Not too surprisingly, the value-added tax (VAT) still remains vague for many, with some mistakenly believing it is only a source to raise additional finances for the federal budget. The fact is greater — and much more important — than that.

Besides being a source of new income, VAT is deemed an effective tool to improve economic performance, direct resources and control pace of growth in line with development requirements. But how does it work?

The European experience demonstrates that the use of VAT has contributed to the recovery of several economies and in curbing higher consumption as well as the resulting negative effects. This has been done by incorporating changes to the VAT rates.

In the first case, if growth slows down, then encouraging and attracting investment becomes a priority. And decision-makers will thereby reduce the tax rate to support growth and consumption. If the opposite happens, the rate will be increased.

This indicates that the VAT rate has never been constant for a long time. In the UK, for example, it has ranged from 12-20 per cent, depending on the economic conditions and development requirements. This is also the case for other countries that have levied the VAT.

However, this measure does not happen overnight but after a comprehensive review of the situation to avoid any confusion within the wider economy. Such an important economic instrument is largely similar to the way interest rates are dealt with, which are raised or cut depending on the general conditions and development requirements.

Yet, there is a difference between these two tools; the first is mainly related to prices of goods and services, while the second is linked to bank loans and finance. At the end of the day, both have an active role in identifying and directing economic activity.

Unfortunately, this has led to some problems for economic blocs and common markets. For example, VAT rates in the EU are not unified, affecting the competitiveness of the member countries that freely transfer goods, services and funds among themselves.

With that in mind, countries with low VAT rates are deemed as the most competitive and that is why there have been many calls made by EU countries to unify the VAT rates so as to bring about a just competitive atmosphere.

In this context, the Gulf Cooperation Council (GCC) countries adopted the right decision, collectively applying the VAT in the six Gulf countries on January 1. Nevertheless, some obstacles have come in the way of a collective application, either because the legislative and technical structure is not ready or for reasons related to prevailing economic trends.

Thereby, the VAT was implemented in some countries and postponed by a year in others and is still under discussion in others. To date, this disparity has not created a significant difference between the countries as the postponement by one year is not that long and the tax rate does not exceed 5 per cent.

Hence, its effects are limited and can be dealt with. The VAT results will reflect positively on the implementing countries, where using the proceeds will help guide economic policies, and develop financial and tax regimes to fit modern economies. It will also provide revenues for state budgets and reduce dependence on oil revenues. It will create a new consumer culture and an accumulation of experiences that will aid sound economic planning.

Other GCC countries too can benefit from others’ experiences, and this highlights the need to unify tax rates to support Gulf-wide cooperation and create equal investment opportunities within the common market.

Dr Mohammad Al Asoomi is a UAE economic expert and specialist in economic and social development in the UAE and the GCC countries.