The upcoming reversal of the UK's emergency VAT cut could spark a collapse in New Year retail sales and ultimately derail the nation's economic recovery, M&G retail fixed income head Jim Leaviss says.
VAT is set to return to 17.5% from 15% in less than a month's time. However, as the move has been pre-announced, Leaviss says it is possible savvy consumers will "frontload" consumption this month before easing off early next year.
The net result, Leaviss fears, could be to "slow things down dramatically" and send the UK economy spiralling back into recession.
Reports the Conservatives will announce a further rise in the VAT rate to 20% should they come to power will also serve to exacerbate the situation, he adds.
"[The VAT reversal] will not only cause a blip upwards in inflation rates - most of the CPI basket apart from food attracts the tax - but might also derail the recovery of the UK economy," Leaviss says.
"Because this VAT hike is pre-announced, is it possible that we will see lots of frontloading of consumption in December, and a big fall back in 2010?"
Leaviss points to examples of what happened in other countries around the time of a pre-announced increase in consumption taxes as testament to the dangers facing the UK economy.
Citing Japan as "the most famous example", he says as the nation's fiscal position was poor in 1997, it hiked consumption taxes from 3% to 5%. In the month before it came into effect, Leaviss notes retail sales soared 12% year on year.
But the following month, post the consumption tax increase, they plummeted and remained "extremely weak" for months afterwards.
"It looks therefore that the impact of the tax hike was to bring forward consumers' purchasing decisions in order to mitigate the impact of that tax, an entirely rational thing to do," Leaviss says.
"I would guess therefore that in the run-up to Christmas the UK will see bumper sales - especially of big ticket, non-food items. But the impact of the VAT hike in 2010 will be to slow things down dramatically.
"Post the April 1997 Japanese tax rise, the economy slipped back into recession with average quarterly negative growth of around 0.3% for the next 2 1/2 years!"
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