Investigating the Relationship between Introduction of VAT (Value Added Tax) and Price level after implementation of VAT

1.  Introduction:

There are a lot of speculations were going on around execution 5 % VAT tax in UAE. They were based on previous negative experience of people, customers’ expectations, rumors, “common sense” and so on. People expected consumer prices to rise, shrinking the purchasing power of people, whipping the spiral of inflation with it. This in return may reduce level of expenditure of consumers, moreover, rise in prices in Dubai may drive tourists – one of the pillars of UAE economy, away. This in response would significantly reduce country’s income as it is largely built on travelers and visitors. Such negative effect in a country, hosting world’s most important event – EXPO 2020, can mean a disaster. Therefore, a comprehensive study on effect of VAT to a UAE economy must be conducted as soon as possible to understand and eliminate such speculations and adverse effect on UAE economy. In addition to that, all other GCC countries are planning to introduce such tax in their states. This sort of study will serve well on predicting what may happened there and highlight areas of attention.

 Unfortunately, there was little practical evidence, historical experience, and scientific research on consequences of posing tax in a “Tax-free” economy for the first time. Economy of UAE has its own specialties, strong sides in conjunction with weak ones. No need to underestimate the role of UAE government aiming perfection in all areas and working hard towards it.

Consequently, it was difficult to predict what will be the effect on price level in the country for a regular consumer?

Whether it creates a competitive advantage and business growth?

How it will affect tourists- one of the main source of income for UAE? Luckily now, after more than 6 months since introduction of VAT in UAE, we accumulated enough statistical data and practical evidence to evaluate effect of VAT on Price level in the country. We can start judging by looking at Consumer Price Index (CPI) calculated by the Dubai Statistics Center.

The Index measures changes in the prices paid by consumers for a basket of goods and services. Consumer Price Index also measures relative change that occurs on a particular phenomena in terms of Prices, Quantity and Value for a particular period of time. Indices are one of the most important economic indicators widely used in planning and economic studies, which can identify the economic changes in countries as well as reflect changes in the community productive and consumer sectors. In addition, it forms a unit of measure in planning and identifying inflation or recession. That’s why Dubai statistics Center is computing many indices, such as Consumer Price Index. Let’s look at it closely. Here at your attention is “United Arab Emirates Consumer Price Index” (CPI). This table provides United Arab Emirates Consumer Price Index (CPI): actual values and historical data for the period of time from July 2017 till June 2018.

As we can see the CPI jumped up suddenly from 109.29 in Dec 2017 to 112.29 in Jan 2018. Than it was slowly going down reaching an all year low of 107.36. This forms average CPI of 111.50 for the year. As we can see that the change in CPI doesn’t carry a stable or logical pattern. It shows rather seasonal change and does not represent sadden and stable rise or 5 points as it was expected by critics and consumers. Subsequently, from this AVERAGE Index it is really difficult to judge whether VAT affected Price Level in UAE in 2018^th or not. Better to look at more specific indexes provided by Dubai Statistics Center. Be aware of column highlighted in green color. It represents Average CPI for the whole year of 2017. Next column to it, highlighted in blue represents only one month of 2017 – December. This arrangement will help in comparison with January 2018.                                                                                                               

 

This table is very representative. It shows that different categories of consumable products reacted on VAT differently. Some, (like tobacco) showed large and constant increase in price. And this is quite rightfull – this type of product was targeted the most and taxed with no exception. On the other hand, health and medical services were not impacted at all. This is also quite predictable as it is an exempt from taxing. Than again, housing showed very unusual behavior: instead of predicted increase, it dropped by 2 compare to Dec 2017, or even 3 points compared to 2017 average. So we cannot derive a solid conclusion whether VAT impacted the price level in UAE in 2018 or not.

Economists explain this

After VAT was first introduced, a survey was conducted by Alan S Tait (Value Added Tax: International Practice and Problems, Alan A. Tait, June 15, 1988) on its impact in several countries on the basis of International Monetary Fund data, which shows that VAT is never introduced in isolation.

