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Feb 27 2013

Why Kuwait needs a long-term fiscal reform process

By Nada Al Rifai of Zawya Why Kuwait needs a long-term fiscal reform process

In late January 2013, the Kuwaiti government announced plans to submit a draft law that stipulates imposing value added tax (VAT) for the first time in Kuwait. There's also been a proposal to amend a 1995 law that bans imposing public services charges without a passed law by the Assembly.

This highly controversial issue of introducing taxes was raised several times, and previous national assemblies had rejected attempts to introduce such laws in the past. However, the policymaking landscape in the country has witnessed a lot of changes over the recent years with repeated government resignations and the elections of February 2012.

For 13 years in a row, Kuwait has posted fiscal surpluses, indicating strong macroeconomic outcomes and large fiscal buffers.

However, challenges to create economic base diversification to drive the country away from oil dependency are still significant. Introducing VAT and income tax would contribute to building a more balanced economic structure and stronger economic pillars.


Risks

By 2017, Kuwait's oil revenues will be exhausted by government expenditure, according to IMF estimates.



Kuwait also still faces external risks from the European crisis where any worse developments could lead to lower global oil demand and prices. This in turn would significantly lower the country's fiscal revenues and affect its financial reserves which have long served as a cushion against crises.

Moreover, government expenditures, especially the wage bills, have witnessed sharp growth in recent years. In fact, over the last six years, the average growth rate of the public sector wage bill has more than doubled, according to IMF estimates. This demands considering multiple revenue options.


"Many Middle Eastern governments that felt a little panic from recent development in the Arab world decided to raise their social spending as a measure to keep away the unrest. As such, governments, including Kuwait, have opted for inflationary policies," Dr. Fereydoun Barkeshli, senior adviser on international affairs at the Institute for International Economic Studies, told Zawya.

"Rising public sector wage and pension costs and rapid population growth are expected to exert pressures on public finances in the medium term," the IMF notes.

Dr. Barkeshli begs to differ. Kuwait's major obstacle will not really stem from population growth but from welfare policies, according to him.

"I personally do not see the population factor as a major reason for the drastic government budget squeeze. Population and the rate of population growth in Kuwait may not greatly contribute to a need and criteria for Kuwait's financial reshuffling and change of financial and fiscal policies. Population growth may not be a sufficient reason for a drastic change of fiscal and financial policies by the government. This stands true with all oil rich low population countries including Qatar, the United Arab Emirate or Oman," Dr. Barkeshli said.

The retirement age in Kuwait is also relatively low. This exerts additional pressure on the government in the form of a pension system.

For 2013, Kuwait's real GDP growth is set to reach 3.2%, according to National Bank of Kuwait forecasts. But the bank predicts that Kuwait's oil production would stabilize over the next two years, which renders the same constant oil revenues, while a rise in spending is expected at the same time. This combination would lower the country's surplus to below 20% of its GDP, according to the bank's estimates.

The Economist Intelligence Unit also predicts slower oil production and exports, which would slow real GDP growth to 4.6% in 2013.

In light of these circumstances, there's a pressing need for a wide fiscal reform in order to correct the economy's imbalances.


Fiscal Reform

The proposal to introduce VAT and income tax is considered a significant step in the medium-to long-term fiscal reform process.

Although the direct impact of introducing the proposed 5% VAT on the government revenues is modest over the short term (an increase of 2%-3% of GDP according to IMF estimates), the real impact would be felt over the long term.

With Kuwait's ambitious development plan setting the pace for a strategic long-term vision, the country's non-oil sector is expected to expand. This would increase the impact of VAT on government revenues, which would rise progressively in parallel with that expansion.

"With a pro-government parliament now in place, there is a chance that progress on economic development may pick up as a less obstructionist legislature allows government initiatives through," the EIU states in its latest report on Kuwait.

However, the think tank predicts that the ongoing political turbulence and structural constraints would result in further delays to implementing the USD 104 billion 2010-14 Development Plan.

Better fiscal management also entails reallocating more funds towards capital expenditure, which fosters growth for the country's non-oil GDP.


Conclusion

Many analysts agree that the deeply embedded welfare mentality in Kuwait needs to go, if the oil-rich state is to preserve wealth for future generations. Introducing value-added and income tax is only one step forward on a wide but necessary fiscal reform process.

"The welfare policy based on the current cradle-to-grave arc demands a modern structural change in government monetary policies. The accent has to be on a self-sustaining long-term policy that should help Kuwait get back to be the powerhouse of the region - a powerhouse that it was before the invasion," said Dr. Barkeshli.

"Kuwait was the first country in the region to become globalized, before the UAE did. Kuwait needs to get back to the world in a big way."



© Zawya 2013

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