David Prosser: The bigger picture on the VAT increase

Outlook Anecdotal evidence yesterday appeared to undermine the claims of Labour's leaders, lead by Ed Miliband and Alan Johnson, that the VAT rise would be a major drag on consumer spending – and thus the economic recovery. There was further data suggesting shoppers have been out in force since the post-Christmas sales began, while every news channel was running vox pop items in packed shopping centres, where the majority of people did not seem to be bothered by a small increase in VAT.

Still, it is difficult to believe this sort of optimism is sustainable. Were VAT being increased in isolation, the effects would no doubt be modest, particularly on non- "big ticket" expenditure, where price rises, assuming they are passed on at all, will often be barely noticeable. But this is not a one-act play: the VAT increase is just one small part of an outlook in which the forecast is for real disposable incomes to fall by the largest amount for more than 30 years.

Indeed, for many people, the increase in VAT yesterday will have been insignificant compared to the size of the hikes they saw in the cost of transport. Double-digit fare increases in many parts of the country have been accompanied by record petrol prices, which show no sign of easing.

More pain is to come in the form of higher utility bills, thanks to rising oil and gas prices, while food inflation is now running at such a rate that the cost of everyday living is on the up even though groceries are largely VAT exempt.

Add in the effect of the national insurance hike to come in April, continued wage settlement restraint (for those lucky enough not to be affected by rising unemployment, another drag on spending) and other tax increases such as higher insurance premium tax, and Capital Economics, the think-tank, reckons real disposable incomes will be down by 1.5 per cent this year, an average of £500 per household.

It is against this backdrop that the VAT increase has the potential to hinder the recovery. The debate about whether it is progressive or regressive is one thing, but there can be no doubt higher taxes on spending at a time of squeezed disposable incomes will force at least some people to pull in their horns.