Conservative MPs are convinced the Treasury is examining extending the scope of VAT if the Chancellor decides to raise taxes in the Budget as a first step to cutting the Government's soaring deficit.
They reacted warily, however, to suggestions that VAT could be imposed on food, given a fresh impetus by a briefing for supermarket chains that was leaked by Derek Fatchett, a Labour industry spokesman.
Full VAT imposition on food and fuel at 17.5 per cent would be 'unsupportable', one MP close to Downing Street thinking said, while even a 5 per cent rate would have implications for inflation and possibly benefits.
Gordon Brown, Labour's shadow Chancellor, called on the Prime Minister to honour election commitments that he had no plans to widen the scope of VAT.
'If they are considering doing that, they should be up front and open and tell the public that is what they are now having to do,' he said.
Conservative MPs remain deeply divided over whether the March Budget should raise taxes to tackle a public borrowing requirement which on the Government's figures will reach pounds 44bn next year. Many fear it could set back hopes of recovery. In general, however, they would prefer increases in indirect rather than direct taxes.
The Chancellor, Norman Lamont, justified the Government's last increase in VAT to 17.5 per cent - introduced in 1991 to cut poll tax bills - on the grounds that 'the basic necessities of life' such as food, domestic fuel, transport and children's clothes were exempt. Even a 5 per cent VAT on such items would hit the less well off hardest as more of their budget goes on such items.
The UK will face heavy pressure in 1996 to charge at least 5 per cent VAT on food and other items when further European Commission harmonisation of VAT regimes is next discussed.
The UK and the Irish Republic are the only EC states to have a wide range of zero-rated items. While the Government would hold a right of veto on VAT changes, in practice pressure for further harmonisation would be strong. The possibility that it could come in the run-up to the next general election could be an argument for action earlier rather than later.
Imposing VAT at the full rate on all exempt items would raise about pounds 17bn - a significant contribution to a budget deficit which the City believes is likely to reach pounds 50bn in the coming year. A 5 per cent VAT on all exempt items, however, would raise only about pounds 5bn, food contributing about pounds 2bn of that.Reuse content