Fiscal Policy Responses to Oil Price Volatility in an Oil-Based Economy

Oil prices increased from 2004 to historic highs in mid-2008 but have fallen precipitously since then. What are the effects of this volatility on an oil-based economy like Kuwait? This article examines options for policy responses from an oil-based economy perspective. The impact of changes in domestic tax and subsidy policies on the Kuwaiti economy is estimated using a computable general equilibrium (CGE) model. Results show that for a set of scenarios aimed at raising government savings via tax increases or subsidy cuts, the least negative impact on household welfare is for the subsidy-reducing scenario, a reflection of efficiency gains due to reduced price distortions. The most negative effects follow from raising government savings via increases in price-distorting import tariffs and the introduction of a nonuniform value-added tax (VAT). Given the small share of non-oil activities in Kuwait’s non-oil gross domestic product (GDP), the introduction of the VAT on non-oil activities does not generate a significant increase in government revenues.