We know where you're coming from

Benjamin Franklin strikes again: there's nothing certain in this world except death and taxes. Just when you thought there was a place where one of those inevitabilities seems not to apply, there's a danger the party might be spoiled.

Spoiler-in-chief, it might be said, is the IMF, which has been harping on about VAT for many years. A report on the GCC in 1996 suggested that "revenue policies should be directed ? at mobilising non-oil revenue [and] improving the buoyancy of tax revenue", including a "broad-based consumption tax".

Its annual report on the UAE last August was only the latest exhortation, wherein it also suggested extending corporate tax (currently applied only on international banks and energy companies) across all sectors, as well as a property tax.

For its part, the UAE Government obviously has been wary, acutely conscious of not killing the goose that lays the golden egg.

Low or no tax is undoubtedly a key advantage to the region in terms of its powers of attraction, and a critical characteristic from the point of view of firms and workers who come here from abroad. So why this shifting mood?

At one level, it's difficult to tell. The country's finances obviously are buoyant, and tax is supposed to be about raising necessary revenue. Some will say it's also about redistributing wealth, but that's not part of the agenda in this case.

Moreover, the IMF reported that "in general, the UAE has pursued prudent fiscal policy over the years, as observed through its non-oil fiscal balance, gross debt and wage bill".

Furthermore, subsidies have been "relatively low compared to most other GCC countries" and "most government-controlled entities like petrochemical plants, water and power have been commercially-operated".

On the one hand then, not a problem. In fact, "the consolidated fiscal position [meaning the federal government, Abu Dhabi, Dubai and Sharjah] is projected to remain in significant surplus over the medium term".

Presumably, because oil prices were expected to stay high and they have gone higher in the intervening six months.

But ? and you know what's coming. On the other hand, the UAE's "fiscal policy coordination ? remains weak".

For one thing, the Federal Government's own finances (as distinct from the emirates' individual budgets) are limited to certain fees and charges, but particularly transfers, primarily from the Abu Dhabi Government.

That's considered a 'structural' fault, one which more than offsets the oil-price condition, which in principle may be merely 'cyclical', although many are convinced the demand-supply equation has decisively shifted for years ahead.

Cyclicality is a proxy for unreliability, and it's fair enough that public finances should be reliable, especially if you believe that "pressures may build" for higher expenditure to cope with unemployment and pension bills (although there are other ways). Hence the recommendation to 'diversify' revenue.

Remarkable

The chart shows the remarkable extent to which the GCC countries (though not the UAE especially) rely on the oil resource for income, both in the budget and for exports.

But why VAT, and why now?

The same IMF report gave clues, though couched in the timeless narrative of its economic orthodoxy. What that means is that the IMF has its preferred model for economies to follow, and deviations from it are considered wasteful anomalies.

That standard prescription involves VAT. It also involves the relationship between monetary and fiscal policies.

In the GCC, monetary policy is largely governed by the dollar peg, which entails setting interest rates roughly in parallel with the US Federal Reserve, whether it conforms to domestic needs or not.

The IMF observes, "given the limitations of monetary policy under a fixed rate system, the burden of tightening financial policies to stem inflationary pressure will likely fall on fiscal policy". To trained and untrained observers alike, that's a pretty scary thought.

It means that taxes may have to rise to compensate for the fact that interest rates maybe can't (one of the reasons why monetary union can be a daunting prospect).

It is certainly more than arguable that interest rates are a better instrument to contain a liquidity bubble.

From a consumer's perspective, it's pretty galling to find that taxes may rise to offset the inflation from which you have been suffering anyway and which could have been avoided.

Raising tax generally, but especially in such circumstances, has both emotive and economic consequences. It risks throwing the baby out with the bathwater.

If it makes you feel any better, that may not be the main reason VAT is being considered. The upfront idea is the loss of customs duties because of trade liberalisation itself an IMF preference as has been institutionalised now across the GCC in the form of WTO membership. Thus, one set of taxes to replace another.

According to the IMF, VAT is "alluring". Only finance boffins could see it that way. In reality, it's a form of consumption tax, which appeared first in France around sixty years ago, and has been spreading like a contagion ever since.

It forms about 40 per cent of the finances (in terms of 'own resources') of the EU, but is not used in the US, which applies a sales tax instead.

Unlike sales or turnover tax, VAT is applied throughout the production and distribution chain (rather than ultimate consumer), but offsets output tax against input tax, and therefore weighs evenly at each stage from producer, to wholesaler to retailer and does not distort business decisions.

That's its key advantage. Its disadvantages include the bureaucratic burden (especially on smaller businesses), its potentially inflationary impact (as costs are passed through to prices), and its proportionally higher impact on the poor.

The detail of VAT's costs and benefits are technical and inconclusive, and depend on circumstances.

A survey of the IMF's own experience of advising on its introduction (covering 37 countries) found that the system's design was not contentious, but its implementation was patchy.

"Success ? cannot be taken for granted," it judged, ominously. Failures tended to relate to political policy choices. For instance, too many zero-rated or exempt categories (not strictly the same thing).

Also, multiple rates, creating distortion which the system is meant to avoid, and registration thresholds set too low, catching too many small firms.

The reluctance of governments to refund exporters, again intrinsic to the system, can create "troublesome tension", so much so as to be the system's "Achilles heel", owing to ineffective audit mechanisms.

That sounds like lukewarm endorsement, from the idea's sponsor, for a tax with very significant ramifications.

The IMF noted that a key issue in future would be "VAT's implementation in decentralised states and within regional trading blocs", i.e. across borders. Given the relationships between emirates and with the GCC, the UAE will have to grapple with that too.

All in all, there's a lot for the Government to think about.