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VAT impact on unemployment “not clear cut”

14th Jan 2011
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While it is difficult to predict with any accuracy the effect of the recent 2.5% VAT increase on the unemployment rate, there are theoretical indicators that can help build a picture.

The Chartered Institute for Personnel and Development (CIPD) recently demonstrated the potential impact on unemployment, producing a figure of 250,000 job losses.

The CIPD came to this figure using OBR statistics - suggesting that the 20% VAT rise will reduce real GDP in 2011/12 by 0.3%, which when applied to employment estimates, gives a figure of 250,000 loses.

In spite of these less than encouraging projections, there are as usual many in the profession voicing a level of scepticism about the stats.

George Bull, head of Tax at Baker Tilly, said: “To what extent will the theoretical figures reflect the eventual reality? The answer is, unsurprisingly, not clear cut. Looking at other member states across Europe that have increased their standard VAT rates within the past two years, such as Spain, Hungary, Estonia, Latvia and Lithuania, the picture is far from consistent.”

Bull continues: “At a time when the private sector will, it is hoped, create new jobs to reflect those being lost in the public sector, the spectre of VAT-induced job losses has been raised. To what extent will the theoretical figures reflect the eventual reality?”

The level of rising unemployment as a direct result of the VAT increase will be difficult to gauge over the coming years; however, many businesses that are unable to recover VAT and organisations that are in a price-sensitive industry will be the likely victims.

Lessons from other EU member states

The lessons learnt from other European Union member states that have raised VAT rates could provide a window to how the increase will affect unemployment.

Across the EU results are mixed and the only certainty is that the VAT rise is just one factor among many affecting unemployment.

In Spain unemployment was on the increase before the 2% VAT increase in July 2010 - after that date, the rate continued to rise but at a slower rate and now appears to have stabilised.

An indicator that the VAT increase is just one factor among many can be seen in Hungary and Estonia where unemployment was increasing before any VAT increase, and has since started to decline after an early 2010 peak.

Even more dramatically, Germany had a 3% VAT increase in early 2007 and has since seen a substantial overall fall in its unemployment rate.

The EU member state experience demonstrates that a rise in VAT does not necessarily mean unemployment will rise, but is often the result of many contributing factors.

Theoretical indicators are interesting, but it remains very difficult to predict with any accuracy the full impact of the 2.5% VAT hike.

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