Why IMF's tax and cut ideas are wrong for the UAE in era of low oil

Rather than being a harbinger of doom, as is often the case with visits by the IMF, Christine Lagarde’s arrival in the UAE this week was a recognition of the increasingly important role the country plays in the Middle East’s financial system.

Abu Dhabi and Dubai have become the two main hubs of the whole region, where bankers, financiers and international policymakers choose to do business.

But it’s undeniable her visit comes at a critical time for the UAE, as it grapples with the challenges posed by US$35 oil. If, as many economists believe, this is the beginning of a new era of lower oil prices, the UAE and the region have to rethink their whole economic strategy. It is a time for imaginative and innovative solutions.

What did Ms Lagarde offer? The two headline recommendations of her mission were: taxes and budget cuts. While they sound obvious and sensible proposals for a low-oil future, in fact they are riddled with difficulties for regional economies and societies.

It’s hard to avoid the suspicion that these are the standard IMF panaceas trotted out to any basket case of an economy, from South America to Africa, with little regard paid to the special circumstances of the Arabian Gulf.

Take taxes. It is generally recognised the traditional Gulf “rentier” model will have to be adapted in the new circumstances. Governments will have to find new sources of revenues when energy is so volatile. But to suggest a blunt programme of tax imposition – VAT, followed by extended corporation tax, with income tax coming inevitably after – is to underestimate the existential problems tax presents for the region.

The best economists of the GCC have been struggling with some form of VAT for years, and the wide-ranging effects it would have on consumer spending patterns. The jury is more or less decided that it will be introduced soon, although there is still much debate about the pot­entially harmful effects it would have on regional economies.

Extension of corporation tax and introduction of income tax present much bigger hurdles. The first threatens to destroy the competitive edge that attracts big global companies to choose the UAE as their regional headquarters and redraw local corporate balance sheets.

Imposing income tax would be an even more radical step, threatening the delicate “social contract” that makes the UAE such a good place to do business and the flow of talented people from all over the world. There was no discussion of these issues in the sweeping IMF statements this week.

Budgets cuts raise similarly far-reaching problems. It seems plain homespun common sense that you have to reduce your outgoings as energy income is reduced, but modern economists should have far more sophisticated techniques at their disposal.

A slash-and-burn approach to UAE government spending – with huge consequences for national employment, infrastructure investment and economic growth – creates more problems than it solves.

Maybe in her private discussions with UAE policymakers Ms Lagarde showed some greater awareness of the region’s very special economic circumstances. Maybe in time she’ll share it with the rest of us too.


Follow The National’s Business section on Twitter

Share This Post