Economists prefer VAT to other kinds of taxes

UAE residents should find solace at the 5 per cent rate of the GCC’s value added tax – some countries charge more than 20 per cent. However, even while the UAE government has no plans for personal income taxes, the VAT will inevitably push up everyone’s cost of living.

The former prime minister Stephen Harper cut the goods and services tax from 7 to 6 per cent, and then to 5 per cent. Tom Hanson / AP Photo
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Attention, residents of the UAE and other GCC countries. Here is a message from almost everyone else: welcome to our world.

When your value added tax takes effect on January 1, you’ll be dipping one toe into the chilly unpleasant reality of personal taxes. The rest of us are in much deeper already.

As you contemplate your monthly budget, you may seek consolation in the low 5 per cent rate of the new GCC Unified Agreement for Value Added Tax (GCCUA VAT): some European countries charge more than 20 per cent. And you should find solace in knowing that the UAE Government has no plans for personal income taxes.

Not really much comfort, is it? Even at 5 per cent, and with many goods exempt, the ­GCCUA VAT will inevitably push up everyone’s cost of living. But somebody must pay for government services – and for now, at least, foreign buyers of Arabian Gulf oil are not that somebody.

Throughout modern history, governments have been endlessly inventive about taxation. Until about a century ago, few states had bureaucracies efficient enough to impose and collect comprehensive taxes on income or spending. Many countries relied on customs duties and taxes on luxury goods to pay for public administration and to sustain armies and navies.

The cost of waging war has, in fact, often generated new taxes and tax increases. The UK became a pioneer in income tax as long ago as 1799, to raise money to fight against France. The US introduced income tax in 1861, to pay for its civil war against secessionist southern states. Canada’s was born in 1917 – exactly a century ago – as military spending soared during the First World War. Only the richest had to pay. Canada’s War Tax Upon Incomes was expected to be temporary – but it endured. Taxes are like invasive weeds: once established they’re more likely to grow than to vanish.

Most of us outside the GCC would say you are lucky to be spared the fantastically complicated paperwork, encrusted with special provisions, that is typical of income taxes. US personal and corporate income-tax laws fill 74,600 pages, stuffed with deductions, tax credits, reduced rates for specific activities, and the like. Many of these permit the wealthy to pay less. Economists and bureaucrats refer to them as “tax expenditures”; everyone else calls them “loopholes”. Warren Buffett, whose investment acumen is legendary and whose estimated net worth surpasses Dh227 billion, has grumbled that his income tax rate should not be lower than that of his secretary.

Most national income tax codes also have various special provisions for middle-income earners and the poor, each designed to nudge public behaviour or help favoured groups. Many countries use tax breaks to encourage investment in film and television production, for example, since this is deemed healthy for a nation’s culture. “Green” efforts also often win the taxman’s favour now­adays. Several countries offer tax breaks to parents who save for their children’s post-secondary education. The UK among others reduces taxes on money put into a trust for “vulnerable persons”. And so on.

These complexities help to explain why many experts prefer a VAT over income tax, even if taxpayers do not.

Canada is a good case study. In 1989, Brian Mulroney, the prime minister at the time, proposed a 9 per cent VAT – the Goods and Services Tax (GST) – to replace the unwieldy, unfair, old wholesale-level tax. Canada is a federation, like the UAE, and most of the 10 provinces already had a VAT, so the concept was familiar. And it was widely despised. After fierce debate, and some defections from the governing Progressive Conservative Party, the GST came into effect, at 7 per cent, as 1991 began. Jean Chrétien, the leader of the opposition Liberal Party, vowed to cancel the tax; that’s one reason he swept to power in the 1993 election.

While Mr Chrétien remained PM for a decade, his promise languished.

In the 2006 election, the Conservative opposition leader Stephen Harper promised to reduce the GST – and won. He lowered it to 6 per cent, then to 5 per cent. Today, it’s usually “harmonised” with provincial VATs; the total rate varies between 5 and 15 per cent. The GST provides about 11 per cent of federal government revenue, compared with 49 per cent from personal income tax and 14 per cent from corporate income tax.

Voters loved Mr Harper’s sales tax cuts but economists did not. The GST could be called the “Generally Sensible Tax”, says William Watson, a former head of the economics department at Montreal’s McGill University.

“Most economists like the idea of a consumption tax better than income tax,” Mr Watson said in an interview. “With high taxes on income you’re discouraging people from going out and working … achieving … investing.” Some people say that an income tax is fairer, since it takes more money from the richest. But ultimately, it turns out, so does a sales tax. “In terms of lifetime taxation, people tend to consume their incomes,” said Mr Watson.

An ideal VAT would cover everything, he says. “It’s too bad that there are exemptions” because “to make exceptions, the system must be much more complicated”. Planning must be done, cash registers modified, forms filled out “and it opens up ways for people to finagle things” legally or otherwise. In Canada, one Tim Hortons doughnut is deemed a restaurant meal and therefore taxable – but six purchased at once are groceries, which are exempt. So, critics say, the tax encourages doughnut consumption. Much better, Mr Watson says, to tax everything and return the money to poorer people through an annual tax credit.

So that’s the VAT. You’ll get used to it. But don’t expect to like it.

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