The pros and cons of increasing value added tax

Effective today, Saudi Arabia is tripling its value-added tax (VAT) to 15 percent, as part of financial reforms intended to support the fiscal imbalance between public revenues and expenditures caused by the negative impact of the coronavirus crisis. Saudi Arabia ratified VAT and the excise tax agreement of the Gulf Cooperation Council on Jan. 31, 2017. Pursuant to the agreement’s provisions, the government has issued the common tax agreement for both VAT and excise tax.

The General Authority of Zakat and Income Tax is the Saudi government body responsible for collecting VAT and excise tax, and ensuring that they are properly levied. It is also responsible for applying penalties against violators and tax evaders.

VAT and excise tax are both indirect taxes. But the former differs from the latter as VAT is usually charged to goods and services rendered by the seller with a fixed and lower rate than that charged to excise tax at every step of the supply chain, from the manufacturer to the end consumer.

Excise tax is usually levied at a higher rate at the moment of manufacture on certain goods that are considered to be harmful to human health, such as tobacco (it could reach up to 100 percent of the sale price), energy drinks and carbonated drinks.

The moment the Saudi government announced the tripling of VAT, a number of economists raised concerns about the possible negative impact on businesses, consumers’ purchasing power, consumption and inflation. I believe the government has chosen to apply the least painful austerity measure to mitigate these concerns, especially when considering that a wide range of goods and services are VAT-exempt, such as private education, health-related products and services, and up SR850,000 ($226,718) of the price of the first house bought by a national.

It is worth noting that despite the Saudi government tripling VAT, it is still lower than in most developed economies such as Denmark, Sweden and Norway, whose VAT reaches 25 percent.

One of the expected positive outcomes of raising VAT is to rationalize Saudi society’s consumption habits, which in turn will enhance individuals’ savings by reducing the purchase of comfort goods.

The government is pursuing the austerity measure with the least direct negative impact compared to other solutions such as dismissing government employees, reducing salaries, and freezing bonuses and promotions.