UK PM David Cameron (r) and deputy PM Nick Clegg (l) share a joke as coalition is unveiled

UK PM David Cameron (r) and deputy PM Nick Clegg (l) share a joke as coalition is unveiled

It seems highly probable that David Cameron's Con-Lib coalition Government will use the emergency budget – due in the next 50 days – to raise the headline rate of value added tax in the UK from 17.5% to 20%.

This move will have a significant impact on the cost of discretionary goods.

However, UK businesses and the public at large seem accustomed to the idea of the “pain to follow” after the drama of the financial crash, bank bailouts and escalating public debt. Rhetoric in the country has largely switched to the “inevitability” of spending cuts and tax hikes.

This, combined with the Conservative belief in a low-wage economy, means that the consumer is now likely in for a prolonged period when household finances will be squeezed.

What remains a more controversial issue is the introduction of VAT on non-discretionary purchases such as food, prescription drugs and children's clothing.

In an unusual move last week, the IMF suggested that one of the most effective ways for the coalition government to raise cash would be to remove the zero-rate of tax on food and other items.

"There is substantial scope for improving the revenue performance of the VAT in almost all countries, including by eliminating exemptions and reduced rates,” the IMF argued. 

Looking at the UK in particular, the IMF claimed that the Government could raise 3.3% of economic output (approximately GBP 50bn) per annum by halving the number of items exempt from VAT.

The IMF suggestion, published in a survey of global public finances, would have a massive impact on living standards, particularly in low income households.

Indeed, as Sainsbury's CEO Justin King emphasised last week, the introduction of VAT on food would essentially wipe out the highly publicised tax cuts for lower earners, an integral part of the coalition agreement between the Conservatives and Liberals.

“The coalition have announced they will raise the tax band for lowest earners but if they put VAT on food they take all that benefit back. It is the poorest in our society that spend the most of their weekly money on food so that would be counter-intuitive,” he said on a conference call with analysts following Sainsbury's full-year results release.

In recent months, consumer confidence has slowly begun to return. The recession was not as protracted or as deeply felt as many commentators had feared, and the public at large has breathed a collective sigh of relief.

However, as the incoming Government prepares to tax and cut its way out of the financial quagmire that it has landed in, all eyes have turned to where the sacrifices will be made.

If VAT were to be added to food and prescription medicines, it is clear that the move would be most keenly felt by those on a lower income.

What remains to be seen is the extent to which consumers would feel the need to – or, indeed, be able to – reduce their spending on food items.

Even as sales of premium and luxury items pick up in the UK, the industry must surely be wondering whether changes to taxation could mean this revival is short lived.