Recent history in the UAE has seen hundreds of thousands of expatriate workers, tourists and foreign businesses flock to cities like Dubai and Abu Dhabi, with the surging economy offering well-paying jobs and phenomenal business opportunities, while the absence of income or sales tax has made working and shopping in the Emirates exceptionally attractive.
The honeymoon of this “tax haven” is set to end soon though — as early as the beginning of 2009 — with the implementation of the government’s proposed value added tax, or VAT. Although Abu Dhabi has been conducting studies concerning this for several years, there was a recent announcement that Dubai Customs — the department responsible for instituting the VAT — is aiming to have all the necessary infrastructure in place by the end of 2008, ready for the government to implement the proposed levy of 3-5% soon after.
The stated aim of the tax is to begin the process of diversifying government revenues away from the current heavy dependence on energy resources. However, with 40% of the UAE’s GDP directly dependent on oil and gas output — some estimates put earnings-per-day at $225 million — it would seem the possible revenue gain through VAT would be relatively insignificant in comparison. This begs the question: how effective can this attempt at revenue diversification be?
“I think it [VAT,] will be very small compared to oil revenues, but nonetheless it is very important to introduce these taxes just so that you have increased revenue sources,” said Monica Malik, director of economics at EFG Hermes investment bank in Dubai.
Diversifying revenue
Mohsin Khan, director of the International Monetary Fund’s (IMF) Middle East and Central Asia Department agreed that, regardless of the amount of income government earns from VAT, simply having an alternative energy resources is essential. He remarked that, “The VAT revenue [will be] dwarfed by the oil revenue, but the important thing is to have a stream of revenue that is independent of oil and gas.”
Khan pointed out that the IMF has recommended the VAT be implemented in coordination with other governments in the Gulf Cooperation Council (GCC). “This is because the VAT should be seen in the context of establishing a single, unified market comprising all the GCC countries,” he explained. “The introduction of a tax that does not discriminate against trade in the context of removal of borders is an important element in the development of a single market.”
As it stands, however, the UAE looks to be well ahead of other GCC members in bringing in VAT, and in so doing is garnering much criticism from those who say the timing could not be more inopportune, with the Emirates having endured an average of 11% percent inflation through 2007 and as of yet no sign of relief in 2008.
Inflation paints a somewhat vexing problem for policy makers in the UAE though, as upward price pressures are being fuelled by roaring demand for housing and property, the global increase in food prices and the sinking value of the American dollar, to which the UAE’s dirham is pegged. The dollar peg
also strips monetary policy control from the UAE’s central bank and thus removes the standard option governments use to control inflation — raising interest rates. Price controls typically offer only temporary relief and can have damaging distortive effects on the economy, while fiscal restraint to curb inflation isn’t plausible given the massive infrastructure projects the UAE is undertaking. According to Khan, “The bottom line is that it may be necessary to tolerate a somewhat higher inflation rate in the short term, and focus on bringing inflation down in the medium term.”
In this context the new VAT would only be adding to these inflation woes, at least in the short term according to the IMF, which has stated that it expects VAT to cause a one-off jump in inflation of 1-2% during the first year, but that the tax would not cause permanently higher inflation.
VAT impact disputed
Dubai Customs has been quick to dismiss the IMF’s forecast however, claiming that any price increases resulting from the VAT will be offset by the planned cuts to customs duties on imported products — undertaken as part of the obligations the UAE has assumed for itself through signing on to international trade agreements, including with the US and European Union (EU).
“VAT is going to replace the current customs duties amounting to five percent,” said Abdulrahman al-Saleh, executive director of corporate support sector at Dubai Customs, in comments made in May. “Thereby it is expected to support the price level and mitigate the rise of the inflation rate.”
However Malik said it is too early to tell what the impacts might be, as it is yet to be determined which products will subjected to the new tax. “If there are a number of goods that are exempt from the customs [duties] and then would have VAT [imposed on them], then that would have a greater inflationary impact. But these all depend on which ones are going to have the VAT put on and which ones aren’t, so a lot of these questions will come out later on.”
She added that by international standards, the UAE’s proposed VAT rate is very low — internationally, for example, VAT rates are typically between 15-20%. Malik also pointed out that even though Dubai has been raising the cost of some government services — such as electricity, water and road tolls — “the fact that you don’t have income tax means you will still be very attractive for expatriates to come in and live here.”
141 nations currently collect some form of VAT, including almost all first world economies — bar the US — and as Mohsin Khan remarked, “The GCC is the only major region … that does not have a VAT. It is perfectly normal for an economy to have a tax based on turnover in the private sector. And it gives you a chance to get rid of elements that are negative for business, such as local fees and charges.”
Thus, while the timing of VAT implementation in the UAE could be open to criticism due to inflationary worries, if the Emirates are truly going to earn their place in the modern global economy, the government ought to have diversified revenue streams and a refined taxation system comparable to any of the world’s most advanced. Properly implementing VAT would go a long way in this regard.
