Executive Summary

In October, Bahrain announced plans to raise its value-added tax from 5% to 10% in January 2022. The tax rise falls under the umbrella of Bahrain’s fiscal balance program, which was recently revised after the coronavirus pandemic interrupted its implementation. Bahrain has the smallest demonstrated oil and gas reserves of the Gulf Cooperation Council countries, and the fact that oil prices have for the most part been below $80 per barrel since 2014 has led to credit downgrades and a demand from investors for fiscal reforms.

The decision to raise taxes was unpopular among the general public, and many citizens called for the government to consider alternatives, including a tax on foreign transfers (remittances) by migrant workers, a progressive wealth tax, and a tax on company profits. These proposals sought to minimize the tax burden borne by low- and middle-income Bahrainis, at the expense of expatriates or the wealthy.

However, Bahrain’s status as a small open economy that is deeply integrated with the economies of neighboring GCC states would undermine the effectiveness of these proposed alternatives. Rather than leading to the wealthy paying their fair share, they would most likely lead to capital flight, exacerbating the government’s fiscal problems. This is because the wealthy are particularly adept at evading taxes by rapidly moving their money out of small open economies. In the case of taxes on remittances, although focused at the lower end of capital accumulation, they would threaten Bahrain’s reputation as a financial hub that imposes no controls over capital flows, which is a central element of Bahrain’s strategy for attracting foreign direct investment.

Even though an increase in the VAT seems the most viable option, higher levels of public buy-in could be secured through greater transparency in fiscal policy. In particular, Bahrain’s successful coronavirus strategy has been built on transparent deliberations and proactive engagement with the public, and emulating these aspects in the fiscal domain would help Bahrain implement its needed reforms more smoothly.

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