The decline in oil prices since mid-2014 has hurt economic growth and weakened fiscal and current account balances across Gulf Cooperation Council (GCC) countries. Fiscal retrenchment in the form of spending cuts, lowering of capital expenditures and subsidy reforms have undoubtedly reined in expenditures substantially over the past one year. However, a proactive revenue diversification policy is necessary to make government finances less susceptible to oil price fluctuations.
Taxation is a globally accepted practice of augmenting government revenues. According to the International Monetary Fund (IMF), value added tax (Vat) is highly effective in mobilising and diversifying government revenue.
Although the introduction of taxation in the region was first discussed several years ago, it remained more in academic realms as GCC countries have been financing their government expenses on oil exports and revenues. The fact that the GCC oil revenue’s consistency grew and had a positive outlook to the period up until 2014 prompted governments to hold back on domestic tax policies.
However, persistent low oil prices over the past three years have brought considerable economic pressure on the GCC countries. This led to an urgent need to diversify revenue streams. In February this year, GCC countries agreed on the introduction of Vat at a uniform rate of 5 per cent in 2018. VAT will be implemented gradually so that the region’s competitive edge against other countries is not suddenly lost. The UAE, along with Saudi Arabia, is poised to introduce 5 per cent Vat, starting 2018. Studies show the introduction of Vat across the GCC is expected to raise additional revenues between 1.2 to 1.6 per cent of GDP in the first year, with the UAE and Saudi Arabia likely to see the greatest revenue generation of about 1.5 to 1.6 per cent of GDP.
While Vat is expected to bring much-needed fiscal relief, the introduction of a new tax in a region that is used to subsidies and absence of any tax, comes with apprehensions on its effectiveness, impact on the economic growth and inflationary pressures. Clearly, tax comes with a cost on whom the final burden falls. Vat being a consumption tax, it is expected to cause a modest increase in inflation. However, with some key components of the consumer price inflation basket remaining either zero-rated or exempt will mean that the percentage point rise in inflation directly from Vat will be far less than the tax rate, especially as residential housing tends to have the largest weightage in the inflation basket.
Despite the modest inflationary impact, with the prospects of oil prices remaining low for long, it is time people are made to understand that options are limited for governments. Either a viable pricing mechanism needs be implemented to fund public services or governments will end up resorting to big borrowings, which is unsustainable in the long term.
