While the Tory party is keeping quiet over reports it may up VAT to 20%, economists and trade bodies are not impressed by the idea. James Ball reports


Every street brawler knows the punch they don't see is the one that floors them. MPs and the food and drink industry, spurred on by The Grocer's Push Back the Tax! campaign, have spent the past six weeks battling the government over the date VAT returns to 17.5%.

But, just as the pressure is coming to bear on the Chancellor, the Conservatives have stepped in to the VAT battle with a right hook that has hit the industry with a new set of worries.

Newspaper reports last week claimed the Tories the party most likely to form the next government plan to raise VAT to 20% within weeks of an election. Some Shadow Cabinet ministers have denied the speculation, but the party refuses to rule the move out. Would a second VAT hike within the space of six months prove a knockout blow to the sector?

As the UK economy recovers, the next government will have to make painful decisions about the tax hikes and public spending cuts needed to help reduce its £800bn public sector debt, which is why the Conservatives might be tempted by such a move. Treasury estimates suggest that increasing VAT from 17.5% to 20% when the economy is stable would raise about £12.5bn a year for the Treasury.

But this amount might not be raised if consumer demand is still recovering, warns Gemma Tetlow, an economist from the Institute of Fiscal Studies. It could also damage the economy.

"Consumers who are well off, and aren't credit constrained, are likely to spend less following a further VAT rise because the subsequent price increases would make discretionary purchases less attractive," she says. "This would reduce spending and depress any economic recovery."

VAT distorts the market, she adds, because some goods are subject to it while others are not, making the untaxed products relatively more attractive. Upping VAT would increase these distortions, and Tetlow suggests it may be more advantageous to extend VAT to more categories (such as books or kids' clothes) rather than raise it.

Announcements of VAT increases often lead to a surge in sales as consumers bring forward purchases to beat the price hike. But Tetlow warns this might not be the case if the 2.5 point hike went ahead after an election because many shoppers would have already made purchases six months earlier, before VAT returned to 17.5%.

A mid-2010 VAT rise "would hardly leave retailers jumping for joy", coming so soon after the administration expenses of another costly VAT hike, warns the British Retail Consortium. It does accept, however, that VAT and other taxes may need to increase, says head of communications Richard Dodd.

The Association of Convenience Stores is more strident, arguing against any VAT rate above 17.5%. It believes a 20% rate would hurt sales for the convenience sector at an already challenging time.

"We would oppose such a plan," says public affairs director Shane Brennan. "We understand the next government will need to raise more revenue, but this relies on supporting the economy, not undermining it. Increasing VAT seriously hits sales for our members, devastatingly so for shops in other sectors."

Shadow Chancellor George Osborne has not committed himself to increase VAT but, to date, he will not rule it out. The Grocer has urged the government not to restore VAT to its standard 17.5% rate until the end of January, to protect Christmas trading. No-one disputes that the next Chancellor will have to raise tax to mend the UK's finances. But he would need to think carefully about whether a second VAT hike inside six months is the way to do it.

Since such a move couldn't help at the ballot box, or raise the kind of revenue that would put a serious dent in the debt mountain, Osborne's knockout VAT blow could easily end up smacking him square in the face.