Implementing excise tax in Kuwait

Kuwait: The economy of Kuwait, as is the case with the other Gulf Cooperation Council (GCC) economies, is known for its hydrocarbon wealth. However, as Kuwait strives for diversification and fiscal sustainability, taxation has become an increasingly important tool. One key area is excise tax, a form of indirect tax levied on specific goods, i.e. excise goods.

What is excise tax and why is it used?

Excise tax is levied on specific goods, typically those considered harmful to health or the environment, such as tobacco products, sugary drinks, and energy drinks. The GCC countries - Kuwait, Saudi Arabia, the (UAE), Bahrain, Qatar, and Oman - approved the Common GCC Excise Tax Agreement in 2016. Except Kuwait, all GCC countries adopted an excise tax system a few years ago.

Generally, there are two primary objectives behind excise tax implementation:

• Discouraging Consumption: By raising the price of these goods through taxation, the aim is to discourage people from consuming them, leading to potential health benefits for the population.

• Generating Revenue: Excise tax provides a new source of income for governments, which can be used for various purposes, such as funding public services and infrastructure development.

Excise tax rates

The GCC countries have adopted a harmonized approach to excise tax rates on specific categories:

• 100 percent: Tobacco products, electronic smoking devices, and energy drinks.

• 50 percent: Carbonated beverages and sweetened drinks.

It’s important to note that these are the standard rates. Each GCC member state may have slight variations in implementation or additional excisable goods under their jurisdiction.

The impact of excise tax

The introduction of excise tax has had a noticeable impact in the GCC. Studies by the International Monetary Fund (IMF) suggest a reduction in tobacco consumption by as much as 20 percent in some GCC countries following the implementation of excise tax with a target of 30 percent reduction in tobacco consumption by 2030. Similarly, a report by Euromonitor International indicated a decline in sugary drink sales by 12 percent in the region after the tax was introduced.

Excise tax has also generated significant revenue for governments. According to a report by the Gulf Cooperation Council Secretariat General, excise tax contributions to non-oil revenue in the GCC reached an estimated $13 billion in 2022. This represents a significant increase from the pre-excise tax era and highlights the growing importance of this revenue stream. However, excise tax has also brought challenges. Some argue that it disproportionately affects low-income earners who may find it harder to absorb the price increase. Additionally, there are concerns about potential disruptions to supply chains and cross-border trade within the GCC.

The road ahead for excise tax

The future of excise tax in the GCC is likely to involve ongoing evaluation and potential adjustments. Here are some key aspects to consider:

• Effectiveness in Reducing Consumption: Governments will likely monitor the long-term impact of excise tax on consumption patterns. If the desired reduction in consumption of unhealthy goods isn’t achieved, tax rates or the scope of excisable products might be revised.

• Balancing Revenue and Affordability: Striking a balance between generating revenue and ensuring affordability for all citizens is crucial. The GCC countries may explore targeted social support measures to mitigate the impact on low-income earners.

• Combating Tax Evasion: Ensuring compliance with excise tax regulations is essential to maximize revenue collection. Governments may invest in robust tax administration systems and collaborate with regional partners to prevent cross-border tax evasion.

• Expansion of Excisable Goods: As public health priorities evolve, the GCC may consider expanding the list of excisable goods. For instance, sugary snacks or products with high saturated fat content could be potential candidates for future excise tax inclusion.

Excise tax is a relatively new tool in the GCC’s fiscal toolbox. While it has demonstrably reduced consumption of unhealthy products and generated revenue streams, challenges remain in ensuring affordability and efficient implementation. As the GCC economies continue to diversify, excise tax is likely to play a significant role in achieving sustainable fiscal positions while promoting public health.

Economic insight: Tax incidence

It is important to distinguish between statutory incidence and economic incidence. The statutory incidence of a tax is who the law says pays the tax. The economic incidence of a tax is who really bears the tax. Taxes don’t always land on the shoulders they’re intended for. This concept, known as economic tax incidence, depends on how sensitive consumers are to price changes, i.e. elasticity of demand.

When demand is inelastic, meaning consumers buy a good regardless of price fluctuations (e.g. cigarettes), they end up absorbing most of the tax increase. The seller can raise the price to cover the tax because consumers have limited options. Conversely, with elastic demand (many substitutes exist, e.g. sweetened juice), the burden shifts to producers. Since buyers can easily switch to alternatives, sellers have to absorb most of the tax by lowering their profit margins to keep the price attractive.

This elasticity also impacts the government’s tax haul. Inelastic goods generate more revenue because even with a price increase, consumers still buy them. On the other hand, elastic goods might see a significant drop in consumption when taxed, leading to lower overall revenue. Excise taxes, often levied on “harmful goods” like cigarettes, carbonated drinks, and energy drinks, and aim to achieve a dual purpose: Discourage consumption through higher prices and raise government’s tax revenue.

The effectiveness of this strategy hinges on demand elasticity. With inelastic goods, the tax successfully discourages consumption while generating revenue. But for elastic goods, the tax might not significantly curb consumption and could even lead to lower revenue due to decreased demand.

Strategic insight: Businesses

From a different perspective, companies face some strategic issues when dealing with excise taxes, namely:

• Pricing strategies: Companies in inelastic markets (e.g. cigarettes) have more leeway to raise prices and pass on most of the tax to consumers. However, they might offer discounts or promotions to soften the blow and maintain market share. In elastic markets (e.g. sweetened juice), companies might absorb some of the tax to keep prices competitive. They might also reduce costs or introduce smaller, cheaper product options to entice price-sensitive consumers.

• Market Share: In both scenarios, companies will likely employ strategies to retain customers. This could involve increased marketing and advertising to emphasize brand loyalty or introducing new product features that differentiate them from competitors.

• Tax Shifting: Companies might explore legal avenues to minimize their tax burden. This could involve lobbying for exemptions or shifting production to countries with lower excise tax rates (if feasible).

• Product innovation: In some cases, companies might develop new product variations that fall under lower tax brackets or explore alternative ingredients to reduce the taxable component of their product. However, these are just some of the strategic considerations companies make when navigating excise taxes. The optimal approach depends on the specific market dynamics and the degree of demand elasticity for the product.

NOTE: Hassan M Abdulrahim is a Senior Instructor – Economics & Finance at Canadian College Kuwait and Deputy CEO of Visionary Consulting Co.

Understanding

excise tax: A

balancing act