The short road to full-scale VAT implementation

On April 10, 1954, Maurice Laure, Joint Director of the French tax authority — the Direction Générale des Impôts — became the first to introduce a value added tax (VAT). Since then, it has come to dominate the discourse of public finance and fiscal policy, and has been adopted by more than 145 countries.

It has become the preferred way to raise revenues for many governments (in France for example, VAT is responsible for nearly 50 per cent of state revenue). As the GCC gears up to implement VAT in 2018, it is worthwhile to examine the impact and incidence to the local economy and the likely repercussions that will accrue and shape-shift the marketplace.

VAT has proven to be a remarkably durable and popular source of raising revenue across the world. Despite apprehensions, a number of studies have shown that the levy of VAT does little to impact spending, especially as it is “price coated” and, depending on its impact and incidence, has proved to be more economically efficient than any direct taxation levies, both from a revenue raising as well as an evasion and fairness point of view.

These studies reveal the positive impact on GDP growth (an OECD paper in 2015 estimated the net positive impact at 0.6 per cent per annum to GDP over the past 10 years).

It also allows for the creation of a fiscal policy framework that channels resources into the economy for programmes the accelerate growth by way of infrastructure and capital spending, through domestic resource mobilisation, rather than importing of capital.

It is this multiplier effect that allows the government to pursue stimulus that serves as the holy grail for economic growth. With the marginal propensity to consume as a result of the levy being only slightly impacted (if at all), the spending boost more than counterbalances this leading to the fiscal multiplier.

If it functions as it should, any VAT is indeed a uniform tax on final consumption, to which all textbook models in principle apply. However, a less than perfectly functioning VAT is an analytical mess, with particularities of production relationships and compliance behaviour immediately becoming the key.

It is these nuances, particularly across the supply chain, that need to be assessed, especially with regards to developing countries, as the UAE looks to implement a fiscal policy that starts to rely on domestic fund raising based on domestic consumption.

With the economy moving from an investment-oriented culture to that of a consumer base, public finance and fiscal policy will play an increasingly critical role in smoothening the visibility and sustainability of infrastructure spending going forward.

The UAE with its forward looking vision is now in the phase of an economic transition where a rapidly rising population base now enables it to implement programmes funded from domestic economic activity.

It is this transition that will increase the level of economic efficiency as diversification efforts that have been long pioneered in the country — and particularly in Dubai — bear fruit.

This paves the way for further structural reforms including — but not limited to — safety net policies as it seeks to unlock savings from the expatriate population and reduce leakages as the population becomes rooted.

Attention will now shift in the coming months to the mechanism for filing and registering for the VAT, with particular emphasis on how the registration impacts SMEs.

A recent working paper by the IMF estimated that an overtly bureaucratic filing system in some OECD countries shaves off up to 15 working days in a year in terms of productivity lost, with little effectiveness being achieved in terms of addressing tax leakages such as “carousel fraud”.

With concurrent initiatives such as Dubai’s Smart City project, the UAE is poised to introduce a system that will undoubtedly address some of these shortcomings. For the consumer, as well as the investor, the outcome remains clear.

The implementation of a taxation system via VAT not only is part of the process of ensuring continued economic growth and spending, but also integral to accelerating economic reforms that call for greater fiscal packages that will accelerate such growth. It is this channelling and generation of domestic resources that will make the difference between stagnating growth rates and a dynamic economic marketplace in the years ahead as fiscal policy finally gets its place under the sun.

— The writer is Managing Director of Global Capital Partners.