Introduction of VAT in UAE and Gulf region 'likely to hit economic growth'

Value added tax (VAT) will bring in around $6.5 billion to the UAE’s coffers, but will likely hit the Gulf’s economic growth, economists said.

Gulf ministers this week signalled agreement on a 5 per cent tax on consumption to be introduced across the region by 1 January 2019.

The UAE’s finances have been hit as the oil price, on which the government depends for more than 60 per cent of revenues, scrapes 12-year lows. That has led the government to cut public spending by more than 20 per cent – and look to new taxes – as it attempts to close a budget deficit expected to swell to double digits this year.

Simon Williams, HSBC’s chief economist for the Middle East, Africa and Central Europe, said: “I think it’s inevitable that this takes place. Non-oil receipts will have to increase given the fiscal strain that the GCC is facing. It’s encouraging that we’re going to see some action being taken.”

But he and others worried that new taxes would contribute to the Gulf’s economic slowdown.

“It will add to the fiscal squeeze, whether you’re cutting spending or raising taxes, and it will reduce the fiscal impulse to growth,” Mr Williams said.

Christian Haefke, professor of economics at New York University Abu Dhabi, said that the timing of the new tax would be critical. “I am somewhat afraid that right now we are moving into a slowdown in global activity – and that in 2018, VAT may come at a time when we are in recession,” he said.

With growth slowing in the UAE’s major trade partners – China, India and the remainder of the GCC – the new tax could hit growth just when the country is most vulnerable.

“Depending on how quickly the next recession occurs, [the introduction of VAT] will either be horrible, or if it occurs during the next boom, it should be good news as it slows down an overheating economy,” Professor Haefke said.

What will VAT mean for you in the UAE?

Alp Eke, senior economist at the National Bank of Abu Dhabi, worried that VAT could make the Gulf less attractive for foreign companies.

“VAT levied at any rate will reduce the competitiveness of GCC economies. One of the main pillars of the GCC’s competitiveness and strong appeal to international investors is it’s a ‘tax free’ business-friendly environment, which makes it a very attractive place to do business,” he said.

“Moving away from this would likely have a negative impact on sentiment towards the GCC in this context.”

But HSBC’s Mr Williams disagreed with this assessment. “The region will remain a very low tax environment,” he said. “What will be more of an issue isn’t the tax rate, but the slowdown in economic growth, and in the demand for expatriates associated with that – and there might be a drop in wages too.”

Major technical challenges would have to be overcome if the Gulf were to implement the tax collection system across the region, Mr Eke said.

“The mechanics of the system and administration involved are very extensive indeed. Virtually all businesses – from large corporates to SMEs and small family businesses – would need to be educated in terms of how to apply the levy, and more importantly how to submit the filings regularly to the government.”

Saudi Arabia, Oman and Bahrain would be “more sensitive to VAT and reductions in consumer expenditure”, while the UAE and Qatar, with smaller budget deficits, would be “more resilient”, he said.

But the tax could bring in up to $6.5bn by 2019, he estimates – equivalent to 1.5 per cent of the UAE’s GDP.

VAT would help the government produce more accurate and regular economic data, Professor Haefke said. “Through VAT, policymakers will have much better ways of measuring economic activity because they will have more real-time insights into economic activity.”

Monica Malik, chief economist at Abu Dhabi Commercial Bank, said that the staggered introduction of VAT would help the country close its fiscal deficits gradually, without hurting the country’s competitiveness.

“A rate of 5 per cent looks to balance increasing government revenue, while also limiting the impact on economic growth and competitiveness,” she said. “The introduction of VAT will likely particularly benefit the UAE, where much of the consumption is from tourists.”

Christine Lagarde, the managing director of the IMF, visited the UAE this week, bringing with her a clear message: the Gulf needs new taxes.

To Ms Lagarde, the situation is clear. The UAE has been blessed with oil reserves but its season of plenty is now at an end, and it must raise taxes to plug the gap. “It’s as simple as that,” she said.

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