Oil-producing countries are being forced to rethink their tax mix as oil prices remain low.
The oil-rich states of the Persian Gulf, long a byword for stupendous wealth and extravagance, are feeling an unfamiliar financial pinch.
The rivers of cash that once gushed into public coffers from their fuel exports have slowed to a trickle as oil prices have slumped.
Between 2014 and 2016 average crude oil prices tracked by the International Energy Agency (IEA) plummeted by almost 60 per cent in nominal terms, dropping to an average of US$41 a barrel last year – the lowest level since 2004, due to increased US production and the Organization of the Petroleum Exporting Countries’ (OPEC) failure to curb supply.
Oil prices unlikely to recover until 2020
Although oil has since regained some ground, reaching more than US$50 a barrel in March 2017, the IEA does not expect any significant recovery in global prices before at least 2020.
In the meantime, the governments of oil-rich countries have gaping holes in their budgets to fill.
According to the IEA, oil and gas export revenues for OPEC countries plunged from US$1.2 trillion to US$450 billion between 2012 and 2016, and industry investment fell by a quarter in 2015 and 2016.
The six member countries of the Gulf Cooperation Council (GCC) – Bahrain, Kuwait, Oman, Qatar, Saudi Arabia and the United Arab Emirates (UAE) – are among those hit hardest. Oil was providing between 50 and 90 per cent of their government revenues prior to 2014.
Oil revenue collapsed from almost 34 per cent of their GDP in 2014 to less than 22 per cent the following year.
Oil risk to revenue
The episode has highlighted the dangers for governments that rely so heavily on volatile commodity trade for their income.
Warnings were sounded almost a decade ago when the Global Financial Crisis (GFC) sent the oil price into a tailspin. At the time Dr AbdelAziz Aluwaisheg, then director of the GCC’s Economic Integration Department, said that oil revenue could not be “relied upon on a consistent basis”.
By that time the UAE, with the backing of the International Monetary Fund (IMF), had already been investigating the proposition of a GCC-wide value added tax (VAT).
The idea foundered as the oil price recovered, only to be revived in 2015 as prices hurtled down.
This time it stuck as the GCC faced the prospect that a combination of slowing growth in oil demand, a huge accumulation of oil reserves and sustained strong production would hold prices down for a prolonged time.
The IMF warned members that if they did not find alternate sources of revenue, their collective budget deficit gap would surge to 11 per cent of gross domestic product (GDP) in 2016 and still be more than 4 per cent five years later.
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The taxman cometh
The Gulf states have agreed to introduce a VAT, widely tipped to be set at a low rate of 5 per cent (the OECD average is 19.2 per cent), by 1 January 2018.
While VAT is a common tax measure – more than 160 countries operate such a scheme – it is a leap for countries such as the UAE and Saudi Arabia that do not have income taxes, and limit most corporate taxes to the oil and gas industry and foreign banks.
When the idea of a Gulf-wide VAT was first mooted in 2008, some warned of a backlash from consumers asked to dip directly into their own pockets for the first time to help pay for government services, while others fretted about the blow to the GCC’s image as a tax-free zone.
Analyst Sanyalaksna Manibandhu, head of research at NBAD (National Bank of Abu Dhabi) Securities thinks Gulf citizens will take the VAT in their stride.
“This is something that has been very well signposted,” Manibandhu says.
A low 5 per cent rate will foster acceptance, he adds.
Do value added taxes work?
International experience suggests the VAT is a worthwhile reform, even if the oil price recovers.
Oil-exporting Malaysia introduced a VAT in 2015, and its goods and services revenue virtually doubled the following year to 39 billion ringgit.
The indirect tax contribution to total revenue jumped from a fifth to a quarter – at a time when petroleum tax revenue plunged from 25.6 to 9.3 billion ringgit.
Similarly, gas-exporting Papua New Guinea, which has had a goods and services tax since 1999, saw its mining and petroleum tax revenue halve in 2016 (down to 92 million kina from 195.4 million kina), while its GST take increased from 1.2 to 1.4 billion kina.
Making tax count
Qatar became the first of the Gulf states to adopt the VAT when on May 3 its Council of Ministers formally approved the measure.
The value of the GCC’s VAT is, however, likely to be undercut by a range of carve-outs and exemptions.
Though at the time of writing Qatar was yet to detail how broadly its VAT would be applied, the agreement reached by the GCC allows member countries to exempt a wide range of products and activities including purchases of basic food, essential medicines, healthcare, education, residential property, transport, finance and insurance.
In addition exports, including oil and gas, can be zero-rated (that is, GST is not added to the export price and the producer can claim input tax credits).
Under the agreement, it will be mandatory for businesses with an annual turnover of more than US$100,300 to register for the VAT, but will be optional for smaller firms with a turnover of between US$50,150 and US$100,300.
The IMF believes the tax will deliver a significant boost to Gulf state finances. It estimates that a 5 per cent VAT will deliver between an extra 1.2 and 2.1 per cent of GDP in extra revenue – though it says GCC members should nonetheless consider an eventual move to a 10 per cent rate.
Professor Fariborz Moshirian, director of the Institute of Global Finance at University of New South Wales Business School, says the Gulf states could be making a mistake by setting the rate low because it will be hard to increase.
It also seems that the tax reform will not stop there.
Alongside a VAT, the GCC states have committed to harmonising excises on soft drinks and tobacco products, and are considering introducing or expanding a range of other taxes including on business profits, remittances, foreign worker income and financial transactions.
Oil riches have for decades helped shield Gulf state citizens and businesses from the grasp of the taxman, but not for much longer.
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