Economists are divided in their opinion of International Monetary Fund’s (IMF) recommendation last month to Saudi Arabia’s authorities to consider raising the value-added-tax (VAT) rate from the current 5 percent.

While some economists argued that any hike would impede the drive to stimulate the private sector and risk higher unemployment, others believed the increase is sorely needed and any resultant cost would be short-lived, until the economy makes the required adjustments.

In addition, as oil prices show an upward potential, some analysts said that it would be possible for the government to meet fiscal balance targets without recourse to higher taxes. However, others noted that it is the right time to increase alternative sources of revenue to counter depleting financial reserves.

The IMF country note on Saudi Arabia released last month said: “The introduction of the VAT 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.” Read more here:

 “I do not think that Saudi Arabia will implement this recommendation and raise its VAT rate, at least until the end of the current transformation program 2020 for several economic reasons,” Salem Al-Zammam, the founder of economic consultancy firm Saudi Scope, told Zawya.

According to him, the Kingdom has revised the timeline to achieve the Fiscal Balance Programme from 2020 to 2023 as there has been a delay in increasing non-oil revenue sources.

“Saudi has also launched several stimulus programs for the private sector, and raising VAT again will inevitably raise the costs of doing business which may impede the success of this stimulus,” he said in emailed comments.

“In addition to that, the savings levels in Saudi households are negative, according to the latest survey by the General Authority for Statistics, and one of the objectives of the economic transformation program is to raise it to levels of about 5 percent. Hiking the value added tax now would obstruct this target.”

Al Zammam said the improved and more stable oil prices can help achieve the objectives of the fiscal balance program without the need to raise VAT.

However, Cyril Widdershoven, an economics partner at Verocy, a consultancy firm advising on investment risks in the Middle East, said that with oil prices expected to be reasonably high and showing an upward potential, it is time to increase non-oil government revenues.

“There is no excuse not to do so, as higher deficits will be eating into future revenues and financial reserves,” he told Zawya.

Meanwhile, Saudi Arabia’s general reserves have more than halved in the past four years to $132.2 billion at the end of 2018, from almost $358 billion at the end of 2014, according to Saudi Arabian Monetary Authority’s (SAMA) annual statistics. Read more here:

Also, earlier this month the Saudi central bank warned that a slowdown in world economy could place pressure on Saudi economic growth as it may impact global oil market. More than 63 percent of Saudi government revenues come from oil which accounts for around 45 percent of its GDP. Read more here:

Recovery after austerity

For Fayez Al Rabea, a Saudi economic consultant, raising VAT in Saudi Arabia at this time would add a major negative consequence—a higher jobless rate.

“After Saudi first imposed taxes, raised fees on expat workers and removed subsidies, the economy slowed down. Many businesses exited the market and the purchasing power of Saudis and expats weakened,” Al Rabea told Zawya.

“If the economy is in a state of imbalance or a slowdown, and it is not stimulated by tax cuts and increased spending, unemployment would rise, which I see as one of the worst economic implications,” he said in emailed comments.

Saudi Arabia’s unemployment rate hit the highest level recorded since 1999 in the first quarter of last year at 12.9 percent. The jobless rate showed a slight improvement in the first quarter of this year to 12.5 percent from 12.7 percent in the fourth quarter of last year, according to the latest figures released by the General Authority for Statistics. Read more here:

But overall the Saudi economy witnessed an economic recovery last year growing by 2.2 percent, after contracting by 0.7 percent in 2017, SAMA said in a report. According to it, the economy is expected to pick up further in 2019.

While the non-oil sector only showed a slight improvement last year with a 1.7 percent growth in comparison to 1 percent in 2017, non-oil revenues rose 90 percent in 2018 from a year earlier, with taxes accounting for more than half of it. Overall, government revenues increased by 30 percent in 2018 from the previous year.

Verocy’s Widdershoven sees that the IMF’s call for higher VAT levels as a normal and prudent approach towards fiscal austerity and a move to reduce overall government budget deficits.

“Austerity is needed to counter an expected 7 percent budget deficit this year, and possible harsher financial constraints due to a possible oil price slump. Though the latter should not really be expected during 2019, as demand for OPEC crude is high, and will increase ever further, pushing up price levels during summer and later on,” he told Zawya.

“VAT in the region is still extremely low. By increasing VAT, consumers will be enticed to substitute or change their consumer behavior, without taking out in reality the total from the economy. VAT is part of a redistribution of costs, which is also not put totally on clients/consumers, but will be partly taken on as direct costs for producers or trade,” he said.

“VAT is needed between levels of 6 to 12 percent on consumer goods which is very feasible and applicable, and not high at all at a global level,” he added.

Al Zammam also agrees that the current VAT rate of 5 percent in the kingdom is below the global average of almost 12 percent, and that the contribution of its revenues to the GDP in the Gulf countries, including Saudi Arabia, does not exceed 1.6 percent, while the global average is at about 7.5 percent.

On the other hand, Saudi Scope’s founder argues that a fiscal policy that resorts to taxes to mobilize revenues is more compatible with countries that have invested all of their economic resources.

“But Saudi Arabia and most of the Gulf countries have not yet reached this stage of full economic maturity by investing their resources. For instance, the kingdom’s privatization drive in its several sectors is still at early stages and increasing its composition in the country’s GDP will contribute to revenue diversification without resorting to taxes in general,” Al Zammam said.

According to Widdershoven the criticism that VAT will have a direct negative effect on consumer behavior in general has not been proven to be right in the Western world.

“Some direct short-term effects are reported, but mid-term behavior shows either substitution or a reemerging of the same behavior. Costs are short-term effects, and not long-term as the economy adjusts,” he said.

“The main mistake that is being made in GCC, and in Saudi Arabia, is that when costs or VAT is introduced on consumer goods, the government redistributes part of the new income to alleviate the cost increase. The main message for all should be that VAT is being introduced to increase government budget, lower deficits, and to change behavior,” he said.

“The so-called Saudi austerity is in the eyes of the beholder. When you are used to pay very small amounts for consumer goods or energy, any increase is felt as being harsh. VAT is seen as the same,” he added.

Expanding tax base

Last month, Saudi Arabia announced expanding its excise tax in what is seen as part of measures to boost its non-oil revenues. The tax authority introduced a 100 percent tax on electronic cigarettes and 50 percent tax on sugary drinks. These new taxes fall under selective taxes on harmful products and were preceded by a 100 percent tax on tobacco, 100 percent on energy drinks and 50 percent on fizzy drinks that were imposed back in 2017.

“If targeting especially consumer goods such as cigarettes, high-sugar and energy drinks, the positive effects of a tax increase on the government budget will be significant. Not only financial direct results will be positive on the mid- and long term, it will also positively affect government expenditure on welfare and health,” Widdershoven said.

“By removing the currently still low costs of food, energy and sugary drinks, the government will also free up some additional cash, as lower energy usage in the Kingdom will relieve additional barrels of crude oil for exports or downstream petroleum products exports,” he added.

According to the IMF, economic reforms in Saudi Arabia have started to pay off, with positive results such the pick-up in non-oil growth, rise in female participation in the labor market, as well as reduction in gasoline and electricity consumption after energy price reform.

The fund projects non-oil sector to grow by 2.9 percent in 2019, up from 2.1 percent in 2018), due to the private sector’s structural reforms and the increased government spending. This year, the Saudi government allocated a budget spending 1.1 trillion Saudi riyals ($293.3 billion), the highest in the kingdom’s history. Read more here:

(Reporting by Nada Al Rifai; Editing by Brinda Darasha)


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