How VAT, or its absence, can help the post-Covid economy

In times of economic downturns, reforming the VAT system by reducing or withdrawing it – at least temporarily – is the approach exercised by developed countries

  

Businesses and enterprises the world over have been hard hit by the Covid-19 pandemic. Since the outbreak, the United Arab Emirates has taken a series of measures to help alleviate the fallout on the economy. For businesses in the country, the hefty stimulus packages announced in 2020 amounted to hundreds of billions of dirhams, did away with many government service charges and offered discounts on utility and running expenses.

This is the right approach indeed. Any manner of extra charges should be done away with during times of crisis, as businesses and entrepreneurs – that are the lifeblood of any economy – must not be drowned in the burden of taxes and VAT as they are already enduring the worst of the downswing. Those facing losses in the current climate should be able to deduct the losses against profits when the situation improves and not be dragged down by taxes.

However, for many local firms and homegrown enterprises, the effects of a few months of closure during the national sanitisation programme took its toll, with some being forced to shutter altogether and others curtail their scale of operations or staff to keep up and running.

In normal times, the Value Added Tax (VAT) works as a vital tool in boosting economic activity and keeping the wheels of the market turning by passing on the consumption tax at each stage of the supply chain from production to the end consumer. While I do not, in principle, agree with the essenceof VAT, it is a “necessary evil” – if you may call it that – due to the above reason.

But in times of economic downturns, reforming the VAT system by reducing or withdrawing it – at least temporarily – is the approach exercised by developed countries with sound economic structures in place. It is one of the key ways governments can turn to their advantage to support the different economic sectors and help restore normal business activities until the virus outbreak is fully dealt with.

A temporary cut in VAT rates, at least for a few months for up to over a year, can significantly stimulate consumer demand, especially when implemented in focus sectors such as food, hospitality and tourism. This interim measure even suitably bears a name – “shovel-ready” – one that is easy to implement quickly.

This works by injecting a short-term boost to the economy by leaving more disposable income in the hands of the people to spend, thanks to no VAT. This is called the “income effect”. This has the positive effect of offering an incentive to customers to bring forward the purchases they are considering instead of postponing them – in what is called the “substitution effect” – because they can take advantage of the temporary lower prices at the moment.

Effects

The aforementioned income and substitution effects of VAT cuts work together by resulting in a multiplier effect. Because people are inclined to spend more and turn out greater purchases, this directly leads to more products, work or services required from the businesses offering those outputs, which of course leads to more job creation, employment, and earnings all around, which again leads to more spending in a positive cycle. Anyone can naturally see why this would be advantageous in a situation where the employment market is still getting back on its feet after the debacle that was 2020.

A temporary VAT cut can work effectively, especially when companies and services can cater to the additional demand for their products or services (due to reduced prices). As seen in many places around the world, including Dubai and London, in the event of the lifting of lockdowns or movement restrictions, buyers have returned in a frenzy of “revenge buying” to compensate for the perceived loss of control over their consumer choices and shopping habits during the period of restrictions. In this manner, VAT cuts and the already-in-place stimulus packages can work well together, helping boost the economy affected by the prolonged pandemic.

But governments should not wait any more to assess conditions to consider implementing VAT cuts. Because if the cuts are indeed brought into force, its timing must also be planned in a way that the end of the cut’s period coincides with the natural upswing in the economic cycle.

Compared to other forms of stimulus, a VAT cut can be quickly implementedand can be used to get demand going after social distancing and restriction measures begin to ease or are completely removed at some point in the future. There is also evidence from the past to prove that VAT has indeed helped bring consumer spending back to normal – during the 2008-2009 crisis that affected the whole world, this measure helped rectify the consumer and retail spend situation in some countries. The report titled “The stimulus effect of the 2008 UK temporary VAT cut” by the Institute for Fiscal Studies cites that the temporary VAT cut in place from December 2008 to December 2009 led to a substantial reduction in consumer prices and succeeded in boosting consumer sentiment and retail sales.

If the UK and some European nations – some of the wealthiest, most industrialised and evolved markets in the world – can thrive with a VAT reduction policy in place, other countries like ours would do well to follow their tried-and-tested methods for the betterment of our economies.

All said, lifting some of the financial pain being faced by both businesses and end consumers currently could only lead, in the long run, to economic gain. Certain market pundits may even claim increasing VAT may be the way to go in order to strengthen the economy. As the Arabic saying goes: “Those with their hands in the fire are not the same as the ones with their hands in the water.” But In real-time economy, those with boots on the ground – namely people operating daily businesses or the ones with the proverbial “hands in the fire” – will tell you otherwise regarding VAT, or else they are left to bear the brunt of bigger burdens and pass it on to the consumers, paralysing the people and encouraging a recession.

The UAE also put in place other financial assistance measures last year, such as the targeted economic support scheme to provide temporary relief in interest payments of outstanding loans for all private sector companies affected by Covid-19 and the AED 100 billion fund distributed with zero per cent interest for banks. Through this allocation, the UAE Central Bank directed the banks to provide temporary relief to their corporate and retail clients by deferring loan payments and extending existing facilities, which worked out to be a boon for the private sector.

Other steps included freezing market fees, reduction on utility bills and other fees, suspension of registration fees and many other exemptions, bringing the total stimulus packages in the Emirates to AED 395 billion. Expediting such measures on time displayed the UAE’s preparedness and an overarching concern for the welfare of its corporate sector in times of crisis.

In the West, many countries rolled out generous furlough subsidy programmes, with examples such as Austria and Hungary paying both employee salaries and part of the expected incomes to businesses affected by Covid-19.Austria rolled out support measures to sectors heavily affected by the pandemic, such as tourism. A €100 million loan package was available for hotels that suffered more than 15 per cent in sales. The Hungarian government undertook to subsidise 70 per cent of even private sector employees’ unpaid salaries. The state even reimbursed hotels 80 per cent of the reservations made for October and November 2020, provided all employees were retained for the hotel sector. For restaurants and leisure facilities, the state covered half the employees’ salaries.

The UK government allowed for VAT payments due between March 20 and June 30 to be deferred at the taxpayer’s option, with the deferred amounts to be paid by March 31, 2021. As part of its economic stimulus measures, the government rolled out the Coronavirus Business Interruption Loan Scheme (CBILS). This enabled UK businesses to borrow up interest-free loans for 12 months based on their turnover, with the government guaranteeing the lender banks 80 per cent of each loan and covering the cost of the first 12 months of interest. The UK government also paid the wages of employees unable to work due to the pandemic, giving up to 80 per cent of staff salaries if their employers retained them, and covering wages of up to £2,500 a month. This radical move protected millions of people from being laid off due to the crisis.

The US has kept up its policy of paying out monthly unemployment cheques to those out of a job. While such measures may not be practical in countries where income tax is not levied, governments can still aid their local economies and the private sector by taking the pressure of sales tax or VAT off businesses and end consumers. After all, if the pandemic has taught us something, it is that we all need to help each other and work hand in hand to see us through a crisis.

By Khalaf Ahmad Al Habtoor - UAE Businessman

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