How Will an Increase in VAT Affect the Saudi Economy?

Published May 18th, 2019 - 08:00 GMT
The risk of a VAT increase is that it could set this recovery back even before it properly gets started.
The risk of a VAT increase is that it could set this recovery back even before it properly gets started. (Shutterstock)
Highlights
Essentially, the economic strategists of Saudi Arabia have to weigh whether now would be the right time to raise VAT.

The “school inspectors” from the International Monetary Fund have issued their preliminary findings on the Saudi Arabian economy, and have given the Kingdom a mark somewhere in between an A-minus and B-plus. Good progress this year, but more work needs to be done, keep it up. That was the basic message of the Article IV mission statement issued on Wednesday.

{"preview_thumbnail":"https://cdn.flowplayer.com/6684a05f-6468-4ecd-87d5-a748773282a3/i/v-i-d…","video_id":"d73f03ae-126f-43a3-9700-46ece1f6bc90","player_id":"8ca46225-42a2-4245-9c20-7850ae937431","provider":"flowplayer","video":"10 Most Expensive Arab Countries To Live In, 2019"}

The macro-message was that the reforms launched three years ago under the Vision 2030 strategy have begun to bear tangible fruit. On a whole range of indicators, from non-oil growth, through energy price reform, to capital market efficiency, the ambitious plans are beginning to pay off.

But greater effort is required in some subjects, especially on the fiscal side of the curriculum. Government spending has increased, which could be an issue if oil prices decline. “The economic footprint of the public sector is still large,” said the IMF inspectors, and paying for that big state role risks eating into the huge financial reserves the Kingdom has built up over decades of oil exporting.

In this context, the IMF came out with the most eye-catching line of the whole report: “The introduction of the VAT (valued added tax) has been very successful, and consideration should be given to raising the rate from 5 percent, which is low by global standards, in consultation with other GCC countries.”

On one level, this is a fairly predictable bit of advice from the IMF, which has over the years consistently advised tax rises and spending cuts. But in the context of the Kingdom’s current economic development, the idea of an increase in VAT presents policymakers with some tricky decisions.

Essentially, the economic strategists of Saudi Arabia have to weigh whether now would be the right time to raise VAT. Would the fiscal benefits of an increase outweigh the potential economic downside?

The “school inspectors” from the International Monetary Fund have issued their preliminary findings on the Saudi Arabian economy, and have given the Kingdom a mark somewhere in between an A-minus and B-plus. Good progress this year, but more work needs to be done, keep it up.

Frank Kane

The fiscal side of the equation is important for the IMF, which always likes to see the books as close as possible to balanced. The Kingdom recently announced its first quarterly budget surplus since 2014, which was a very positive step despite the presence of a large one-off dividend in the first quarter figures.

Nonetheless, the IMF still projects that the budget deficit will be about 7 percent of GDP this year — substantially higher than government forecasts. The Kingdom remains committed to eliminating the deficit altogether by 2023, so any help toward this goal — for example from a higher VAT contribution — makes sound fiscal sense.

Leaving aside the vagaries of the oil markets (the IMF assumes Saudi Arabia will produce 10.2 million barrels of oil per day at an average of $65.5 per barrel) there is still a lot to do to reach fiscal parity in just over four years from now.

Toward this end, the IMF also recommends the further elimination of energy subsidies, more (but gradual) increases in fees on expat workers, the scrapping of cost-of-living allowances when they expire at the end of this year, as well as a general reduction in the government wage bill.

All these measures may sound desirable from a fiscally-aware economist’s view, but they have a very real impact on the standard of living of Saudi citizens and on expat workers in the Kingdom. There is a renewed awareness of the need for foreign expertise in Saudi Arabia, as evidenced by the recent “green card” proposals.

On top of all these cuts, increasing the VAT rate could have seriously detrimental effects. The consumer economy is only just getting over the hit it took from the imposition of a 5 percent tax in 2018, with retailers and credit card companies reporting an appreciable, if gentle, increase in footfall and spending earlier this year.

The risk of a VAT increase is that it could set this recovery back even before it properly gets started. After several years of relative austerity, Saudi consumers are unlikely to respond well to calls for further sacrifice on this front.

These are the issues Saudi policymakers will have to weigh as they consider the IMF’s suggestions regarding VAT. They will compare notes with their counterparts in the UAE, who have similar experience of the negative effects of VAT on their vital consumer economy. On balance, they might both be wise to politely ignore the IMF’s teaching — at least for the time being.

By Frank Kane

The views and opinions expressed in this article are those of the author and do not necessarily reflect the views and opinions of Al Bawaba Business or its affiliates.


Copyright: Arab News © 2021 All rights reserved.

You may also like