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3 January 2011
Last updated at 19:42 ET
The top rate of VAT has risen from 17.5% to its highest level of 20% as the government looks to boost tax revenues to cut the UK's debt levels.
Business groups have warned that retailers will be hit by the increase, while opponents of the rise have said the poorest will be hit hardest.
The government says the rise is necessary to help bring down the UK's high budget deficit.
Food, children's clothing, newspapers and magazines are not subject to VAT.
Research by the Centre for Retail Research and online shopping group Kelkoo has suggested that retail sales will fall by about £2.2bn in the first three months of the year as a result of the rise in VAT.
The British Retail Consortium (BRC) has also warned that the rise, announced in the June budget, may have squeezed the traditional January sales period into a concentrated burst around the New Year.
More than seven out of 10 retailers polled by the BRC thought that their customers would bring forward purchases to beat the VAT increase.
It added the that rise comes at a bad time for businesses, which are being squeezed by higher transport costs and commodity prices.
However, BRC spokesman Richard Lim said that although the rise would harm retailers, the increase was necessary to tackle the budget deficit.
Inflation headache The VAT rise is also a worry for the Bank of England.
At 3.3%, the annual rise in the consumer prices index is already well above the Bank's target of 2%, and the increased VAT rate is likely to push inflation towards 4% this year, analysts say.
One member of the Bank's policy-setting committee, Andrew Sentance, has voted repeatedly for a rate rise in recent months, to head off the inflation risk.
But other members think the high inflation is due to a number of one-off events, not least the VAT rise, and will subside once government austerity measures kick in.
Yet the VAT rise may spur a broader increase in the price of goods, according to a survey of 200 senior managers by accountancy group KPMG.
It has claimed that many retailers are planning to use the tax rise to "mask" more extensive price increases.
It said 60% of retailers and consumer product manufacturers planned to increase their prices over and above the VAT rise.
However, the BRC claimed the report was "nonsense".
'Wrong tax' When unveiling the VAT rise over the summer, the Chancellor George Osborne said it would raise more than £13bn a year by the end of the parliament.
On Monday, he said the rise was a "powerful tool" to combat the budget deficit, without which spending cuts would be even greater.
He said the government had no choice but increase the tax after Labour left the coalition with "record debts".
However, the Labour opposition has accused the government of penalising low income families.
Labour leader Ed Miliband said the rise would hit small businesses, jobs and living standards, and would cost the average family £7.50 a week.
He said it was the "wrong tax, at the wrong time", arguing that the rise would hit families at a time when they will be under pressure from government spending cuts.
Mr Osborne accused Mr Miliband of weak leadership and of "jumping on the bandwagon of opportunism", saying that the previous Labour Chancellor Alistair Darling wanted to put up VAT.
Shadow chancellor Alan Johnson has warned the move is likely to hit the poor hardest.
Although they will end up paying less VAT in total, lower income households spend a bigger share of their incomes on taxed goods, meaning they are proportionately harder hit.
The higher rate brings the UK into line with its European peers - at 17.5%the UK had one of the lowest VAT rates in the European Union.
Standard rates of VAT in the European Union
Country VAT % Country VAT % Country VAT % Source: European Commission
Austria
20
Germany
19
Netherlands
19
Belgium
21
Greece
23
Poland
22
Bulgaria
20
Hungary
25
Portugal
20
Cyprus
15
Ireland
21
Romania
19
Czech Republic
20
Italy
20
Slovakia
19
Denmark
25
Latvia
21
Slovenia
20
Estonia
20
Lithuania
21
Spain
16
Finland
22
Luxembourg
15
Sweden
25
France
19.6
Malta
18
UK
20
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Business groups have warned that retailers will be hit by the increase, while opponents of the rise have said the poorest will be hit hardest.
The government says the rise is necessary to help bring down the UK's high budget deficit.
Food, children's clothing, newspapers and magazines are not subject to VAT.
Research by the Centre for Retail Research and online shopping group Kelkoo has suggested that retail sales will fall by about £2.2bn in the first three months of the year as a result of the rise in VAT.
The British Retail Consortium (BRC) has also warned that the rise, announced in the June budget, may have squeezed the traditional January sales period into a concentrated burst around the New Year.
More than seven out of 10 retailers polled by the BRC thought that their customers would bring forward purchases to beat the VAT increase.
It added the that rise comes at a bad time for businesses, which are being squeezed by higher transport costs and commodity prices.
However, BRC spokesman Richard Lim said that although the rise would harm retailers, the increase was necessary to tackle the budget deficit.
Inflation headache The VAT rise is also a worry for the Bank of England.
At 3.3%, the annual rise in the consumer prices index is already well above the Bank's target of 2%, and the increased VAT rate is likely to push inflation towards 4% this year, analysts say.
One member of the Bank's policy-setting committee, Andrew Sentance, has voted repeatedly for a rate rise in recent months, to head off the inflation risk.
But other members think the high inflation is due to a number of one-off events, not least the VAT rise, and will subside once government austerity measures kick in.
Yet the VAT rise may spur a broader increase in the price of goods, according to a survey of 200 senior managers by accountancy group KPMG.
It has claimed that many retailers are planning to use the tax rise to "mask" more extensive price increases.
It said 60% of retailers and consumer product manufacturers planned to increase their prices over and above the VAT rise.
However, the BRC claimed the report was "nonsense".
'Wrong tax' When unveiling the VAT rise over the summer, the Chancellor George Osborne said it would raise more than £13bn a year by the end of the parliament.
On Monday, he said the rise was a "powerful tool" to combat the budget deficit, without which spending cuts would be even greater.
He said the government had no choice but increase the tax after Labour left the coalition with "record debts".
However, the Labour opposition has accused the government of penalising low income families.
Labour leader Ed Miliband said the rise would hit small businesses, jobs and living standards, and would cost the average family £7.50 a week.
He said it was the "wrong tax, at the wrong time", arguing that the rise would hit families at a time when they will be under pressure from government spending cuts.
Mr Osborne accused Mr Miliband of weak leadership and of "jumping on the bandwagon of opportunism", saying that the previous Labour Chancellor Alistair Darling wanted to put up VAT.
Shadow chancellor Alan Johnson has warned the move is likely to hit the poor hardest.
Although they will end up paying less VAT in total, lower income households spend a bigger share of their incomes on taxed goods, meaning they are proportionately harder hit.
The higher rate brings the UK into line with its European peers - at 17.5%the UK had one of the lowest VAT rates in the European Union.
Standard rates of VAT in the European Union
Country VAT % Country VAT % Country VAT % Source: European Commission
Austria
20
Germany
19
Netherlands
19
Belgium
21
Greece
23
Poland
22
Bulgaria
20
Hungary
25
Portugal
20
Cyprus
15
Ireland
21
Romania
19
Czech Republic
20
Italy
20
Slovakia
19
Denmark
25
Latvia
21
Slovenia
20
Estonia
20
Lithuania
21
Spain
16
Finland
22
Luxembourg
15
Sweden
25
France
19.6
Malta
18
UK
20
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