Question

In 2020 Saudi Arabia - the standard rate of VAT increased from 5% to 15%. Discuss the welfare effects of the VAT reform and its implications for business and taxpayers

Answer 1

In May 2020, Saudi Arabia announced an increase in its value addded tax (VAT), from 5% to 15%, as a result of the financial and economic implications of the coronavirus. The tripling of the rate is intended to aid in resolving the fiscal imbalance in the country, caused by both decreasing consumer spending and lower government revenue. Particularly in terms of consumer and national welfare, this is not a good sign. Economic theory proves increases in tax rates usually end up being borne by the consumers, raising prices they pay on products and reducing consumer surplus in the process. The increase in the rate might further have some unintended consequences.

The rate change will directly affect consumers (i.e. the taxpayers) consumption expenditure, both before and after the increase. While increased spending could be anticipated before the rate hike takes place, once the hike comes into effect, these expenditures will almost certainly fall.

There are further implications for the businesses who supply products to the taxpayers. Their concern will be with maintaining their competitiveness, and determining how much of the increase in prices will be pushed out into prices consumers pay.

Many further logistical issues will require dealing with. Taxpayers will have to review existing contracts that provide for ongoing or periodic supplies of goods or services. Suppliers will have to deal with pre-payments already made for future products, goods to be returned after the increase in rate, etc.

But one thing is clear, the increase in taxes will certainly reducing the consumer surplus in the economy, and increase the amount of deadweight losses.