The Gulf Cooperation Council (GCC) countries currently have a single market with a common external tariff of five percent. The introduction of a value-added tax (VAT) in Bahrain, Saudi Arabia, and the UAE under the GCC framework significantly expands the fiscal flexibility enjoyed by the governments. As a result, the Gulf countries should work toward eliminating customs taxes, switching exclusively to VAT. The primary benefit will be in opening markets for the Gulf countries’ new non-oil exports as they implement their economic visions.
The GCC countries are in a unique position of having customs taxes that exist exclusively to generate revenue. Owing to the desert climate, the Gulf economies manufacture very little beyond petrochemicals, relying on imports for an overwhelming percentage of the goods that people consume locally – even in spite of the customs tax. This distinguishes them from most other countries, which use tariffs to protect domestic industries from foreign competition, especially in cases where maintaining a local production capacity contributes to national security, such as US President Donald Trump’s recent aluminum and steel tariffs or the European Union’s long-standing agricultural tariffs. When it comes to the GCC, however, the tariff does not protect any industry, as there is no industry to protect.
With this in mind, shifting away from customs taxes and toward VAT will help the GCC countries boost their exports, as it will help convince other countries to decrease the tariffs that they impose on GCC goods. While there is a vigorous debate about whether or not tariffs help the country imposing them, there is a consensus among experts and policymakers that a country definitely wants other countries to refrain from imposing tariffs on its own goods. This is because having tariffs imposed on your exports decreases their competitiveness, and limits the ability of your exports to create jobs and grow your economy.
The Gulf countries are basing their economic strategies on the goal of diversifying their economies, especially their manufacturing and their exports, in sectors where they have historically had total dependence on imports, such as military hardware or renewable energy components. This means that decreasing customs taxes can be used as a way of negotiating lower tariffs on GCC exports, opening new markets for them.
Since the imposition of VAT, the GCC governments have a ready-made alternative for generating tax revenues. Moreover, decreasing customs taxes and increasing VAT in a compensatory matter leaves consumer prices more or less constant, meaning that consumers won’t notice the difference. And since VAT does not apply to a country’s exports, it will not adversely affect the Gulf countries’ export competitiveness.
Governments levy taxes for a number of reasons: To generate revenue, as in the case of VAT, to influence behavior, as in the case of excise duties on cigarettes or sugary drinks, or for a combination of the two, as in the case of energy taxes. Why were customs taxes previously the favored choice for revenue generation in the GCC? Historically, the GCC countries have deployed a very narrow range of tax instruments, because levying some taxes such as capital gains tax is administratively complex, while levying others such as income tax presents socio-economic challenges. The glut of oil revenues allowed them to largely circumvent these quandaries, and the convenience of a customs tax made it a sensible way of diversifying fiscal revenues.
Did the five percent customs tax – which was pretty average by global standards – mean limiting access to foreign energy markets? It didn’t really matter, because the Gulf countries have literally the lowest-cost oil in the world, meaning that they were always very competitive globally regardless of any tariffs imposed upon their imports. More importantly, energy markets are strategically so important that countries choose what tariffs to impose on imports based on specific and separate criteria.
The 2019 version of the Gulf economies is very different to the 1970 version, however, and the time has come to consider wholesale changes. Yet there are some caveats to keep in mind. VAT applies much more widely than customs taxes, typically levied on all almost all local and foreign goods and services rather than only foreign goods. To ensure that any adjustment is truly neutral, VAT may need to be increased selectively, with an emphasis on goods.
Moreover, tourism is an unusual commodity in that it is a service export that does have VAT levied upon it, because it is an export that is consumed domestically. When a tourist purchases a restaurant meal, for example, they pay VAT on that meal. And it happens to be important to the Gulf countries’ economic visions, especially Saudi Arabia’s goal of expanding religious tourism. This further underlines the need for intelligent adjustments to VAT to ensure that the increased revenue does not come at the expense of central strategic targets. In fact, cognizant of this, the UAE already has a system in place for tourists to reclaim VAT on their purchases.
In a 2018 interview with Time magazine, Crown Prince Muhammad bin Salman emphasized the importance of developing non-oil exports to Saudi Arabia’s economic future. Shifting away from customs taxes can play a small but significant role in opening new markets. And at a time when the international world order seems to be disintegrating, the Gulf countries have an extra incentive to cultivate and build upon their reputation as being constructive members of the global community. One way to do that is to be seen as being pro-free trade.
Omar Al-Ubaydli (@omareconomics) is a researcher at Derasat, Bahrain.
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