Retailers count the cost as VAT returns to 17.5 per cent

Big stores promise to absorb or delay increase in bid to attract shoppers

The emergency £12bn two-and-a-half-per cent cut to VAT ends today, adding hundreds of pounds to the cost of yachts, home extensions, motor cars and other big-ticket items and more modest increases to the price of clothes and other high-street goods.

Several high-street retailers, including Arcadia Group, which owns Topshop and Miss Selfridge, promised to absorb the cost of the rise, and Argos will delay any price increases until its new catalogue is published at the end of the month. Tesco will freeze VAT on many non-food items, adding up to a projected £12m savings for customers, but it and Boots were forced to deny a report that they had been raising prices of many goods stealthily during recent weeks.

Overall, adjusting computer systems and prices for the change is expected to cost retailers £100m. They had hoped that the Government would suspend the move back to the higher VAT until later in the year to allow the sector to recover further, but Alistair Darling, the Chancellor of the Exchequer, stuck to the original timetable.

He cut VAT from 17.5 to 15 per cent from 1 December 2008 in an attempt to refloat the economy as Britain went into its worse recession for decades.

Economists said the 13-month fall in the price of items that attract VAT – which excludes zero-rated food, children's clothing, books and newspapers – had limited the severity of the downturn by generating more money for retailers and shoppers. However the impact of the help, and whether the money would have been spent better elsewhere, was debatable, they added.

For shoppers, two thirds of VAT-able items were reduced, leading to an overall price fall of about 0.5 per cent, according to the Office for National Statistics. That put more money into people's pockets, restraining pay demands and so protecting jobs in firms that might otherwise have sacked workers.

For shops, altering prices cost £90m, but either bolstered custom through lower prices or profits through higher margins where prices were not lowered. Stephen Robertson, director general of the British Retail Consortium, detected a "gentle" improvement in the climate for shops because of the reduction. "It didn't make a dramatic effect, but over the course of the 13 months, we estimate it has boosted VAT-able product sales," he said.

According to the Centre for Economic and Business Research, the policy lifted retail sales by £2.1bn in the first three months to February. Verdict Research consultancy challenged that figure, saying that the improved sales were due to heavy discounting.

Yesterday the Treasury pointed out that the policy had "provided essential support for the economy during the sharpest global recession in 60 years, when businesses, families and individuals needed it most". A spokesperson said: "As the Chancellor made clear when it was announced, the VAT cut was always a temporary measure to provide support during the downturn."

Generally, economists agreed that the exact impact of the VAT cut, both direct and indirect, had been positive. Malcolm Barr, of JP Morgan, said: "It handed £12bn from the Government to a combination of households and retailers at a time when the latter's income and confidence were under pressure."

So who has benefited?

Q. Did some shops keep the VAT cut?

A. Yes. Two-thirds of retailers cut their prices by January this year, but 34 per cent pocketed the tax cut, according to the Office for National Statistics.

Q. Was that a bad thing?

A. For shoppers, yes, but not for the economy. The Treasury pointed out that the cut had two aims: to boost retailers and shoppers.

Q. Did it help the economy?

A. Almost certainly. The Treasury estimates it provided a 0.5 per cent boost to national GDP, worth about £7bn. But its impact was relatively modest when compared with the scale of the recession, which has seen the economy shrink by about 6 per cent. It is also small when set next to the £200bn programme of "quantitative easing" – direct injections of money into the economy – launched by the Bank of England in March.

Q. Why did it help the economy?

A. It had an indirect effect on wage demands and unemployment. Overall prices fell by about 0.5 per cent, helping to restrain pay demands and thus protect jobs in firms that might otherwise have made cutbacks. In turn, this helped the economy to escape an even worse slump and protected the housing market from a surge in repossessions, distressed sales and a meltdown in property prices. Even if it only succeeded in bringing some spending forward, that may have helped to prevent the economy going into freefall.

Q. What do business leaders think?

A. The British Retail Consortium think it has helped slightly. The British Chambers of Commerce believes it helped "some businesses", particularly companies selling more expensive items such as cars.

Q. So was it a good idea?

A. The British Chambers of Commerce said: "It was a £12bn stimulus and the money had to go somewhere in the economy and it had to benefit someone. The real question remains over whether it was the best possible stimulus that could have been offered up from the Chancellor in response to recession. It's difficult to say now." Malcolm Barr, of JP Morgan, added: "As one means to try and stimulate the economy, it was a reasonable thing to do. But it was never going to be a panacea."