Interpreting Middle East Economic News and Analyzing Market Trends

Kuwait to cut subsidies, introduce VAT and income tax in the coming years

Kuwait’s Central Bank is forecasting a slowdown in 2013 as it expects a contraction in the oil sector, according to the Kuwait Times.  The Central Bank trimmed its economic growth to 1.9% this year, compared to 6.3% in 2012 and 8.2% in 2011.  The country has had trouble diversifying the economy away from its dependence on the oil sector so any contraction in this sector will have a significant affect on the overall economy.

 

The country has come to realize, however, that it must not only diversify its sources of revenue, it must also cut subsidies and introduce a consumption tax in the near future.  Gulf countries have a generous welfare system, which includes subsidized food, fuel, housing, water and electricity along with free health and education.  None of the countries in the Gulf have been able to introduce a tax system yet, much less reduce the population’s reliance on subsidies.  This is a very sensitive subject, which we have covered in previous post, here and here.

 

Kuwait now seems to have the will to talk about removing some of the subsidies and begin to publicly admit that a tax system will be needed in the near future.  Here’s more from the Kuwait Times:

 

Kuwaitis and expatriates will all be riled very soon by subsidy cuts, imposition of Value Added Tax (VAT) and income tax. MP Nasser Al-Merri has recently proposed scrapping of subsidy to all Kuwaitis and expats and advised the government to instead improve the services and provide subsidy to Kuwaitis only on basic necessities such as electricity, water and fuel.

Last week, the government admitted that it was studying a mechanism to reduce subsidizing products and services for expatriates before similarly trimming subsidies for citizens as the state was trying to better organize its spending and budget. Water, electricity and fuel in Kuwait are subsidized, apart from other products and services.

Along with the issue of generating income from expatriates is the possibility of imposing value added tax, probably by next year. The government has sought the assistance of World Bank on tax-related issues and mechanism for tax collection. Most of the governmental subsidy that foreigners in Kuwait benefit from pertains to electricity and water services in addition to gasoline.

According to a Kuwait Times report, the mechanism is based on finding new ways to change the pricing of services available to citizens and expatriates, thus enabling the government to charge the fees accordingly. They explained that the state plans to study “similar experiences followed by other Gulf states” and then apply them in Kuwait. The issue is currently being studied by government committees “that are also assigned to chalk out plans for reducing subsidies for Kuwaitis as a first step,” said the sources who did not provide a timetable as to by when a reduction in subsidies was expected to be approved. The state’s budget for the fiscal year 2012/2013 lists the total government subsidy for consumer services at KD 6.3 billion ($22 billion), KD 3.1 billion ($10.85 billion) of which goes towards electricity and KD 1.1 billion ($3.85) towards fuel.

Read the full article from Kuwait Times.

 

The generous subsidies governments in the Gulf have had in place for decades will be coming to and end.  The cost to the governments are ballooning with the rapid growth in population, a calculation these governments may not have taken into account decades ago.  As noted above, Kuwait with a total population of only 2.7 million spends $22 billion a year on subsidies.  This figure does not include the cost of healthcare, housing and education.  It is obvious that it cannot continue to do so.  Gulf countries remain some of the cheapest countries in the world for fuel ($0.89/gallon in Kuwait and $0.61/gallon in Saudi Arabia), water and electricity, which is not economically viable in the long-run.  The first step will most likely be reducing subsidies, then removing them followed by the implementation of a VAT and income tax.  Kuwait has stated that it will not introduce any taxes for at least three years.  This means that they will start working on subsidies very soon.

 

Any reduction in subsidies will come with protest and possibly social unrest.  Kuwait and the other Gulf States cannot continue to support these subsidies that are growing out of control.  Kuwait has come to realize this and is in line to be the first to tackle this challenge.  The rest of the Gulf will be watching.