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All GCC countries will have value added tax (VAT) within five years. The tax, which will replace customs duties to be phased out under free trade agreements, is likely to be set at a flat rate of between three per cent and five per cent and would be applied to all goods and services.
As a tax method, VAT has proved successful the world over and raises about a quarter of the world's tax revenue. World Bank studies suggest that for every additional increase of one per cent in the tax rate results in an additional 0.4 per cent of GDP raised in revenues.
VAT would allow governments to have a stable tax base that will remain constant despite global trends and the fluctuations of the market. However, there are concerns that VAT could raise inflation and the GCC would become less attractive to foreign workers.
Officials however maintain that the new tax will not increase prices for most goods, because it replaces a myriad of other fees currently being levied by governments.
However, certain items would be much more expensive. Cigarettes, for example, are likely to be taxed at 100 per cent as a deterrent to smoking. Premium cars and yachts would also be among a half-dozen items targeted for an increased rate that has not yet been determined.
VAT is paid throughout the production process - from the factory all the way through to the shop, with each intermediary (except the consumer) being able to claim back the tax paid. Its cousin, the retail sales tax, which is used at the state level in America and other countries, is levied only at the time of sale to the consumer. Both are consumption taxes, levied when people spend money rather than when they earn it - as income taxes are.
Consumption taxes are usually hailed as an efficient means of taxation.
A consumption tax is less likely to distort economic behaviour than income taxes. With high marginal rates of income tax, individuals may have less incentive to work hard. With a consumption tax, their extra income is not taxed until it is spent. Consumption taxes can also be levied on a wide base. In theory, people should be taxed on everything they buy. In practice, things are a little more complicated. Many countries have numerous exemptions from VAT. Others tax some goods at lower rates. The wider the tax base, the lower the tax rate needed to raise a given amount of revenue.
The International Monetary Fund recommends tax on selected goods like tobacco, cars and electronic items and the removal of customs duty on all imports, with the tax being collected directly from the distributors, agents and wholesalers. Later, this could be varied to ensure the tax is applied only at the point where the good is actually sold to the customer.
Most analysts feel that the impact of VAT on competitiveness would be small. VAT is unlikely to bring down the GCC's position as a low-tax destination, provided the rate is low.
The tax could be increased during boom times to quell demand, especially for big-ticket luxury items, and reduced during downturns to encourage consumption.
Under the current customs duty system only those goods that are imported into the region are subject to taxes while the inter-GCC trade is exempt from customs duties. But with the introduction of VAT a number of goods that originate within the GCC will now be taxed, applying further pressure on domestic prices.
This supports the argument that VAT could raise inflation further.
The escalating rents, utility charges and rise in the prices of imported items as a result of the dwindling purchasing power of the dollar-pegged currencies are also adding to the inflationary pressures.
VAT is as regressive as any other indirect tax could get and it hits the lower income groups the hardest.
Supporters of VAT argue that it is cost neutral from the point of view of consumers as it would only be a substitute for customs duties.
Albeit, VAT has become especially popular these days the world over. In the 1960s only nine countries in the world levied VAT. Now about 130 do. In the developing world, VAT has become the consumption tax of choice. All Latin American countries now have VAT, as do the ex-Communist economies of Eastern Europe.
