VAT: Chancellor claims Budget hike in sales tax to 20% was 'unavoidable'

(Update) Chancellor George Osborne will increase the rate of VAT to 20% from next year, which will bring in £13 billion of extra revenue over the lifetime of the parliament.

Delivering his first Budget as chancellor Osborne said the rise in VAT from its current rate of 17.5% from 4 January 2011 was necessary.  ‘The years of debt and spending make this unavoidable,’ said Osborne. 'That is £13 billion we don’t have to find from extra spending cuts or income tax rises.' 

Osborne will preserve VAT exemptions for food, children’s clothing, books and newspaper over the course of this parliament. Osborne (pictured) had been tipped to cut some of these exemptions which do not exist in many of our European neighbours.  

The chancellor has also increased VAT on general insurance premiums to 20% from 17.5% for the higher rate, which will spell more travel insurance and product warranties for consumers. The standard rate of insurance premium tax will also increase to 6% from 5% which will impact on the price of car and home insurance.

Osborne was taking an calculated gamble increasing VAT when the economy was still fragile, said Howard Archer, chief UK and European economist for IHS Global Insight. Archer said raising VAT could hit consumer spending and increase inflation raising the prospect of stagflation.  

'There is no good time to increase VAT from an economic point of view but given the state of the goverment's finances action is needed,' said Archer. Osborne had banked on inflation falling back by delaying the introduction of the new VAT rate until the new year, said Archer.  

A hike in VAT was a regressive move which would hit the poorest people, said Erik Britton, director of economics consultancy Fathom Financial Consulting. 'We are disappointed with the VAT rise,' said Britton. 'It would have been better if he removed a number of exemptions which would have raised as much revenue or more or gone for a less regressive form of taxation like income tax.'

Britton echoed Archer's concerns about the VAT hike adding to the inflation problems faced by Mervyn King and the Bank of England monetary policy committee.