Lebanon Pulse

Tax increase puts spotlight on Lebanon's miserable finances

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Article Summary
As Lebanon approves a tax hike to fund employee raises, experts warn the government to implement financial reforms or face default.

Lebanon's parliament passed a new tax law Oct. 9 to fund raises for its civil servants, after repeated delays and a strike Sept. 25-28 by public sector workers. However, opponents said they will continue to challenge the law.

In July, the Lebanese parliament passed Law No. 46/2017 pertaining to a raise for civil servants — after several years of dithering. This law was accompanied by Law No. 45, which contains a series of taxes to finance the raises, the total cost of which is estimated at between $1 billion and $2 billion a year.

After some legislators appealed in August to the Constitutional Council, it postponed the tax law's implementation. The council then annulled the law Sept. 22, kicking it back to parliament and saying it was unconstitutional for many reasons, including: It violated the non-assignment rule by designating the resulting income for fund pay raises, parliament violated procedure when it approved the legislation and the law would involve double taxation in some cases.

The parliament finally met Oct. 9 and approved an amended version of Law No. 45, though opponents say the new version barely touched on the council's concerns. The law includes 15 fiscal measures, among them a value-added tax increase to 11% (from 10%), increased income tax on financial institutions to 17% (from 15%) and a tax hike on imported alcohol and spirits as well as cigarettes.

Opponents say new taxes would be bad for Lebanon's struggling economy. The country, they say, needs to reform its spending and close tax loopholes and put an end to an enormous problem with phantom employees and other corruption.

From a purely economic point of view, the adoption of the salary scale without any funding would have definitely constituted a fatal blow to a financial structure that is already very fragile. Such a scenario would undoubtedly have placed Lebanon on the track of a quasi-debt default, similar to what happened in Greece in 2010 or in Argentina in 2001.

Even the tax increase only postpones the seemingly unavoidable implosion of the system if no structural reforms are adopted. The public deficit in Lebanon reached a historic peak of $5 billion in 2016, compared with $2.3 billion in 2011. Meanwhile, the debt is now close to $80 billion, compared with just over $50 billion at the beginning of the Syrian crisis in 2011.

“Public expenditures have almost doubled from $6.8 billion in 2005 to $13.5 billion in 2016, while nothing has changed in the country. Why this increase and on what exactly was it spent?” Nassib Ghobril, the head of the research department at Byblos Bank, said in an interview with Al-Monitor.

The public finance situation is at the very least worrisome. The International Monetary Fund (IMF) said in a Sept. 14 report that Lebanon must “put its economy on a viable trajectory and halt the increase in public debt.” The institution called for lawmakers to adopt a budget as soon as possible, as the country has been operating without a basic financial framework since 2005, mainly because of recurrent political paralysis and institutional vacuums.

Though the tax increase is essential to avoiding a further widening of public deficit and debt, another argument raised against it is that it will negatively affect consumption and investment, and consequently growth, which has been sluggish since 2011. 

Meanwhile, international rating agency Moody's, which had already warned in July 2016 against the growing exposure of local banks to sovereign risk, downgraded in August the Lebanese debt rating from B2 to B3, as well as the ratings of the three biggest banks in the country: Bank Audi, BLOM Bank and Byblos Bank.

Given this situation, raising wages could indeed precipitate the collapse of the public financial system by substantially increasing expenditures. Public sector salaries — in addition to allowances, indemnities and other benefits — cost $4.7 billion in 2015, representing 35% of total expenditures and 67% of primary expenditures, according to the Ministry of Finance.

Adopting the new pay scale is expected to bring the annual cost of maintaining some 130,000 state officials to nearly $6 billion, even though “several thousands of them are virtual employees or [ones] with productivity close to zero, while some public institutions — such as the Railway Board — only exist on paper and their servants continue to weigh on the payroll,” Ghobril said.

He was referring to the staggering problem of phantom employees. As just one example, the Railway and Public Transportation Authority still employs 350 staff, even though the railways have been closed for decades. Also, some employees are recruited on the basis of their political connections without being held accountable for adding value or being evaluated.

Ending this corruption and waste of public money is essential, as is finding new revenue sources, said Ghobril, who contends that combatting fiscal evasion alone would bring “$1 billion every year to the Treasury from income tax only."

According to him, this “conservative estimate” would reach more than $1.5 billion if other tax revenues are included, which would finance the new salary scale without imposing a greater fiscal burden on businesses and individuals.

There are many other holes and shortfalls that can also help reduce the deficit, Ghobril said. “For instance, 50% of car owners in Lebanon do not pay ‘Mecanique’ fees [annual inspection fees], while 40% of citizens do not pay their electricity bills. If tax collection is improved, this alone can substantially increase revenues. In addition, some illegal sectors do not pay any tax, like [private] power generators, whose global revenues are estimated at $1.7 billion per year,” he added. 

These reforms, along with others, are fundamental to remedy the increasing likelihood of a fiscal implosion. This is especially true since the country is “already living [under] financial crisis conditions,” Toufic Gaspard, an independent economist and former adviser to the finance minister, told Al-Monitor.

In a study he published in August with the support of the Konrad-Adenauer Foundation, Gaspard warned against a possible banking and monetary crisis if structural reforms are not implemented. This caused a public outcry, pushing the Central Bank to publish Sept. 13 an official 10-page clarification for the first time in years. The publication seeks to justify the interest rates paid by the Central Bank to commercial banks and reassure the public that the country is financially stable.

Found in: Economy and trade

Bachir el-Khoury is a journalist based in Beirut. He is a correspondent for several foreign media outlets, including Le Journal du Dimanche, Le Soir and La Tribune de Genève. He also teaches economics at Saint Joseph University in Beirut.

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