The VAT rate will increase within months. The only question is 'by how much?'

There has already been plenty of media speculation about a prospective rise in VAT whichever party is returned to power after the election. No one wants to confirm this move - because they fear the backlash and being blamed for not winning the election.

The Chancellor has no excuse. The Treasury will have advised him of his options re spending cuts and tax rises. He will have to lay out his plans in next month's Budget. George Osborne's team will also have had conversations with the Treasury as part of the plans for a possible transition. It seems likely that there is a clear need to increase taxes. I will leave the economists to dispute the timing and depth of spending cuts that may also be required.

I will also leave aside the precise numbers and how much can be raised through tax rises.

What I want to do here is to simply highlight WHEN tax rises generate money for the Exchequer. And I'll just focus on those key taxes that contribute the most money each year.

Income tax
Assume a second Budget in June or July - part way through the current tax year that starts on 6 April 2010. It is customary to determine tax rates before the start of the tax year. But let's assume instead that income and corporation tax rates were to be raised in respect of earnings and profits of the tax year 2010-2011.

Remember that the PAYE system, which only affects employees and pensioners, is 'cumulative' in the way that allowances, reliefs and taxes are allocated. A tax change half way through the year results in 6 months worth of the annual tax effect hitting taxpayers in one go. Not good news and, I would have thought, all but inconceivable. At least, not without the introduction of complex adjustments that could throw out many computerised payroll systems.

Still, even if income tax rates were increased for 2010 and a solution was found for the PAYE issues summarised above, what about the self employed and the higher rate tax payable by those with investment or rental income? When would they pay the additional tax? Well, it's not due for payment until 31 January after the end of the tax year - so that would be 31 January 2012. And that's if income tax rates are increased with immediate effect. Such a change would clearly not contribute a major reduction in the deficit this year.

And the impact of a rise in income tax rates is further delayed if any increase is deferred until 2011-2012.

Corporation tax (CT)
CT rates for the 2010-2011 financial year could, in theory, be revised mid year and the resultant complaints could be ignored. But again this tax is paid after the end of a company's accounting period. Assume a year end of 31 December 2010. Any increased CT would only be payable late in 2011. And all those companies with 31 March accounting dates would only pay such increased CT at the start of 2012. So, as with income tax rises, this will not do much for the current year deficit. And the impact is further delayed if any increase is deferred until 2011-2012.

National Insurance (NI)
Most classes of NI are payable along with income tax for the year in question. Thus pretty much the same issues arise as for income tax (see above). The only class of NI that could have material sort term impact is the 'tax on jobs' - employers' NI. An increase of 1% has already been announced to take effect from 6 April 2011. And part of that rise was announced in 2008.

Capital Gains Tax (CGT)
I'll write separately about the rate of CGT. For now let's just note that, like income tax, it is payable on 31 January after the end of the tax year. Thus, even if the rate for 2010-2011 was increased from 18%, this would only have an impact on the tax payable on 31 January 2012.

VAT
We have already seen two changes to the VAT rate in the last 18 months. Firstly a reduction to 15% and then an increase back to 17.5%. Both such changes had an almost immediate impact on the Government's tax receipts. There is no other way to do this.

So VAT will have to rise later this year. The only question in my mind is by how much? I suspect 20% as it's a convenient figure but better minds than mine are welcome to suggest alternatives.

The average rate of VAT in the EU is almost 21%. Only Luxembourg and Cyprus have a standard VAT rate lower than the UK. Each 1% rise in the rate of VAT should generate £4-5 billion of additional income for the Treasury. A rise to 20% would still leave the UK slightly below the average rate across the EU, and could generate almost £12 billion for the economy, the equivalent of around 3p on income tax. And let's remember that we all dismissed the 2.5% reduction from 17.5% down to 15% as being unlikely to have a meaningful impact on spending. And when we reversed the cut and put up VAT by 2.5% to 17.5% did everyone cope? Might this always have been the plan, to use such a rise as a test-run for the impact of a rise to 20%?

What do you think?