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Sami Atallah and Mounir Mahmalat, respectively, LCPS executive director and doctoral fellow at LCPS

April 2019
Tax Exemptions Would Undermine Faith in New Government’s Pledge to Reform

While the Lebanese government claims progress on implementing the CEDRE reform agenda, it undermines it at the same time. This week, the Council of Ministers will discuss an exemption for fourteen companies and organizations from paying fines for overdue taxes. While Minister of Information Jamal Jarrah went to great lengths to argue that these companies would be exempted from paying the fines, he evaded explanation of three issues: First, why these companies have not paid their taxes on time; second, why they should be exempted from paying fines that have accrued over multiple years; and third, why only these companies—some of which are connected to the political elite—are receiving preferential treatment when others are not.

These exemptions from fines on overdue taxes would effectively constitute a tax exemption as they reduce the incentives for these companies to abide by the law in the future. Some of the largest and most profitable companies in the country would be sent a message that tax evasion is permissible. Such distortionary and selective exemptions would further undermine the trust of Lebanese businesses and the working class in the legitimacy of state institutions, and would reinforce the widely shared perception that the political elite will continue its abuses of power to maintain its privileged position. That way, they would send the worst possible message to the Lebanese people as well as to the international community and undermine the governments’ reform efforts.

Even more important, these tax exemptions violate the spirit of the ministerial statement and the CEDRE reform program. In both of these documents, the government committed to strengthening the revenue base and reducing loopholes for tax evasion. The exemptions would therefore deprive the treasury of revenues it desperately needs to contain the budget deficit. It is this kind of abuse—the refusal to pay a fair share of taxes through lower tax rates, tax exemptions, or tax evasion—which has forced Lebanon to seek international aid to invest in its public infrastructure.

Let’s get the story straight. Lebanon went to Paris to raise funds to refurbish its deteriorating infrastructure. As LCPS has shown in recent research, the quality of infrastructure is poor not due to the presence of Syrian refugees, as contended by some politicians. Instead, we identify two major reasons: First, Lebanon has failed to spend enough on its infrastructure for many years. The level of capital expenditures to total GDP is less than 2%, well below the average for peer-countries (6%) and hardly sufficient to maintain existing infrastructure. Second, the monies allocated to capital spending are mismanaged.

Successive governments have failed to address these shortcomings and broaden the revenue base. As a result, the treasury has been heavily constrained by other spending priorities, in particular interest payments on treasury bills, wages for public employees, and transfers such as those to Electricité du Liban. These three expenditure items alone constitute some 80% of the state budget, cannot be further reduced, and therefore leave little fiscal space to expand capital expenditures in the short-term.

Ineffective spending patterns are only one side of the coin. Revenue collection proves to be even more problematic, leaving Lebanon’s tax collection comparably low relative to the size of its economy. Compared to peer-countries in the middle-income bracket, Lebanon’s ratio of tax revenues to GDP was 13.6% in 2015, ranking well below the world-average of middle-income countries (16.4%).

One reason for such low levels of taxation is that Lebanese governments have chosen to avoid adequate taxation on wealthier segments of society. The treasury heavily relies on indirect and regressive taxes to finance the state apparatus, which effectively places a disproportionate tax burden on poorer segments of society. Such regressive taxes, including taxes on goods and services (i.e. VAT) and non-tax revenues (i.e. excise fees), constitute two-thirds of government revenues. By contrast, taxes on wealthier segments of society—such as taxes on income, profits, and dividends both from individuals and corporations—made up only about 17% of total revenues over the last decade.

Not only does the present-day tax regime burden the poor more than the rich. The inequalities in Lebanon’s tax regime increased over time, which contributed to a significant increase in income and wealth inequality in the past two decades. As we showed in recent work, tax revenue items that burden the middle and working classes of society grew from 2008 to 2016 at a faster pace than tax items that affect higher incomes. For instance, tax revenues from wages and salaries or from goods such as tobacco or alcohol increased by 12.8% and 10.8%, respectively, while tax revenues from corporate profits rose by 8.5%, capital gains and dividends by 7.7%, and property tax by 6.2%. Moreover, inheritance tax, which is a powerful tool to curb wealth inequality and finance public services, is noticeably absent in the public revenue mix, contributing only 5%. In fact, its growth rate has been negative in real terms since 2011.

But the story does not end there. While the low nominal taxation on high-incomes relative to the wealth of the economy is problematic in itself, the current taxation regime is susceptible to large-scale tax evasion. Two recent reports provide an estimate about the amount of tax evasion in Lebanon, which totaled from $1.13 billion in 2015 (2.28% of GDP) to $5 billion (10% of GDP).

Such a fiscal evasion gap is nearly equivalent to Lebanon’s budget deficit. In comparison to other upper middle-income countries, Lebanon again fares much worse than the world-average of about 0.7% of GDP. The aforementioned reports find that income tax evasion on corporate profits, as well as on wages and salaries, cause the brunt of foregone tax revenue. In fact, Lebanon’s rate of corporate tax evasion to total revenue of corporate taxes totals 54%. In other words, the untapped potential for taxation on corporate profits constitutes more than half of the taxes actually paid.

As Lebanon faces a time of severe economic and budgetary distress, the proposed tax exemptions on selected firms are detrimental to the economy, the treasury, the states’ credibility, and, eventually, the Lebanese people. They must not be approved. Their rejection would send a strong signal to the Lebanese as well as the donor community that this government is finally serious in its effort to comply with the spirit of the reform plans to which it has committed.

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