The 2.5% rise in VAT will drive down retail sales this year, analysts predicted today.
The increase in the standard rate of VAT from 17.5% to 20%, announced in the Chancellor's Emergency Budget earlier this year, comes into effect tomorrow.
The change affects any VAT-registered business that sells or purchases goods or services that are subject to the standard rate of VAT.
Most foodstuffs, children's clothing and books will remain zero-rated and reduced rates will remain on items such as children's car seats and supplies of domestic fuel and power.
Some business groups have unsuccessfully called on the Government to delay the increase because of the recent Arctic weather, which hit retailers in the normally busy run-up to Christmas.
There have also been warnings of job losses, especially in the building industry, where firms fear there will be reduced demand for domestic repair and maintenance work.
Online shopping group Kelkoo predicted that consumers will spend £22.5 billion in the January sales, an increase of £360 million, or 1.6%, on last year.
Shoppers will spend an average of £370 each but many will then rein in their spending for the rest of the year, signalling another period of austerity for the retail industry, said Kelkoo.
It added that the New Year sales could be a "last hurrah" for retailers before the VAT hike, which will make running a car, paying household bills and buying clothes more expensive.
A report by the Centre for Retail Research and Kelkoo predicted that UK retail sales are expected to fall by £2.2 billion in the first three months of 2011 as a direct result of the VAT increase.
Consumers will spend an average of £324 less this year as a result of the tax hike and many have been buying goods such as electrical items and clothes to beat the rise, said the report.
A list compiled by Kelkoo of how the VAT rise will affect prices includes:
- Litre of unleaded petrol will increase from £1.19 to £1.22.
- Pint of lager pubs £3.00 to £3.06.
- Digital camera £131 to £133.79.
- Dyson vacuum cleaner £238 to £243.89.
- Dishwasher £261.99 to £267.57.
- 37 inch TV £449.99 to £459.57.
- Fridge freezer £608.84 to £621.81.
- Sofa £3,995 to £4,080.
- Ford Focus £15,195 to £15,518.
British Retail Consortium spokesman Richard Lim said: "The prospect of the VAT rise gave a modest boost to the sales of big-ticket and high-end goods in December as people brought their buying forward.
"With the weather and weak consumer confidence undermining the sector's performance in the run-up to Christmas, retailers are discounting in a big way now to make up for missed sales. That may mean the impact of the VAT rise is lost amongst discounts, but ultimately retailers can't absorb the cost indefinitely.
"It will push inflation up and, along with National Insurance rises and public sector job losses, harm sales as the year continues.
"But, we do accept that the VAT rise, with substantial public spending cuts, is necessary as part of the Government's package to tackle the deficit."
Worries about consumer demand will force many smaller firms to absorb the cost of the VAT rise and take a hit on their profits, according to internet giant eBay.
The firm's online business index, covering more than 600 VAT-registered businesses, found that nearly a quarter would absorb the cost of the VAT hike to avoid stunting consumer demand, while a further 39% would avoid passing on the whole cost.
Only one in four intended to pass on the full cost of the rise to their customers.
Jody Ford of eBay said: "The VAT rise is set to hit at the busiest time of year for our businesses, with January on average 10% busier for online firms than a typical month.
"Every business owner, including the 160,000 who make their living on our site, faces a difficult dilemma over whether to pass on the imminent VAT rise to their customers. The fact that more than 60% of businesses intend to absorb all or part of the VAT hike reveals the real concerns they have about its impact on consumer confidence."
Bob Crow, general secretary of the RMT transport union, said the VAT hike would exert upward pressure on wage settlements.
Mr Crow said: "The VAT hike will have a massive and immediate impact on standards of living as prices are marked up by an extra 2.5% from midnight and RMT will be ensuring in pay negotiations that our members are not forced to take the hit from this ConDem raid on the working class.
"The VAT increase, which will continue to fuel inflation, will raise the bar in pay negotiations this year as we fight to defend our members standards of living.
"Our members didn't create this financial crisis and we will not sit back while the ConDem Government try and mug them through VAT increases and stealth taxes aimed at propping up a deficit created by the spivs, speculators and bankers.
"We have already rejected a 5.2% pay offer on Network Rail operations and will be taking a tough negotiating stance with all our employers in the year ahead."