VAT rise should have minimal impact on the health of retail sector.

But it could inadvertently act as a catalyst for wider economic changes that may adversely affect retail spending.

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Next January's VAT increase to 20 percent will have a relatively small impact on retailers and should even provide a short term boost to the sector, according to the KPMG/Synovate Retail Think Tank (RTT).
 
However, the panel of retail industry commentators warns that the real danger for the sector is that the increase could trigger wider economic changes, which would adversely impact consumer spending.

According to the RTT, the rise in VAT was preferable to a sharper increase in direct taxation making it the "least worst" option for the sector.  Despite the timing of 4th January 2011 presenting an extra burden for retailers at their busiest time of year, it provides valuable time to plan and allows pre- and post-Christmas promotional strategies to be implemented, which could provide a short term fillip to sales and a positive short term impact on margins, although some of this will be offset by the cost of making the change.

But while January was chosen for the VAT rise as it was hoped that inflation would be under control and falling by then, with the recovery gathering momentum, the RTT warns that this may not necessarily be the case.

Helen Dickinson of KPMG said: "Retailers' need and desire to increase prices in advance of the rise, in order to protect margins which have been severely affected over the past two tough years, may have an impact upon the headline inflation figures.  This, coupled with rising food prices and the additional supply led pressures already in the market, will create pressure for interest rates to be raised. Such a scenario would create a far more dramatic squeeze on consumer income which in turn would threaten spending levels far more significantly than the VAT rise in isolation."

Future fiscal policy such as tax rises, welfare cuts and the public sector pay freeze and/or job cuts are likely to reduce household incomes by three percent according to Capital Economics, with an accompanying effect on consumer confidence. Vicky Redwood, of Capital Economics adds:  "If these are coupled with a premature rise in interest rates, this will certainly seriously stall any prospect of recovery in the retail sector in 2011."

The Office for Budget Responsibility estimates that the two and a half percentage point increase in VAT will raise revenue of £12.1bn in 2011, rising to £13.4bn by 2014/1 although this includes all products and services which are subject to VAT, so not all of the impact will be felt in the retail sector.

According to the RTT, retailers, suppliers and consumers are all set to share part of the pain of the VAT rise, either through margins being squeezed or, in the case of consumers, through lower disposable income, reduced volumes or quality of products consumed.  Retailers have no choice but to pass more than half of the cost to consumers and, due to the highly competitive nature of the industry, absorb the remainder themselves or share it with suppliers.
Overall, the RTT considers that values will hold up well but that volumes will be impacted to an extent, although some groups of consumers will inevitably be hit harder than others and, in turn, some businesses will be affected more, particularly where markets are already weak.
 
Mark Teale of CB Richard Ellis comments: "Bearing in mind general taxation increases, concerns about future unemployment growth and inflationary pressures, in tandem with stagnant savings and pensions markets, consumer confidence looks set to deteriorate further, suppressing spending growth until there is a significant improvement in economic conditions."

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