By Alex Brummer
Last updated at 2:39 AM on 5th January 2011


Chancellor George Osborne: Britain starts the year in better condition than was expected when he delivered his emergency Budget last June

Chancellor George Osborne: Britain starts the year in better condition than was expected when he delivered his emergency Budget last June

The accusation by Labour politicians and the pessimists on the high street that yesterday's rise in VAT will bring the economy to a stumbling halt in 2011 should be taken with a huge pinch of salt.

As with any tax hike, the jump in the main rate of VAT from 17.5 per cent to 20 per cent (estimated to add 12billion to Treasury coffers this year from the pockets of consumers) will inevitably cause some hurt.

But the good news is that the rise is being made in the face of a resurgent British economy that is better able to absorb it now than would have been the case 12 months ago.

Indeed, despite savage public spending cuts in the pipeline as well as several impending tax increases, Britain starts the year in a much better condition than was expected when Chancellor George Osborne delivered his emergency Budget in June.

Against almost all expectations the economy seems to have grown at a shade under 2 per cent in 2010 (we are still awaiting the final figures) against the 1.2 per cent projected in the emergency Budget.

The economy enters 2011 in robust shape thanks to the export-based manufacturing upturn and the stock market in buoyant mood. Leading economists now rule out the possibility of a 'double dip' recession.

There is no doubt that the VAT rise will affect many household budgets. But suggestions from Shadow Chancellor Alan Johnson that a more equitable way of raising money would be through yet more rises in National Insurance is arrant nonsense.

NI used to be a special welfare fund, providing cradle to grave resources for the NHS and state pensions. But the charge, paid by individuals and companies, is now no more than a disguised income tax on workers and a direct tax on jobs for employers.

Major economic think tanks, such as the influential Institute for Fiscal Studies, have argued for some time that the best, and fairer, way of raising taxes is through VAT. Crucially, it leaves consumers able to choose how they spend their money – rather than removing income directly from their pay packets.

Moreover, one should never forget that Britain faces what may be a permanent rise in VAT to 20 per cent because the Coalition inherited from Labour the biggest budget deficit in the nation's peacetime history – with a shortfall of 150billion forecast for the present financial year.

George Osborne has vowed to eliminate that borrowing over the next five years. Eighty per cent of these savings will be achieved by cutting the size of the State while 20 per cent will come via higher taxation.

Economists generally regard taxes on sales, such as VAT, as 'regressive' because they disproportionately hit the poor because they are levied at the same rate irrespective of a person's wealth. But this analysis ignores some basic truths. The impact on poorer households is less severe because some of the most basic needs – food and children's clothing – are VAT exempt.

Beating the tax rise: High Street consumers will be able to choose how they spend their money

Beating the tax rise: High Street consumers will be able to choose how they spend their money

So while there may be secondary effects on food bills (such as through rising transport costs), that should not be too painful. In fact, a far greater threat comes from the surging global price of raw materials such as grain.

Moreover, against rising VAT must be placed the realisation that anyone with a mortgage is benefiting from historically low interest rates. This has produced a large boost to the budgets of the majority of households which far outweighs tax rises.

So what about the impact of VAT on prices in the shops and business? Here the picture is much more complicated than the British Retail Consortium, which represents the main high street retailers, would have us believe. This lobby is the habitual voice of pessimism. Yet, remarkably, retail sales have proved resilient.

The days are long gone since an expected rise in fuel duties in the annual Budget would trigger queues of motorists outside petrol stations trying to cash in on pre-hike prices, or drinkers and smokers bulk-buying in the hope of saving a few pence.

Surging disposable incomes between 1997 and 2007 meant that such purchases are no longer as sensitive to higher duties.

Although the VAT increase will impact on big outlays such as building a conservatory, superstores are much more competitive and the internet means there is much more transparency and price comparison opportunities.

Thus a 2.5 percentage point increase in the cost of a state-of-the-art new TV is dwarfed by the almost permanent reductions, of anything from 20 per cent to 50 per cent, on offer.

Unfortunately, if there is an impact, it is likely to fall on the small, independent businesses which are less able to absorb the VAT increase. During the worst of the 2009 recession, the then Labour Chancellor Alistair Darling's decision to temporarily lower VAT rates to 15 per cent helped some enterprises keep their businesses going and keep staff that might otherwise have been laid off.

But the nation is no longer in recession. And although costs are rising, they are benefiting from a triple boost: Economic recovery, reasonably strong employment levels and current low levels of interest rates.

Of course, no one likes the prospect of surging taxes whatever form they take. But we need to place the current rises in perspective.

As a result of the actions already taken by the Coalition, the Government has managed to retain its 'triple A' credit rating which means the cost of financing the nation's national debt is much lower than would otherwise be the case.

As importantly, there is now a degree of momentum behind the economic recovery. Over the last 18 months, the pound has declined in value by more than 20 per cent against the currencies of our major trading partners, helping exporters.

Yes, the after-effects of the financial crisis still hamper the economy but the stock market and many of our largest companies are in optimistic mood.

That is why it is vital that we should not allow the naysayers on the opposition benches or on the high street to destroy a resurgent confidence that the economic recovery can be seen through.