GEORGE Osborne yesterday dropped a tax bombshell – announcing that VAT will rise from 17.5 per cent to 20 per cent.
The chancellor said the rise, which will be implemented on 4 January 2011, is expected to generate up to £13bn for the public purse.
He said: “The years of debt and spending make this unavoidable.
“This single tax measure will by the end of this Parliament generate over £13bn a year of extra revenues.
“That is £13bn we don’t have to find from extra spending cuts or income tax rises.”
The rate of VAT has been pegged at 17.5 per cent since 1991, except for the temporary reduction to 15 per cent as the Labour government struggled to stimulate consumer spending while the country was in the grip of recession.
The rise will apply to all purchases except basic foodstuffs, children’s clothing, books and newspapers.
Osborne promised that the coalition government will maintain exemptions for everyday essentials for the rest of the Parliament.
The reduced VAT rate of five per cent, for items including domestic fuel and power will be maintained.
Consumer groups warned that the increase would have a disproportionate impact on the poorest members of society.
Mike O’Connor, chief executive of Consumer Focus, said the Budget will be “setting off alarm bells”.
He warned: “Thousands of the things we buy everyday are going to get more expensive.
“The VAT rise will hit the poorest consumers hardest as people who earn least already spend proportionately more of their income on VAT and it will be even more important for consumers to shop around for the best bargains.”
The Conservatives did not signal before the general election that they would raise VAT in the emergency Budget.
Meanwhile the Liberal Democrats campaigned against such a rise. Economists fear the rise will push the Consumer Price Index of inflation up.
It is currently 3.4 per cent – well above government’s two per cent target. A hike in inflation could also force the Bank of England into lifting interest rates sooner than it has planned which could take the wind out of any recovery.
Simon Newark, VAT Partner at UHY Hacker Young said: “A VAT hike could push up prices on the high street by around two per cent, which would have a very significant impact on inflation.”
Higher inflation could trigger interest rate rises. In a worst case scenario that could lead to a double dip recession.
Labour leadership contender Ed Balls said: “The Tories have done what they’ve always done in the past and raised VAT – it will damage our growth and our economic recovery.”