The government forecasts that the rise in VAT to 20 per cent will fill the Treasury coffers with an additional £13.5bn in the final year of this Parliament in 20015 – making it the biggest driver of revenues unveiled yesterday.
But the rise will hit consumers every single day from 4 January next year whether they are buying clothing, going to the pub, filling up their car, eating at a fast-food restaurant or booking holiday accommodation in the UK. In short, this regressive tax, which takes no account of a person's ability to pay, will hit those on the lowest income the hardest.
In real terms, the VAT rise will add 2.1 per cent to the price of everyday goods, leading to an extra 2.5p on a litre of petrol, 12p on a packet of cigarettes and an average of 7p on a pint of lager, according to Kelkoo, the price comparison website.
The only good news for hard-pressed UK consumers is that the Chancellor wrong-footed some forecasts by keeping items classed as "essential", including food, children's clothing, newspapers and magazines, exempt from VAT.
George Osborne said: "The years of debt and spending make this [VAT rise] unavoidable." The Treasury has forecast that the rise in VAT will generate additional revenues of £12.1bn in its first full year of implementation in 2011/12, but this would rise to £13.45bn in 2014/15.
But Harriet Harman, the acting leader of the Labour Party, said that rise in VAT "punished the poorest the most", saying it would leave pensioners, for example, with less money to spend. The Government hopes that by delaying the increase in VAT till January, it will minimise the impact on consumer spending at a time when the recovery is fragile. But economists fear that the rise in VAT could trigger a sharp rise in inflation and therefore higher interest rates, which could lead to a "double-dip" recession.
Simon Newark, a VAT partner at the accountancy firm UHY Hacker Young, said: "A VAT hike could push up prices on the high street by around 2 per cent, which would have a very significant impact on inflation. Higher inflation could trigger interest-rate rises, risking the spectre of the double-dip recession."
The impact on consumer spending of the rise in VAT will be most marked on big-ticket items, such as TVs and washing machines. According to the price comparison website Kelkoo, the price of a Lady Gaga CD will only rise from £8.95 to £9.14 in January, but it would add £63.79 to a sofa from DFS priced at £2,995.
Yesterday's survey by Kelkoo also found that after the change in VAT, 43 per cent of Britons will spend less once the new rate takes hold. Of those surveyed, the biggest group at 30 per cent said they would cut back on dining out. Following closely behind, 28 per cent said they would reduce their spending on home entertainment, such as music, DVDs and video games, and 26 per cent plan to trim their expenditure on travel, holidays and hotels.
Based on a survey of 2,000 people and their spending plans with VAT at 20 per cent, consumers will spend £324 per person less on retail goods from £1,836 to £1,511, said Kelkoo.
Stephen Robertson, director general of the British Retail Consortium, said: "We didn't want a VAT increase. It'll hit jobs, consumer spending, the pace of recovery and add to inflation, but we accept the Government has no easy options."
In May, the BRC warned that increasing VAT to 20 per cent would cost 163,000 jobs and reduce consumer spending by £3.6bn over four years. While opinion among retailers was divided about how much spending the recent rise in VAT sucked forward, many shoppers did snap up big ticket purchases before it went back up to 17.5 per cent on 1 January 2010.
The accountancy firm Deloitte said that the average worker earning £24,000 will pay an extra £183-a-year as a result of the VAT rise.
The rise in VAT will also hit motorists at the pump. The Automobile Association said with fuel duty going up 1p a litre in October and another 0.76p a litre on 1 January, the hike in VAT adds £117.98 to the annual cost of fuel for a family with two petrol cars, based on today's prices.
For pub goers, the Campaign for Real Ale said the VAT increase would add 10p on to a pint of beer and would increase the rate of pub closures from the current level of 39 a week in the struggling sector.
But in a rare piece of goods news for the nation's drinkers, the Chancellor did not unveil an increase in beer tax in yesterday's Budget.
Brigid Simmonds, the British Beer and Pub Association's chief executive said: "We applaud the Government's decision to freeze beer tax and deliver on its promise made in the coalition agreement to not penalise pubs, responsible drinkers and important local industries."
ZERO AND REDUCED-RATE VAT
0%: Books, children's clothing and footwear, lottery tickets, maps, magazines, and food. (Some food and drink items, such as snacks and alcoholic drinks, are standard VAT-rated.)
5%: Children's car seats, gas or electricity for domestic usage, energy-saving materials, smoking cessation products, contraceptives and women's sanitary towels.
Case Study: 'This will have a huge effect on some firms'
Tom Harvey, 33, of the Lake District, runs Clocktower Electrics with his parents in Cumbria. They employ four other members of staff, selling washing machines and domestic appliances, with a turnover of £300,000.
"The VAT rise was what we expected. For retailers selling non-necessity items or with extremely low margins, it could have a huge impact. Some businesses will have to look at their business models and see whether they work now they need to incorporate this higher level of tax. But for us, I don't think the VAT rise will make too much of a difference. We might see a bit of a boost in sales beforehand and people might start buying appliances at the cheaper end of the scale. But if your washing machine is broken, it needs replacing; it's not something you can put off. I don't think an extra £10 on a £500 washer is going to make any difference to people. So I think raising the VAT is a sensible way of balancing the books.
"I'm happy to see a reduction in corporation tax in the budget – it will be very beneficial to small companies like ours and can only be a good thing. "Small businesses" to the government can mean around 200 employees, not five. Enterprise schemes and so on are snapped up by the bigger companies and it can feel like small and medium sized businesses are ignored.
"I believe in conservative values both at home and as a business owner. I have always voted Conservative and will continue to do so unless they make a big mistake. I think the Government put forward a strong budget."