The economies of the Gulf Corporation Council (GCC) countries are highly dependent on the energy sector, where the hydrocarbon sector constitutes around 40% of their GDP. Moreover, revenues from the oil and gas sector accounts for about 80% of the governments’ budgets. Consequently, the recent drop in oil prices has had a large impact on the GCC countries’ budgets, as reflected in their realising fiscal deficits in the past year, compared with large surpluses in 2012. The volatility of oil prices has motivated GCC countries to initiate reforms with the goal of diversifying their income sources. Hence, came their decision to impose a 5% Value Added Tax (VAT) in an effort to elevate the robustness of government income. It is expected that the tax will be applied in January 2018, or 2019 at the latest.
VAT is the most common consumption tax in the world, being imposed in more than 150 countries, including all members of the Organization for Economic Cooperation and Development (OECD), with the exception of the US. Its growth has come largely at the expense of excise taxes. It is an effective revenue-collection tool, compared with other indirect taxes. If designed and operated properly, it can have a small administrative cost, and exhibit a limited impact upon economic activity. For example, economic distortions and administrative costs are smaller when VAT is levied, as opposed to varied taxes with different rates, on a narrow base, and with many exemptions.
Existing taxes in the GCC are characterised by low rates and narrow bases, with revenues generated insufficient to ensure the sustainability of financial flows to the budget. For example, Bahrain, the UAE and Oman have taxes below 10% on hotels and entertainment, property rents, and government services. No personal income tax is imposed in the GCC, while corporate taxes are applied only on foreign-owned companies. Therefore the existing taxes are modest and their contribution to the budget is insignificant. Higher revenues can be generated and the efficiency of the tax system can be improved by introducing VAT.
Potential revenues from VAT are higher than other indirect taxes since VAT is imposed on a broad base and there are smaller opportunities for tax evasion. For example, a consumer can avoid a sales tax through buying wholesale, or through purchasing through an employer. For this reason sales taxes can have higher administrative costs since, in many cases, it is difficult to determine whether the product purchased will be consumed directly or used for production. Furthermore, VAT may encourage savings and investment because it is a tax on consumption rather than income.
Imposing 5% VAT in the GCC countries is expected to generate revenues approximately equal to 1.6% of the GDP in Bahrain and Saudi Arabia, 1.5% in the UAE, 1.4% in Kuwait and Oman, and 0.8% in Qatar, implying a significant rise in current, non-oil revenues. This income can be used to finance development projects that target low-income individuals, as well as for redistribution programmes. Redistribution through government spending can be more effective than setting different tax bands and exemptions.
Due to the low tax rate of 5%, the negative effects of VAT are not expected to be significant. Even though the GCC will no longer be able to promote itself as a tax free region, a low-rate VAT is unlikely to have an impact on foreign direct investment. Yet, a challenge that the GCC currently faces is that it does not have the necessary infrastructure and expertise in tax management, it must therefore build a modern tax administration system that ensures compliance.
A wide range of reforms are expected in the GCC, not just in terms of tax rises, but also through government efficiency drive, privatisation of public companies, and efforts to increase private sector investments. For example, Saudi Arabia has recently introduced the Saudi vision 2030 which includes a variety of reforms that aim to stimulate the economy and diversify income. The GCC states have already started cutting energy subsidies, which constitute more than 3% of the GDP of some GCC states – and up to 10% of GDP in Saudi Arabia and Bahrain. The subsidy cuts help alleviate budgetary pressure and reduce misallocations and distortions in the economy resulting from low energy prices.
Introducing a value added tax and removing energy subsidies forms a part of a wide-ranging programme of economic reforms in the region. The GCC states realise that although the imposition of VAT will contribute to the diversification of sources of income, they also need to consider changing the nature of government spending in parallel.