VAT vital to shore up economy

Christine Lagarde, Managing Director of the International Monetary Fund (IMF), made a pertinent point when she described tax as “the lifeblood of modern states”. Addressing finance ministers at the recent Arab Fiscal Forum in Abu Dhabi, she drove home the idea of introducing Value Added Tax (VAT) to shore up GCC economies.
Her call for the Gulf states to introduce the VAT was timely as the region is gripped by plummeting oil prices. The taxes would provide more revenues for governments to create much-needed funds for spending on infrastructure, health care and education.
As they diversify their economies away from oil, it is also appropriate that they have initiated negotiations over the terms of a region-wide introduction of VAT probably within two to three years.
As the region has been running a tax-free economy, introduction of the taxes now may face challenges in terms of legislation and management of the taxation system, even though such difficulties can be addressed and tackled well.
According to Younis Haji Al Khoori, Under-Secretary of the Ministry of Finance, the UAE will earn estimated VAT revenues of between AED10 billion and AED12 billion in the first year of its application.
To avoid any future hurdles, the committees and taskforces have been formed to study the anticipated socio-economic impact of the imposition of VAT and the proposed percentages. The committees have suggested a VAT rate of between 3 and 5 per cent for the various sectors, with the exception of healthcare, education and 94 food items on which there will be no VAT.
Each GCC state needs to put in place a domestic tax laws structure before the GCC-wide implementation of VAT.
“The VAT can be introduced once any two of the GCC countries are ready with their tax laws and present the same to the GCC Secretariat,” Al Khoori said.
Though the VAT tax would further strengthen the UAE GDP, the country must continue to follow a policy of economic diversification and should not rely on any one source of income. The contribution of oil revenues has already shrunk from about 90 per cent of GDP to much low rates.
The impact of a VAT system on consumers in the UAE may vary depending on household incomes and spending behaviour, and how much will be levied on goods and services, analysts say.
Given strong purchasing power of residents in the UAE, levying of a 3-per cent to 5 per cent VAT may generally be hardly noticeable, especially if the essential food items are exempted. But a tax rate of 10 per cent or higher is clearly seen to have a negative impact on consumer spending. Indeed, the authorities in the UAE and other GCC states may tax VAT in lesser percentage that would not affect consumers, but would enhance the economies.
The introduction of tax reforms has long been discussed in the Gulf Cooperation Council (GCC) region. But the subject died down as there was no urgency to impose the tax.
With the tide changing course and economies in the region facing budget deficits due to oil price decline, it is good that the proposal has again gained momentum and will become effective in two years.