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23 June 2010 Last updated at 13:18

Budget: How the rise in VAT will work

Value added tax, or VAT, has been increased in the coalition government's first Budget.

The standard rate will rise from 17.5% to 20% from 4 January next year.

But what does this mean?

Given that VAT is the tax you have to pay when you buy goods or services - it is almost unavoidable.

So presuming that retailers pass on the rise, it means that many of the things you buy in the UK, will become more expensive.

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There has already been criticism, with deputy leader of the Labour Party, Harriet Harman, saying raising VAT "punished the poorest most" meaning that pensioners, for example, "had less money in their purses".

It could have been worse for shoppers, given there had been speculation that VAT might be applied to food.

However, Chancellor George Osborne promised that those items classed as "essential", including food, children's clothing, newspapers and magazines, would remain free from VAT.

Continue reading the main story Trade drop-off?

´óÏó´«Ã½ business editor Robert Peston said that the deferred VAT rise would cause "significant anxiety to retailers" amid concerns consumers would stay away.

"That said, many would argue that the UK became too dependent on retail spending in the boom years running up to 2007," our correspondent added.

A third of small businesses quizzed by price comparison site Uswitch expressed concern that the tax rise would lead to a drop-off in trade.

And implementing the changes also carries costs, said Uswitch's small business energy expert Jake Ridge.

"Small businesses are battling to recover from the recession. The VAT hike will not only cost many money to implement, but it will also make trading even harder."

The Federation of Small Businesses said that many of its members would suffer from another government plan - increasing insurance premium tax from 5% to 6%.

"For many small businesses insurance on many items is a must and the proposal... should be reversed," it said.

European standard

The chancellor's decision to increase VAT did not come as too much of a surprise.

It had been widely suggested that increasing VAT would be a good way for the coalition government to raise some of the extra cash it needed to reduce the amount it has to borrow.

The chancellor said the move would raise more than £13bn a year by the end of the parliament.

"That is £13bn we don't have to find from extra spending cuts or income tax rises," Mr Osborne said.

And the raising of the standard rate of VAT, brings the UK more into line with rates elsewhere in Europe.