction in spending power of £560 per household or 1.66% a year. Following reports of slowing sales this week from both Tesco and Sainsbury’s, this move has been strongly opposed by major retailers. 

Impact on Low Income Groups

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).

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. 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 report estimates that 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% – potentially leading to a 1.6% reduction in retail staff or 47,360 employees, and resulting in the closure of around 9,480 stores nationwide.
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. 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. In stark contrast, 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%.

Impact on the Economy

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. However, the recent announcement from Office of Budget Responsibility (OBR) confirms that this is now unrealistic and 2011 growth is likely to reach just 2.6%2. 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 could make growth forecasts 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 the 12 month period following the introduction of the VAT increase. 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%.
Bruce Fair , Managing Director of Kelkoo UK, said: “George Osborne has got his work cut out at next Tuesday’s emergency budget as the first Conservative Chancellor in 13 years. With a projected £2.4bn gap to plug through higher taxation, VAT seems like an obvious choice. However, as with all tax increases there will be repercussions for consumers, retailers and the economy. 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. Consumers would be left facing an increase in the price of everyday goods which is likely to result in lower levels of spending and a subsequent reduction in retail sales, all at a time when the retail industry is recovering  from the worst recession in living memory.”
Increase in Costs of Basket of Goods:

Source: Kelkoo , prices correct 15/06/10