Lebanon's taxation smokescreen

4 November 2017

On 9 October, after seven months of chatter, Lebanese parliamentarians finally voted in a new tax law, presented as a vital measure to address the country’s economic woes. Extensive debates have not clarified, however, what exactly the reform will do, at what cost, and to whom. Indeed, the duration and complexity of the process have obfuscated the fundamental problems with Lebanon’s taxation system and broader macro-economy. These problems will undoubtedly remain when the smoke clears, and may even be worse than they were to begin with.

As often in Lebanon, legislative proceedings turned into something of a saga. Parliament first tabled a draft law in March 2017, including 22 changes to the existing law—notably a one point increase to the value added tax (or VAT), from 10 to 11%, which became the legislation’s hallmark. The proposal drew condemnation from a handful of politicians and gave rise to short-lived protests in Beirut among citizens who viewed the measure as a way of redressing Lebanon’s economic problems at the expense of average Lebanese. 

On 20 July, parliament nonetheless passed the law, which came into force a month after—until the Constitutional Council froze the law on 31 August and annulled it on 20 September, only to have MPs then pass a cosmetically updated new text on 9 October. An advisor to the Kataeb, the party most virulently opposed to the move, griped: “What politicians did was change the title and remove redundant taxes” [i.e. repeated taxes on the same items]. They also redressed the procedural shortcomings that had ultimately undercut the July legislation. Meanwhile, ordinary Lebanese grew tired of the whole matter, and seemingly resigned themselves to whatever outcome.

The main argument behind the tax hikes is a widening public deficit, which various Lebanese and international bodies estimated at up to 10% of GDP in 2016—and which appeared set to widen following the introduction in August of a new salary scale for civil servants at an estimated cost of $917 million annually. Against that backdrop, Beirut has sought to raise additional revenues from taxation.

Proposed changes, however, suffer obvious shortcomings. Most obvious is the endemic tax evasion at all levels of Lebanese society, which will constrain any efforts to narrow the deficit through higher taxation—and may indeed incentivize creative new forms of dodging. Moreover, tax hikes will do nothing to redress the inefficient public spending that has long fueled Lebanon’s economic malaise. On the contrary, they may well provide Beirut with latitude to continue indulging its worst macroeconomic habits. Balancing the budget, ultimately, should derive from smarter spending and improved tax collection, not higher tax rates.

Particularly disingenuous was the argument—notably advanced by the Ministry of Finance—maintaining that the new system would bear primarily on the wealthier Lebanese, and spare the more vulnerable. True, the VAT excludes basic goods such as bread, rice or dairy products–but it also exempts precious stones, yachts and sailboats. More fundamentally, the new law doesn’t redress, and may indeed exacerbate, the regressive nature of Lebanese taxation—that is, the fact that Lebanon’s tax code places a heavier burden on lower income Lebanese than on their wealthier counterparts. 

This trend is largely attributable to the outsized importance, in the Lebanese context, of so-called “indirect taxes” levied on goods and services—as opposed to direct taxes, such as income tax, that citizens pay directly to the state. Such taxes constitute more than half of the Lebanese state’s budget, and disproportionately affect middle and lower income Lebanese households that spend a large part of their incomes–if not their entire budgets–on such goods and services. By contrast, higher earners are inclined to save or invest, thus decreasing the percentage of their wealth that goes into consumption. The new tax law, instead of correcting the great imbalance between indirect and direct taxes, mostly reinforces this trend by ramping up VAT and other indirect fees that weigh down on poorer citizens.

Moreover, the opaque and convoluted process of tweaking Lebanon’s tax code creates various distortions in an economy already fraught with uncertainty and informality; these distortions, in turn, primarily affect the middle and lower classes. For months, Lebanese have expected prices to increase, leading economic actors—from local supermarkets to private schools—to plan adjustments regardless of the precise nature of government policies. A young Lebanese described a surreal situation at her usual corner shop: “The owner increased phone credit by LBP 5,000. He said that VAT had increased, when the law had in fact been frozen.” In a largely informal economy, many small businesses neither pay nor collect VAT, but are nonetheless keen to use the opportunity to raise their prices, if only because they are suffering from an ailing economy themselves.

Ultimately—and although Lebanon’s tax code indeed needs an overhaul—the measures described above do precious little to redress the structural flaws in a system fueling some of the world’s worst inequality. The past two decades have seen a fraction of the population accumulate wealth while a majority suffered deteriorating living conditions. Even as the overall economic output, or GDP per capita, more than doubled between 2000 and 2014, the bottom half of the population incurred a significant decrease in individual wealth over the same period—from a yearly maximum of $6,519 per adult in 2000 to $6,175 in 2014. The tax law may or may not enable the government to balance its budget; but it certainly won’t help most households do so.

A palpable (and justifiable) trepidation exists within the political class at the prospect of a deepening economic crisis—and the popular anger it would likely trigger. Aside from pinning the blame on the large numbers of Syrian refugees Lebanon has hosted, the government’s response has centered on the taxation saga—although the linkage between these tax hikes and the economy’s deep structural flaws is tenuous at best. Prime Minister Saad Hariri went as far as to claim that, had the law not been passed, “six months later the [Lebanese] lira would have collapsed.” The Lebanese pound may well be in a precarious equilibrium, for reasons that Synaps has explored at length; but Lebanon’s monetary conundrum, serious as it is, calls for fundamental structural reform—not half-hearted fiddling with taxation.

In the final analysis, it seems plausible that Beirut chose to focus on taxes not because they are particularly relevant to the country’s economic shortcomings, but because these hikes happened to be the only thing Lebanese politicians could agree upon—in a system where more meaningful reforms raise all sorts of unseemly conflicts of interests. Unable to articulate any coherent economic policy, the government filled the void with a news-grabbing process designed to create the impression of movement. If movement there was, it ended up being in the wrong direction.

Rosalie Berthier

Lebanon's taxation smokescreen: Houses of Parliament in the Fog by Claude Monet, oil on canvas, 1903, High Museum of Art / public domain; Smoke screen 01 by Alexander W / licensed by CC.