The UK opposition Labour Party has attacked the rise for its impact on families and the 250,000 jobs it may cost, while Chancellor of the Exchequer, George Osborne, defended the move as the “least damaging” means to tackle the budget deficit.
Whether raising VAT is the least damaging means to tackle the deficit in the context of the UK’s fragile economic recovery remains open for debate as it will have an impact on consumer spending, retail profit margins and the real estate sector, but it is clear that other governments see putting up the tax as the easiest option politically.
“People don't see the impact on their back pocket as directly,” says Niall Campbell, KPMG's global head of indirect tax. “Everybody knows what an extra 1% income tax means on their take-home pay. However, a one percentage point VAT rate rise does not have the same personal impact. It does not reduce disposable income and is, in theory at least, partly elective as it is only payable to the extent of actual spending.”
Eight other European countries are raising their VAT rates this week, including Switzerland, from 7.6% to 8%; Portugal, from 21% to 23%; Poland, from 22% to 23% and Slovakia, from 19% to 20%. Spain and Portugal also raised rates last year, along with Finland, where a further increase to the EU maximum of 25% may be proposed.
Impact
The UK government expects to raise £13 billion ($20 billion) from the change, however one adviser is concerned about its impact on the retail sector.
“If we accept the previous government’s figures which show that the impact of the VAT reduction in 2008 was very beneficial to retailers, then we have to anticipate that any increase now will be very detrimental,” said Mark McMenemy, head of retail at Alvarez & Marsal Europe.
McMenemy believes that larger retailers may absorb the rise to maintain clear pricing.
“A £20 dress will not be re-priced at £20.50,” McMenemy said. “The weaker players already on thin bottom line margins cannot afford to absorb another 2.5% cost increase so this could be another challenge for those who are already stretched.”
Where retailers pass the tax rise onto consumers, it may affect spending habits and in turn profit margins, especially where consumers opt for cheaper own-brand items instead of premium products. This would benefit larger retailersat the expense of smallerones.
“Higher prices are more likely to move many consumers away from the mid-market to the value sector,” said McMenemy.
McMenemy’s colleague, Richard Baxter, head of indirect tax at Alvarez & Marsal Taxand UK, is more concerned about the impact on the real estate and banking sectors.
“All the focus has been on retail but it is often forgotten that in addition to the poor consumer, banks, insurance companies, hospitals and real estate groups are the sectors most adversely impacted by the VAT increase; it will add significantly to their cost base,” Baxter said.
Banks cannot recover VAT on their costs, while a 2.5 percentage point rise will have a significant effect on multi-million pound real estate deals.
Trend
One of the main reasons European governments are pushing up VAT is to pay for falling corporate tax rates as countries compete to attract foreign investment. The same budget which introduced the UK’s VAT rise also introduced an annual cut in corporation tax by one percentage point until 2014.
“The UK is in good company this week with its VAT hike,” said Richard Asquith, head of VAT at TMF Group. “International governments had been plotting for many years to raise indirect taxes such as VAT to subsidise cuts to job-creating business taxes... We can expect more increases in 2011 as more countries come under financing pressure.”
The trend towards rising VAT rates across Europe and the rest of the world looks set to continue.
“We are very clearly seeing a trend towards more indirect taxes in Europe,” said Eduardo Gracia, head of tax at Ashurst in Spain. “Particularly within the EU single market, member states need to compete to attract or retain capital and human talent which means offering attractive corporate and individual income tax rates.”
