PRICES

The imposition of VAT on groceries is being actively considered by Whitehall officials as a radical means of reducing the national deficit. The feasibility of introducing the food tax is being raised informally between civil servants, industry bodies and retail insiders. So politically-sensitive is the move that all the talks are occurring "under the radar", according to retail industry insiders. Basic supermarket groceries are currently immune from VAT, along with books, newspapers and children's clothes.

However a VAT levy on food of between three and five per cent would raise billions of pounds in tax and help reduce Government borrowings, which are expected to hit £180 billion this year. Food sales from supermarkets are estimated to total £120 billion a year. The tax would be controversial as it would disproportionately affect poorer families. Any move to impose it would be vehemently opposed by the UK's large food retailers, who argue that it would be a 'tax on living'.

Justin King, the chief executive of J Sainsbury, said this weekend that a tax on groceries would be a "very bad idea". Another supermarket executive said that the tax would be "political dynamite". The topic is being tentatively brought up in Whitehall as politicians, lobbyists and civil servants examine possible ways of raising revenues, according to multiple retail industry sources. An increase in headline VAT above its current 17.5% level is also being mooted.

One senior industry executive said, "VAT on groceries is being talked about in very tentative terms, rather than as a formal consultation. But it is happening in all parts of Whitehall. It is informal and sensitive. It is such a red hot topic. They are thinking the unthinkable. It might not happen, but don't think that people are not having that conversation. They are." A Treasury spokesman said that there was "absolutely no question" of the current Chancellor imposing VAT on groceries.

However civil servants are examining all the permutations available to the next government to bring in revenue following the election. The food industry is against the move. Mr King said, "On food, VAT acts in a very regressive way. The poorer you are, the higher the proportion of your household income you spend on food. So if you were to introduce VAT on food that would be very damaging for the poorest in our society. So I think that would be a very bad idea and I think most governments would understand that."

A second supermarket chief executive said, "My view is that it would be totally inappropriate. You are taxing what people have to eat to live. Groceries are not discretional spend." He added that if the new tax were imposed, retailers would have to pass it on to customers in the form of higher prices. It is understood that the British Retail Consortium (BRC) is in the process of compiling a major report into the impact on the consumer economy on both direct and indirect taxation. The report will be published prior to the election.

John Lewis Partnership warned that shoppers are already wary of higher taxes. He said, "Consumers will also be wary that further out they are very likely to face higher taxes as part of the major corrective action that will be needed to rein in the government finances. It has been mooted for example that VAT could rise to 20%." Late last year the National Institute of Economic and Social Research said that families face the prospects of income tax increases and having to pay VAT on previously exempt goods such as basic food if the Government's budget is to be balanced. (Source: Daily Telegraph, Mar/10)

The victim culture of modern Britain has taken wholeheartedly to the idea that we, the public, are the hapless victims of a vast conspiracy by manufacturers and retailers. The Office of Fair Trading ordered an inquiry into car prices recently or rather, one should say it ordered "another" inquiry, since we have had one before without any obvious result. But after people have fully indulged their "ain't it awful" emotions, they generally have not got much of a theory to explain exactly why prices are so high. There have been remarkably few serious attempts to nail down the real reasons.

One suggestion has been that British businessmen and women have a particular kind of high-margins mentality. According to this theory, American culture is such that US businesses "pile 'em high and sell 'em cheap", but the British have limited horizons and can think only of high mark-ups as a way to make money. This "cultural theory" of high prices tends to be offered by those who have no experience of business, or even reporting on business. It is also unsustainable, being undermined by examples of supposed business cultures that have changed when legal, tax and other circumstances change.

A second, similar, theory doing the rounds is that British businessmen and women are uniquely greedy. This idea seems to have some bases in fact: British super-markets do indeed have bigger profit margins than, for example, French ones. The profit margin of both Tesco and Sainsbury is 5.6%, whereas the profit margin of Carrefour, in France, is only 3.8%. That difference, less than 2p in the pound - does not, of course, go very far in explaining some of the much bigger differences in prices. But the gross profit margin of a business is not the key thing, as anyone concerned with business knows or ought to know. The key thing is the return on equity, ie the return on the capital put into the business by shareholders. On that measurement, the British supermarkets are no more "greedy" than the French.

So is there any third theory to explain "high-price Britain"? Surprisingly there is, although you could be forgiven for not knowing about it. It was put forward in research on British productivity, done for the Government by the management consultants McKinsey. This theory is that high prices result from all sorts of interferences with the free market. Wherever the consultants looked, they found major obstacles to free and full competition, generally created by governments. This may seem strange: we are accustomed to reports that Britain offers an attractive business environment. It does, in terms of taxation and the social costs of employment. But it is far from perfect.

Take supermarkets. McKinsey points out that it is particularly difficult to get planning permission in Britain. It has become even more difficult in recent years since John Gummer, as environment minister, discouraged out-of-town developments in 1993 and again in 1996, a policy that Labour has largely continued. The policy may be supported on aesthetic or "environmental" grounds, or because they imagine it will improve town centres. But the policy has a direct impact on supermarket prices. It means that the cost of land for supermarket-building is as much as 40% more expensive here than in America. It also means that the supermarkets built here are relatively small: the average size in France is 50% bigger; in the US, 90% bigger than in Britain.

The result is that French and American hypermarkets enjoy much bigger economies of scale. The cost of building a double-size supermarket is much less than double the price of single size. The architect's bill is not double, nor the builder's. In a more favourable planning environment, permission is easier to obtain. Yet the sales of a double-sized supermarket are nearly twice those of a smaller supermarket. So big super-markets are inherently more profitable. They can therefore afford to have lower margins. All this is exactly the same logic that makes the price of food in a supermarket lower than that in a corner shop.

Or take car prices. Once again, government is at fault. As Christopher Booker has previously pointed out, past governments have obtained an exemption from the EU rule that dealers and manufacturers must not enter price-fixing agreements. Meanwhile, McKinsey points to another obstacle to free competition. A European Union deal has limited the Japanese share of the market to 12% for many years. In other words, the most successful car manufacturing nation in the world has been prevented from competing properly. In theory, this limit should be removed at the end of this year; meanwhile, the limit has kept prices high across all Europe.

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