By TBY | UAE | Sep 13, 2017
History will look back on the current period as the end an era of government dependency on oil wealth, and by that hand the end of the Gulf as a global tax haven.
Since the steep drop in oil prices in 2014, the UAE and other countries in the GCC have had to face the reality that revenue from petroleum can no longer sustain the national economy. This is not to say that the UAE has been caught unaware. There has been a long-term push to diversify the economy with strategic initiatives like Abu Dhabi’s Economic Vision 2030, which serves as a roadmap for pulling the private sector into alignment with the long-term goals of the Emirate. Despite these efforts, the UAE needs a new source of revenue to finance its budget, thus 2018 will mark a pivotal point in the country’s history with the new 5% VAT being implemented on January 1, 2018.
The decision to implement a VAT in tandem with other GCC states comes after several organizations, including the IMF, raised flags over the capacity for oil rents to cover the budget deficit since oil prices began to slide in 2014. The MENA region has been hit hard by the price drop, with these countries collectively losing USD340 billion in oil revenue in 2015, accounting for 20% of the region’s GDP. The UAE in particular has seen a drop in government revenue from oil, slipping from 41% of GDP in 2013 to 29% of GDP in 2015. Despite this, the UAE maintains its provision of public services to nationals and expatriates alike, with state spending rising 4% during the same period. As such the Emirates are looking to the 5% VAT to finance the gap.
Government proponents see VAT as the right move for filling the void, as corporate tax is not on the agenda as many fear it would disincentivize businesses. This would be antithetical to the vision for a competitive and diversified economy that Abu Dhabi is so firmly committed to.
The UAE was ranked 12th in the world by the World Economic Forum’s Global Competitiveness Index, ahead of 22 EU members, with special recognition given for the excellent tax environment. The UAE is known for its zero direct tax policy, which will be unaffected by the VAT, an indirect tax.
Critics, however, argue that as a consumption tax it encourages saving over spending. This is significant for low-income earners that do not have the capacity to avoid the tax by reducing spending, often living paycheck to paycheck. These individuals end up paying a higher proportion of their income to the VAT. By comparison, high earners tend to spend far less than they earn, and are therefore taxed on a far smaller proportion of their income. In the face of vast income inequality in Abu Dhabi, this could become a contentious issue by aggravating the existing income gaps.
To combat this effect, the Ministry of Finance announced exemptions designed to protect low-income earners. The list of products and services that will not be eligible for the VAT includes 100 food items, mostly staple foods, as well as social services, healthcare, and education services.
As it stands, the expected revenue is optimistic, with the UAE set to collect more than any other GCC state implementing the tax. The Ministry of Financial Affairs expects the VAT to generate AED12 billion in the first year, accounting for 2.1% of GDP. This amount is expected to reach AED18 to 20 billion by the second year.
With the law coming to effect in 2018, the government is beginning to raise awareness, educating businesses and individuals on how to prepare to comply with the tax, and how to prepare for the effects of the policy. It is unclear whether this will serve as a solution to the revenue problem as the UAE steps away from the hydrocarbon economy; however, a VAT represents a solid first step in preparing for a future without oil.