New taxes in Egypt’s latest economic program will do little to spur recovery

New taxes in Egypt’s latest economic program will do little to spur recovery

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Thu, 28/03/2013 - 16:53

It’s easy to lose track of how many economic plans the government has presented since President Mohamed Morsy’s election, the endless dialoguing around it that often leads nowhere and the numerous economic decisions taken and suspended by officials wary of a harsh public backlash.

The back and forth has consistently proven detrimental to the perception of the overall economy, by both local and foreign investors, at a time when the cash-starved government is in dire need of luring capital into the market.

Just this week, a sudden decision was announced by the Egyptian Tax Authority to implement a 10 percent capital gains tax on shareholders who profited from the takeover of National Societe Generale Bank by Qatar National Bank. Shares of NSGB, the second biggest private bank, fell 10 percent, pushing the benchmark index down to its lowest level since December.

The move has alarmed already cagey investors and further highlights the ad hoc nature of Egypt’s economic decision making, all of which serve to undermine the credibility of the local market.

The capital gains tax comes as part of a bundle of taxes presented in the government’s latest economic program, which, after delays and modifications, was billed as the way to spur recovery and bring about social justice, while paving the way for a long-anticipated agreement on the $4.8 billion International Monetary Fund loan.

Initial reactions from those inside and outside Egypt, however, suggest that those lofty ambitions are out of reach. More importantly, the new economic program may well fail to restore the beleaguered public finances or light the much-needed spark for economic growth. Sources have reported that even the IMF — whose loan negotiations are seen as the main reason behind a bundle of controversial taxes introduced in December — is unhappy with the latest version of the economic program.

Compared to what was proposed and removed in December, the new plan is meant to soften the social consequences of the reforms, decreasing the number of products and services that will bear a tax hike from 25 to six, as well as by raising the income tax exemption ceiling from LE9,000 LE to LE12,000.

Morsy stressed that this latter measure would alleviate the tax burden of 2.5 million families. Compared to the November plan, mass consumption products such as fertilizers, cooking oils and wood are exempt from tax increases.

Still, the six products that will see a tax hike are widely used by a majority of Egyptians: cigarettes, soft drinks, steel rebar, cement, mobile phone use and alcoholic products.

A new, old plan

The new economic program makes few new propositions despite it being a supposed result of a national dialogue called for by the president after the public backlash prompted by the December plan resulted in the suspension of its implementation, namely the bundle of new taxes.

But the public sessions of the dialogue showed how far the first tax plan was from general expectations.

The confirmation of a majority of the measures introduced in the initial plan is a tacit acknowledgment of the failure of this dialogue, as the government struggles to find a balance between the proposals of the IMF on the one hand, and the mounting pressure from the public and the private sector on the other, who will bear any further economic muddles.

The lack of an ideological shift from previous economic models was also highlighted by critics of the program.

In a December interview, independent economist Reda Issa told Egypt Independent that the economic plan presented by Morsy is the same as former President Hosni Mubarak’s and those of former Prime Minister’ Kamal Ganzoury’s Cabinet.

“I compared it with the 2008 program under Mubarak and it’s the exact same,” Issa said.

Towing the same line, unfair indirect taxation is still favored at the expense of progressive direct taxation.

“We actually need, instead of having amendments here and there, to revamp the whole taxes system,” former Prime Minister Ali Lotfy, who served under Mubarak in the 1980s, said during one of the national dialogue sessions.

No solutions are offered for the longstanding major shortcomings in the tax collection process. “The historical problem of the government is to collect direct tax from private companies and individuals,” said economist Amr Adly in a previous interview.

Relying on Suez Canal revenues, tourism inflows, and rents from petroleum products, the governments of the past decades were able to avoid tackling this sensitive issue; but this has led to the mushrooming of the informal sector and a widening gap in the budget.

Governments have resorted to indirect taxes to boost revenues and, as Adly says, “The old regime had no legitimacy to force people to pay taxes.”

Moreover, the actual tax system offers little incentive for the informal sector to formalize its business presence. For instance, the income tax law puts citizens earning LE4,000 a month in the same bracket as those earning LE80,000. Also, companies of all sizes pay a flat 25 percent corporate tax.

The minor shift in the progressiveness of the income tax law does little to alter the fundamental injustice of the overall system.

In a statement following the suspension of the initial tax plan, the Freedom and Justice Party said it “does not accept issuing decisions that affect large segments of society while parliament is absent.”

Inflation and discontent

Beyond the fact that these measures are being taken without the consent of an elected parliament, the timing of the reform adds stress to an ailing financial system. With the pound in a steady decline against the dollar, and foreign reserves down to critical levels, inflation reached 8.7 percent in February. Vital food and medicine products have been heavily affected and experts fear price increases will continue.

Raising taxes on mass-consumed products and services such as cigarettes, shisha tobacco, soft drinks and mobile communications will push inflation higher and affect the purchasing power of the majority of Egyptian families.

With unemployment also soaring, reaching 13 percent in the fourth quarter 2012, according to CAPMAS, fears loom over the further fueling of social discontent amid an already flammable political and economic climate.

The IMF loan, which is expected to unlock around $15 billion in further aid and investments, looks further away from completion than it did a couple of months ago

Sector destabilization

The sales tax hike purposely targets luxury industries: beverages, tobacco, telecoms and real estate. Still, the increases will inevitably affect investment and employment levels in these sectors, and the tax burden will probably be borne by consumers.

Coca-Cola Company, for example, said it would pass the hike on to consumers.

Meanwhile, mobile operators increased prices of pre-paid cards by 18 percent in January in answer to a 5 percent sales tax increase to restore a reported drop in profit margins. There is no reason to believe they would not do the same again.

Mobile operators Egypt Independent contacted refused to comment on this matter.

The tax hike on cement and steel has already hindered the construction materials sector in the midst of sizeable cost increases. The devaluation of the pound raised the price of raw materials, while energy bills have ballooned.

According to Bruno Carre, general manager of Suez Cement, his company had to bear a 30 percent increase in gas prices in 2012 and a new 70 percent increase on gas and mazut in 2013.

Energy amounts to more than half of production costs — this along with ongoing industrial action and energy shortages diminishing production levels. Cement prices have soared as a result of these combined factors.

Despite the inflationary environment, the real estate sector is still growing. It remains a safe haven for investors who cannot take their money out of the country and are fearful of investing in the private sector.

But small contractors have faced difficulties between soaring costs, a flourishing black market and buyers who suffer from the crisis. “My profits are shrinking and I do not want to invest anymore because I am scared to lose money,” one contractor tells Egypt Independent.

In the longer term, fewer homes may lead to a more pronounced price increase in the future.