There are a number of variables influencing price change, and therefore, it is difficult to empirically assess the effect of VAT on prices. The impact of VAT on prices, therefore, cannot be strictly segregated from the general trend in inflation. First, the taxes that have been replaced are also relevant. They could be a wholesale sales tax of the cascading type, a simpler VAT, a multistage ring system, a cascade production tax and so on.

Second, the design to yield equal or higher revenue also makes a difference.

Third, other concurrent changes such as rise in oil or steel prices in international and internal markets, increase in utility rates, changes in wage levels, administrative changes such as tighter monetary policy, price control, monitoring of prices and so on, make due impact on the price rise.

So, let’s now try to understand what is this tax and how it may or may not affect the economy of UAE.

VAT is a Value Added Tax- an additional duty on prices.  It is a type of consumption tax that is placed on a product whenever value is added at any stage of production and at the point of retail sale.  It is imposed on a product every time, value is added at any stage of production and at the point of retail sale. Moreover, this type of Tax also applicable on Import of goods and even import of services. Thus, the price of final product can be increased several times during production.  Consequently, the final price can be increased significantly. This can reduce purchasing power of people slowing down their activities in market. Therefore, a country can be entering a cycle of recession, reducing economic growth and stability.

Despite visualized above possible problems, 165 countries all over the world are introducing VAT tax to their people. It ranges from 27% in Hungary to the lowest of 4,5% in Andorra, it comprises a significant portion of a governmental finance (up to 50% in some countries like France). It is preferred to be done for additional money inflow to the disposal of a government in order to improve services to its residents, finance health and education, invest in development and research, build up the infrastructure of a country, capitalize in military and security system.

VAT calculation process: the amount of VAT that the user pays is on the cost of the product, less any of the costs of materials used in the product that have already been taxed.

This is not happening due to Tax return policy of the government. The amount of Vat a company pays to the government can be deducted by amount a company purchases goods or raw materials or services it uses.

Amount to pay = Tax payable – tax refundable.

effects of vat:

Price level is the extent to which goods can be sold to consumers. Price level refers to the purchasing power of people and often associated with inflation.

A price level is the average of current prices across the entire spectrum of goods and services produced in the economy. In a more general sense, price level refers to any static picture of the price of a given good, service or tradable security. Price levels may be expressed in small ranges, such as ticks with securities prices, or presented as a discrete value.

2.  Propositions:

Based on this, the paper forwards the following propositions:

P1: VAT do increase price level but within a very narrow range

P2: The price increase is even lower than the level of Tax 5%

P3: VAT do not slow down the purchasing activities of customers in UAE, Average expenditure

Price level:

Price level is the extent to which goods can be sold to consumers. Price level refers to the purchasing power of people and often associated with inflation.

A price level is the average of current prices across the entire spectrum of goods and services produced in the economy. In a more general sense, price level refers to any static picture of the price of a given good, service or tradable security. Price levels may be expressed in small ranges, such as ticks with securities prices, or presented as a discrete value.

Read more: Price Level https://www.investopedia.com/terms/p/price_level.asp#ixzz5BJtgI7Ma

3.  Conclusion:

The ideas proposed in the preceding paragraphs deserve empirical attention. The paper highlights key ingredients that deserve to be studied. According to K. Marks Kapital (1956), posing a lot of taxes can lead to people’s upset and consequently to torments and even to revolutions. In order to avoid this, economists and leading governors should implement such measures with care, have full picture of the effect of Tax on actual price level.

It is evident from the discussion that inflation had not surfaced in the countries under the study, which cover a cross section of countries from the world over, because of VAT alone. There may be a minor one-shot increase or once and for all impact to begin with under certain circumstances due to replacing other taxes and consequent adjustments by the traders and also because the overall number of tax payers would increase, but the crucial question is whether this one time increase would lead to further price escalation.