The rising cost of goods due to yesterday's VAT hike coupled with the new year fuel duty increase could result in an 'inflationary time bomb', Greater Manchester Chamber of Commerce has warned.

Deputy chief executive Chris Fletcher said businesses will face 'harsh choices' following the rise in VAT from 17.5 per cent to 20 per cent, having to weigh up whether to keep prices down or pass on the increase to customers.

“Either way, we will see business profits potentially take a hit, which could have an impact on investment and expansion plans,” said Mr Fletcher.

“The longer term impact of goods costing more, coupled with the fuel duty increase, could be an inflationary time bomb that could impact heavily on the economy.

“Our members are really worried about inflation rather than the VAT increase, and this is causing a few of them to hold back on investment into their businesses, which would see a slowdown in any planned and much-needed employment growth.”

The Federation of Small Businesses is urging the government to increase the threshold above which firms have to register for VAT.

More than 70 per cent of the 1,600 firms surveyed by the FSB said they expected to be hurt by the VAT rise, with almost half of respondents saying they will have to increase prices as a result and 45 per cent believing it will hit turnover.

John Walker, national chairman of the FSB, said. "If the government truly believes that the private sector is going to strengthen the recovery, we need to see action.

"Increasing the threshold at which companies have to register for VAT will put almost £900m back in the pockets of small businesses. Without this, small firms will struggle to bounce back as the spending cuts start to bite."

Phil McCabe, of the Forum of Private Business, said: “Some large retailers have said they will not pass on the VAT increase to their customers. Most small businesses do not have that luxury and will put up their prices accordingly. It is likely that, as a result, trade will decline at a time of rising fuel prices, increasing late payments and continued lending restrictions.

“Unless more is done to free firms from the shackles of red tape and tax, and help them to maintain some kind of cash flow, 2011 will be another difficult year and economic growth will be slow.”

The VAT hike has been designed to raise £13bn a year to help balance the nation's public finances.

Chancellor George Osborne defended the hike - announced in his emergency Budget in June 2010 - as "a powerful weapon to tackle debt".

Mr Osborne has previously said that the 20 per cent rate is 'not temporary' but a structural part of the tax system, leading economists to predict it will remain at least until the next general election, scheduled for 2015.

Mr Osborne said: "I think it is a reasonable rate to set, given the very difficult situation we find ourselves in. The VAT rise is a tough but necessary step towards Britain's economic recovery.

"If you don't want to raise VAT, you have got to do something else."

But the Chancellor was accused of "treating the British people like fools" by Labour leader Ed Miliband.

Mr Miliband said: "He (Mr Osborne) claimed that this VAT rise was fair - but David Cameron admitted before the election that VAT rises were unfair.

"Everybody knows it's poor and middle-income families that will be hit hardest."

He said Mr Osborne should apologise for "misleading Britain".

Mr Miliband added: "The truth about this VAT rise is it's the wrong tax at the wrong time."

The rise is the second VAT increase in a year, after Labour Chancellor Alistair Darling restored the 17.5 per cent rate last January, having temporarily reduced it to 15 per cent for 13 months to stimulate the economy during the recession.

The change affects any VAT-registered business that sells or purchases goods or services that are subject to the standard rate. Most foodstuffs, children's clothing and books remain zero-rated and reduced rates remain on items such as children's car seats and supplies of domestic fuel and power.

TUC general secretary Brendan Barber said: "Raising VAT, while failing to tackle the tax loopholes exploited by big businesses, means that ordinary people will soon pay a higher rate of tax on purchases and earnings than the banks pay on their profits.

"VAT bears down on those who did least to cause the crash, while the Chancellor is asking for little more than a token contribution from the banks."

Some experts are warning VAT rate could reach 25 per cent in the future.

A report by the Centre for Retail Research suggested consumers will spend an average of £324 less in the remainder of this year as a result of the VAT hike, cutting UK retail sales by as much as £2.2bn in the first quarter of 2011 alone.

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