Raising the rate of VAT in January is set to reduce gross domestic product (GDP) by 0.3% next year, the Government’s tax and spending watchdog has said.
Chancellor George Osborne is to increase the sales tax from 17.5% to 20% on January 4 in a move he expects will generate an additional £13 billion a year.
But fears that the move would damage the economic recovery were fuelled when the independent Office for Budget Responsibility (OBR) released its view of the rise on Thursday.
The watchdog said its analysis of the overall impact of the June Budget – in which the VAT hike was announced – had assumed a 0.3% fall in GDP as a result of the higher sales tax.
“The interim OBR’s June 2010 Budget forecast assumed that the increase in the standard rate of VAT from 17.5% to 20% would reduce the level of real GDP in 2011/12 by around 0.3%,” it said in response to a parliamentary question.
The disclosure led to renewed demands for Mr Osborne to re-think the VAT rise.
Tom Clougherty, executive director of the right-leaning Adam Smith Institute, said: “There’s no doubt that raising VAT will hit consumer confidence and damage the economy, and the Office of Budget Responsibility is right to highlight this. Tax rises are the last thing we need while the economy remains so fragile.”
The OBR’s analysis of the VAT rise was incorporated into its jobs and growth forecasts at the time of the June budget.
The watchdog predicts that, overall, the UK economy will grow by 2.3% in 2011. But while the impact of the hike was set out in the Red Book as part of a series of “fiscal multipliers”, the OBR has not previously cited the 0.3% figure explicitly.
A Treasury spokesman said: “As we have seen this week with the euro zone, concerns about countries’ sovereign debt have not gone away. The Government is tackling the unprecedented deficit fairly, with the majority of the reduction coming from reducing spending, rather than tax rises.”