Balance the books • Focus: Budget and spending

In one of the most challenging periods in modern history, Saudi Arabia takes a necessary step toward becoming a truly modern economy by shifting the state’s reliance from oil revenue to tax.

AN OIL-RICH NATION, and thanks to reasonably high oil prices over the last five decades, Saudi Arabia has become one of the top-20 economies in the world—and therefore a member of G20. However, with rapid digitalization, the increasing use of renewable energies, and the shift from manufacturing-based economies to service-based ones, the demand for crude oil has undergone several major fluctuations since 2014, finally taking a nosedive in 2020.

In 2015, the global demand for crude oil was growing at the rate of over 2 million bpd; however, in 2019, the figure had almost halved, dropping to below 1 million, according to statistics released by the International Energy Agency (IEA). What is more, the COVID-19 pandemic has—quite unsurprisingly—pushed the demand even lower. “Global oil demand is expected to decline in 2020 as the impact of the new coronavirus (COVID-19) spreads around the world, constricting travel and broader economic activity,” IEA had forecasted, and this prediction indeed came to pass.

As early as March 2020, merely a few weeks after COVID-19 made its first appearance, the international oil market experienced one of its worst free falls of all time, with benchmark crude prices such as Brent dropping by 20-30%. By mid-March 2020, Brent was priced at under USD25 a barrel, while a barrel of West Texas Intermediate (WTI) could hardly fetch USD20.

This, of course, is hardly good news for the world’s leading crude oil export. Even though in recent years Saudi Arabia has made a tangible effort to diversify its economy away from oil, oil revenues still make up a notable portion of state spending in the Kingdom. As such, Riyadh has been contemplating the idea of downsizing state expenditures throughout 2020. In early 2020, the Ministry of Finance invited “state agencies to submit proposals for cuts of at least 20% to their budgets in a fresh austerity drive to cope with a sharp drop in oil prices, four sources familiar with the matter said,” according to Reuters.

Nevertheless, budget cuts in the region of 20%—or even as large as 30%—may not be enough to offset the Kingdom’s budget deficit in the early years of the 2020s, given current oil prices. If IEA’s forecast are anything to go by, the global demand for crude is unlikely to pick up anytime soon, either. According to a forecast by IEA, global demand for oil in 2025 will be growing at the same rate that it was in 2019—which was hardly an impressive rate. Under such conditions, the largest economy in the Middle East has decided to take the same path that most developed economies have taken at one time or another: increasing the state’s reliance on tax revenues mainly from large businesses in the private sector and the citizenry.

Saudi Arabia has enjoyed well over five decades of high oil revenues, during which period its private sector has become robust enough to stand on its own feet. In one analysis, the Kingdom’s natural resources have done their job; oil revenues have functioned as a booster to lift the Saudi economy off the ground. Now that Saudi Arabia’s economy has become strong enough to be a member of an elite fraternity such as the G20, the time has come for the state to shift its reliance from oil export revenues to tax revenues. This shift had to happen sooner or later, and the current trying circumstances may turn out to be a blessing in disguise once Saudi Arabia has taken this critical step.

Like many oil-rich countries, Saudi Arabia had practically no tax bureaucracy since the 1970s, though things started to change in 2018, when it introduced a value-added tax (VAT) of 5%. In 2020, and in the wake of the pandemic and the free fall of oil prices, the government decided to triple the VAT, raising it to 15%. This latter measure was accompanied by certain undesirable consequences: unlike the 5% VAT, the introduction of the 15% VAT displeased a number of businesses and citizens, while also causing some inflation in the KSA in the second half of 2020. However, the 15% VAT may be a temporary measure. The Ministry of Information noted in November 2020 that “the Kingdom could review its VAT increase after the novel coronavirus pandemic ends, a move which may spur economic recovery after the tax increase boosted inflation,” according to Reuters.