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Adding value?
Value added taxes have the ability to create a sustainable revenue base for Gulf countries, ensuring they are protected from swinging oil prices
- By Rod Monger, Special To Gulf News
- Published: 00:05 November 19, 2008
Value added taxes (VAT) raise an estimated $18 trillion (Dh66.06 trillion), or about one-fourth of all government revenue throughout the world, each year.
That affects about 4 billion people or 70 per cent of the global population, according to the International Monetary Fund (IMF), with most of the growth in VAT usage occurring over the past decade. Currently about 50 countries use value added taxes. That includes MENA countries like Morocco, Tunisia, Sudan, Lebanon, Jordan and Egypt which have implemented VAT with future installations planned for Syria, Yemen, and GCC countries.
Value added taxes were implemented in MENA nations primarily to replace customs duties lost under free trade agreements, also a factor in the UAE. Estimates are that the UAE value added tax will be upwards of 5 per cent replacing custom duties though the net impact in terms of whether an increase in tax burden will materialise remains unclear.
Even at 5 per cent this would make the UAE one of the lowest rates in the world. Some countries have introduced the tax in stages. For example, Lebanon introduced a 10 per cent VAT in 2002 which is unofficially expected to increase in stages to 16 per cent by 2015. But these numbers can be misleading as they sometimes refer to taxes that are not truly VAT.
Unification
The implementation of VAT in the Gulf region is part of larger discussions about economic unification and diversification. VAT issues are also tied closely to the effort to unify GCC currencies. For example, the European Union found that while introduction of the euro increased liquidity in capital markets, barriers to full integration remained due to tax, accounting and legal differences implying that all these issues must be worked hand-in-hand.
It's not as easy as one might think, which may explain some of the on-again, off-again feel of GCC efforts to implement both a unified currency and VAT. A part of the reason, one source suggests, is that GCC countries are on "different pages." For example, some favour an income tax over VAT while others want a coordinated introduction of VAT across all GCC nations.
A new tax system begets the need for appropriate administrative structures including audit compliance units and a system to refund taxes promptly. The European unification contributed to rounds of 'carousel' fraud - scams where VAT is collected by intermediaries but never remitted to the government - false addressing on digital sales and other avoidance schemes.
In addition, the tax must be designed to be equitable. This raises issues: should small traders be excluded because they offer little revenue and represent major administrative headaches? And does the tax create a bias against one economic sector when compared to others?
In its purest form, VAT is a 'broad based' tax that applies to the supply of all goods and services, notes Dean Rolfe, Tax Partner and Middle East Tax Leader with accounting powerhouse PricewaterhouseCoopers. Though governments sometimes favour the idea of providing exemptions for reasons such as social policy for areas like health, food, medical services and education. However, these exemptions make the tax more difficult to administer.
Diversification
Also, until recently, little fodder was available to fuel a value added tax in the largely oil-dominated export GCC economies. But financial services, transportation and real estate have now crept up to account for about 19.2 per cent of total GDP.
Thus, value added taxes now have the potential to create an alternate and sustainable source of revenue and thus help insulate Gulf economies from swings in oil prices - a point made poignant by the recent drop in crude. In addition, the UAE government has an additional mechanism to 'calibrate fiscal policy,' says the IMF. In other words, rates can be manipulated to moderate supply and demand.
However, in the short term, with upward pressure on UAE prices, the worry has been that introducing VAT will cause inflation to spike. To make matters worse, regional IMF personnel created a brouhaha last year by predicting a temporary increase of 1 per cent to 2 per cent. But Dubai Customs estimates that the effect will be less than half a percentage point based on a 3 per cent to 5 per cent flat VAT rate replacing existing duties.
Rolfe says this is a complicated question. But almost always the effect is a "one time hit" which depends on a host of factors. How much is the VAT? Can businesses absorb the tax without passing it along to customers? What other government taxes and charges are being replaced?
For example, a local business might not want to increase its product price to recover the new VAT fearing that doing so would cause sales to be lost. Instead, the business decides to absorb the tax and not pass it along to customers. In this case, no inflationary pressure results.
Another issue is what other changes are in progress when the VAT is introduced. As already noted, some 5 per cent customs duties are being eliminated. The bottom line is that the introduction of a 5 per cent VAT does not translate into a 5 per cent increase in prices. It may result in no increase whatsoever and almost without doubt, no sustained increase.
But why are value added taxes so popular? All tax schemes have consequences, not the least of which is their unpopularity with the people and businesses which must pay. Yet VAT is considered "less imperfect" than other taxes because it is a broad-based consumption tax included in the final price of goods which results in end consumers paying tax on an ongoing basis via their purchases. Income taxes for both individuals and businesses are far more visible and therefore unpopular.
Another reason is that value added taxes are easier to collect than income taxes, especially since globalisation has increased capital mobility. Value added taxes are also more adept at tapping into informal portions of the economy, particularly in developing countries.
Taxes give incentives for avoidance, says Mohammad Al Azzam, an economics professor at the American University in Dubai. But "VAT can be high without triggering evasion because of the mechanism of collection. In other words, each business owner has strong incentives for its supplier to pay their taxes which in turns allow VAT rates to be higher with less tax evasion."
The effectiveness of VAT and its efficiency in collecting taxes is a much debated issue complicated by insufficient data. However, in general, VAT has received good marks. Some studies suggest that VAT does better in economies with a high ratio of trade to GDP because collecting tax on importations is easier than on activities inside the domestic economy. Also, VAT does better in countries with a high literacy rate - a question of understanding the obligations - and where the tax has been in place longer.
- Rod Monger is an independent journalist who writes on economic, business and political issues.
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