VAT rise hits UK economic growth

International Tax Review is part of Legal Benchmarking Limited, 1-2 Paris Garden, London, SE1 8ND

Copyright © Legal Benchmarking Limited and its affiliated companies 2025

Accessibility | Terms of Use | Privacy Policy | Modern Slavery Statement

VAT rise hits UK economic growth

office-for-national-statistics-logosmall.jpg

New figures announced by the Office for National Statistics (ONS) today show that GDP growth has slowed to 0.2% in the second quarter of 2011. What the figures do not show is economists’ belief that January’s VAT rise is partly to blame and this may affect future tax policy.

office-for-national-statistics-logosmall.jpg

The ONS cited five factors to account for the UK’s weak economic growth between April and June: the royal wedding and the extra bank holiday provided for it, the aftermath of the Japanese tsunami, the first phase of Olympics ticket sales and the warm weather in April.

Leading economists agree that these factors are important; however they also believe that January’s VAT rise to 20% is continuing to stunt UK growth.

“Effectively there’s a squeeze on real incomes and VAT is impacting on that,” said Andrew Smith, chief economist at KPMG.

Smith points out that a VAT increase means spending is initially brought forward before the rise and it slumps immediately after that. These factors would have worn off by the second quarter, but the VAT rise is continuing to squeeze domestic demand.

“A VAT cut now would help relieve the income squeeze,” Smith said. “But the big thing is high inflation. The main factors driving inflation are oil, energy and food prices and the VAT rise didn’t help either.”

Andy Goodwin, senior economist at Oxford Economics, agrees that the VAT rise is impacting on growth.

“The ONS have ignored it because it’s been sitting in the background since January,” said Goodwin. “The main factors are the bank holiday and the tsunami. But it’s put up prices for consumers and demand is weak.”

This is a view shared by one tax director.

“Undoubtedly people are just not spending money,” he said. “The man on the street would certainly think twice before making purchases.”

The economists’ analysis is bad news for the retail sector, though evidence that the VAT rise is hitting growth could be good news for those seeking to change the direction of tax policy.

Last month, Shadow Chancellor Ed Balls called for a temporary VAT reduction back to 17.5% to jump-start the UK economy. The Federation of Small Businesses has also called for targeted VAT cuts to boost the tourism and construction industries.

Goodwin believes that a temporary VAT cut would have a small effect, but it would not be enough to rescue the economy alone.

“There’s a good reason why the government put VAT up in the first place,” Goodwin said. “Our rate is lower than those of our rivals on the continent and most people are comfortable with the increase. The main bone of contention is the timing. The government was unlucky in that the VAT rise coincided with rising commodity prices, which put pressure on consumers.”

Stuart Adam, senior research economist at the Institute of Fiscal Studies, would not speculate on whether the VAT rise has had a direct impact on growth in the last quarter, but confirmed that in the long run, higher VAT is likely to reduce the level of GDP, though not the long-run growth rate of GDP, because it reduces work incentives.

“But you have to bear in mind that the VAT revenue finances public spending which could potentially increase GDP, for example if it leads to a better educated population or better transport infrastructure,” Adam said. “Without the VAT rise, either spending would have to be lower, or the revenue would have to come from some other tax, which might reduce GDP just as much as VAT does.”

Adam’s analysis is likely to give some comfort to the government, which is unwilling to reverse its VAT policy. However the latest growth figures, which have been affected by the VAT increase, will add to the mounting opposition to higher VAT rates in the UK. Companies, consumers and industry associations looking to see a cut will find their case has added weight.

more across site & shared bottom lb ros

More from across our site

Tax expert Craig Hillier agrees with the comparison of pillar two to using a sledgehammer to crack a nut
The amount is reported to be up 57% from the £5.6bn that the UK tax agency believes was underpaid in the previous year
The US president also unveiled a new 50% levy on copper imports; in other news, a UK wealth tax proposal has been criticised by the Institute for Fiscal Studies
Wim Wuyts, who had been head of the specialist tax network since 2017, is moving on to a new role with WTS’s Belgian member firm
MNEs are increasingly using algorithmic tools in TP. Sahasranshu Dash argues that data ethics should therefore plug directly into the TP design process
The Institute of Chartered Accountants in England and Wales also queried whether HMRC resources could be better spent scrutinising larger entities
Grant Thornton’s Austria tax head likens his practice to an escape room, shares his football coaching ambitions, and explains why tax is cool
Awards
ITR is delighted to reveal all the shortlisted nominees for the 2025 EMEA Tax Awards
Awards
ITR is delighted to reveal all the shortlisted nominees for the 2025 Asia-Pacific Tax Awards
The fates of pillars one and two hang in the balance after the US successfully threw its weight around in G7 and Canadian negotiations
Gift this article