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Featured Analysis

Samir El Daher, Economist

December 2019
A One-Time “National Solidarity Wealth Tax”

A fiscal solution to Lebanon’s public debt problem 

There is by now general consensus that Lebanon’s public debt has spiraled out of control. It cannot be put on a sustainable path without a major policy adjustment, in parallel with a massive, if at all bearable, fiscal effort. It needs to be reduced both as a share of GDP and in absolute amount, in order for the country to get back on its feet.
Debt restructuring has been the conventional approach employed to address the debt overhang. Restructuring the debt entails several steps: Rescheduling payments, by postponing installments and agreeing on different ones; lowering interest payments; and most distressingly, reducing the principal amounts due. In legal terms, the failure to make timely repayments of the amounts and interests due, and not respecting the original contractual terms, is construed as a default. A default on a specific debt issue, or a specific borrower, may trigger cross default clauses on all debts outstanding. This would mean that other creditors not affected by an instance of default would consider that their money is potentially at risk, and would be entitled to call for their money to be paid back immediately before the due date.
In Lebanon, the main creditor of the Lebanese state is the banking sector, encompassing both commercial banks and the central bank. A public debt restructuring would therefore affect banks’ balance sheets through a write-off of shareholder equity and, if insufficient, through a “haircut” on some, or all of the deposits.
A debt restructuring will dent Lebanon’s once stellar image as a creditworthy, resilient country that never failed its financial obligations, even at its darkest hours. It will ineluctably translate into a sovereign rating downgrade to the lowest rung, and will impede the country’s future ability to access international and domestic debt markets other than at forbidding costs, if at all. S&P had already downgraded Lebanon’s sovereign rating to CCC, or “junk” in vernacular terms, before 17 October.
An alternative solution to debt restructuring, which would achieve the same objective, could be through fiscal policy. It is the undisputed domain of the sovereign state that can adjust its tax code at will. Altering the tax policy is not interpreted as defaulting even if the change is enacted in the context of debt resolution. The proposed fiscal approach to the debt problem will have bank depositors shouldering the cost of adjustment to seek to buy back the $34 billion foreign currency denominated debt,1 or a substantial part of it. This would be done through a wealth tax by levying a one-time “national solidarity” tax. In that context, wealth will be narrowly defined as foreign currency deposits in Lebanese banks at the exclusion of all other assets. To ensure fairness between depositors who kept their funds in Lebanese banks and those who transferred them overseas, the measure could bear retroactively on the value of deposits present in Lebanon on a certain date. Were it to be applied, this tax will have the same effect of a haircut without triggering a default on the debt with a subsequent sovereign downgrade.
Some may argue, rightfully so, that the fiscal approach would be to take cuts from the deposits and not the shareholders’ equity, which is unusual since the bank equity capital is precisely there to provide the first line of defense for the deposits since any loss should first be deducted from the capital. They would be the first to take a loss under any debt resolution program. Given the deleterious condition of the banking system, the fiscal solution might spare banks for now, from further loss of scarce capital when measured against their hollowed assets base. This plan, however, doesn’t preclude later measures of restitution for shareholders.
A number of scenarios could be envisaged, taking into account the distribution and size of bank accounts. If this tax is to be levied on all $120 billion foreign currency deposits, it would have the following returns: $12 billion for a 10% tax rate, $24 billion for a 20% tax rate, and $30 billion for a 25% tax rate.
For the measure to be socially fair and acceptable, it should target larger accounts. Here too, various scenarios may be considered. For instance, applying a 20%, 25%, or 30% tax rate on the 1% of the largest accounts (that represent about $80 billion in total) would yield respectively $16 billion, $20 billion, and $24 billion. The same analysis can be done in applying various tax rates on the largest 10%, 20%, or 30% of the accounts.
It is also important that the proposed one-time national solidarity wealth tax not be viewed as a retaliatory measure against the wealthy. Antagonizing and demonizing the affluent will have harmful and irreversible long-term economic costs in driving investors, entrepreneurs, and job and wealth creators out of the domestic economy. In this frame, it would be useful to assess the effect on those affected by this tax by measuring over relevant periods the after-wealth tax returns on bank deposits in Lebanon. This comparison may also well demonstrate that the real economic loss to wealthy depositors has been mitigated by the attractive returns they have reaped on their high interest-paying deposits in Lebanese banks.
[1] The problem of the Lebanese pound denominated debt, major as it is, can be addressed separately, as in terms of priority it is less critical than the external debt, especially in the context of a depreciating national currency.

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