The top rate of VAT has risen from 17.5% to 20% as the government looks to boost tax revenues to cut the UK's debt levels.
Business groups have warned that retailers will be hit by the increase, while opponents of the rise have said the poorest will be hit hardest.
The government says the rise is necessary to help bring down the UK's high budget deficit.
Food, children's clothing, newspapers and magazines are not subject to VAT.
Research by the Centre for Retail Research and online shopping group Kelkoo has suggested that retail sales will fall by about £2.2bn in the first three months of the year as a result of the rise in VAT.
The British Retail Consortium (BRC) has also warned that the rise, announced in the June budget, may have squeezed the traditional January sales period into a concentrated burst around the New Year.
More than seven out of 10 retailers polled by the BRC thought that their customers would bring forward purchases to beat the VAT increase.
It added that the rise comes at a bad time for businesses, which are being squeezed by higher transport costs and commodity prices.
However, BRC spokesman Richard Lim said that although the rise would harm retailers, the increase was necessary to tackle the budget deficit.
Inflation headache
The VAT rise is also a worry for the Bank of England.
At 3.3%, the annual rise in the consumer prices index is already well above the Bank's target of 2%, and the increased VAT rate is likely to push inflation towards 4% this year, analysts say.
One member of the Bank's policy-setting committee, Andrew Sentance, has voted repeatedly for a rate rise in recent months, to head off the inflation risk.
PDF version The rise in VAT to 20% has provoked what is becoming the usual argument about whether or not the impact is progressive or regressive. On the one hand, Ed Miliband has said that the rise will hit poor and middle-income families the hardest. On the other hand, the Government are defending the rise as the “least worst” option compared with income tax or National Insurance increases. George Osborne has also quoted the Institute for Fiscal Studies (IFS) in support of the claim that the VAT rise is progressive. Other tax analysts disagree.
In June last year, IFS analysed the impact of the rise (PDF) across the income distribution. They concluded that if you measure incomes at a single point in time and show losses from the VAT rise as a percentage of net income (the usual way of doing things), it is in fact regressive, hitting the poorest tenth more than twice as hard as the richest. Overall, the bottom 30% by income lose the most (over 2%) and the top 10% the least (under 1%) with the rest of the population affected more or less equally, losing about 1.25% of their net income.
But the IFS go on to make the (obvious) point that VAT rises hit those who spend the most – with the caveat that VAT does not apply equally to all items. They also say that the bottom tenth of the income distribution have to spend more compared with their reported incomes. So, when you compare the impact of the VAT rise as a proportion of spending rather than income, then you get a mildly progressive pattern where the highest 10% by income lose a little bit more than the lowest 10%. In fact, the impact is pretty much equal across the whole population when you look at it like this, i.e. as a proportion of spending. There is a much more pronounced progressive pattern when you put everyone in order according to how much they spend rather than their income. The answer, then, is that the VAT rise is regressive when you look at it by income, but progressive when you use expenditure.
Although this is illuminating, in addition to the income picture, showing that a tax on spending hits those who spend more the most is a rather circular way of analysing the issue on its own. The fact that some people who report having a low income actually have relatively high levels of spending does cast doubt on the validity of some of the income data. But that doesn’t mean we should ignore those on the lowest incomes (i.e. the bottom tenth) completely.
Critics of the VAT rise should also be aware of the impact on the level of benefits – the rate by which they are increased each year will take the VAT rise at least partly into account via its impact on the Consumer Price Index (CPI). This may not be the case for low earners facing pay cuts or successive years of 0% pay awards.
Many people are genuinely in ‘deep’ poverty – partly because of the low levels of out-of-work benefits, especially working-age adults, but also because a significant and rising number of people are not claiming the benefits that they should be getting. Rather than looking at each issue in isolation, there needs to be much greater awareness of how all the factors affecting poverty are connected – an approach JRF strives to demonstrate.
http://www.jrf.org.uk/blog/2011/01/vat-rise-affecting-people-poverty
The poorest 20% of UK households spend a higher proportion of their disposable income on VAT than the richest 20%, the Office for National Statistics said.
Its research covered 2009/10, which was before the increase in VAT from 17.5% to 20% in January 2011.
When Chancellor George Osborne announced the increase in his 2010 Emergency Budget, the government said that VAT was a progressive tax.
But the ONS research suggested that is not the case.
It said that the poorest fifth spent 9.8% of their disposable income on goods attracting VAT in 2009/10, while the richest fifth spent 5.3%.
That figure for the poorest fifth showed a considerable fall from the figure of 10.7% in 2008/9 and 12.1% in 2007/8.
It is sometimes argued that the poorest households are not hit as hard by rises in VAT, because the tax is not charged on essential items such as food and non-alcoholic drinks.
The ONS research also found that the poorest households spent 58% of their expenditure on goods on which VAT was charged in 2009/10, much higher than the 45% they had allocated to VAT-charged items in 1986.
"This latest piece of research reinforces what is widely perceived to be the fundamental inequality at the heart of VAT: the poorer pay more of it relative to their incomes than the wealthy," said David Breger of HW Fisher & Company chartered accountants.
"It's clear that the Government needs to reconsider the full effect of VAT, which is inherently regressive."
Today's rise in VAT to 20% will cut the amount of social care that charities can deliver, Sue Ryder Care has warned.
The charity, which supports people with end-of-life and long-term care needs, said its VAT bill would reach £1m as a result of today's hike, equivalent to six months funding for a 16-bed hospice.
The Charity Tax Group estimates that the rise in VAT from 17.5% to 20% will see the charitable sector as a whole lose £140m on top of £1bn it already pays in VAT.
Sue Ryder is calling for charities to have the right to claim back some of the VAT they pay,
Limited companies, local authorities and some NHS services can claim back VAT from the government, but this is not the case for charities, even where they provide NHS-commissioned services.
"We have heard a lot about the Big Society and support the idea of charities delivering more high-quality, innovative and cost-effective public services," said Sue Ryder chief executive Paul Woodward. "However, this is only possible if we are afforded the same benefits that the NHS and local authorities are given relating to VAT."
As a first step, Sue Ryder said charities taking on services transferred to them by the NHS should be given the same tax benefits.
http://www.communitycare.co.uk/Articles/2011/01/05/116050/vat-rise-will-...