As part of Executive’s ‘10 Ways to Save Lebanon’ issue, we asked leading experts from a range of fields to put the case for one major policy for the country. In this article, economist Jad Chaaban makes the case for rewriting the country’s tax laws.
Lebanon’s current tax rules are both deeply unjust and ultimately counterproductive. They are unfair primarily because they rely so heavily on indirect taxation — mostly Valued Added Tax and taxes on consumption. On average, when you buy goods in Lebanon, 18 percent of the cost is tax. These indirect taxes make up 70 percent of the government’s revenue and equate to around 12 percent of gross domestic product.
In contrast, direct taxation — income tax and other levies paid directly by individuals and companies — represent just 6 percent of GDP, compared to 15-20 percent in most western European economies. This is vitally important as indirect taxes are deeply regressive. With VAT and other indirect taxes, the rich pay less as a percentage of their income than the poor. Consider, for example, the country’s phone tariffs — the highest on average in the Middle East. Of the average 15 cents per minute phone call, around 65 percent is indirect taxes. These taxes are exactly the same for a millionaire banker as they are for a local shopkeeper, but will cost the shopkeeper far more as a proportion of their income.
Even the direct tax system is often unfair. While income tax is at least partly progressive (though there is still only a 15 percent top rate), the same can’t be said for company taxes.
As an individual starting your own business, you pay a progressive tax rate ranging from 4 to 21 percent, but as a limited liability company or corporation you pay a flat 15 percent rate. That means that if you are a tailor or a web developer and you set up your own company making $200,000 a year, you pay 21 percent tax. But if you are a bank making $200 million a year, you pay 15 percent. This is deeply unfair.
This is also counterproductive as it is polarizing Lebanese society economically. In 1974, the share of families on middle incomes was around 60 percent. By 2004, this had dropped to 20 percent. The civil war and the ensuing decades have created a system where the richest 20 percent of the population has 50 percent of the wealth, while many more live on or below the poverty line. The middle class has largely disappeared.
Building on broad shoulders
This matters not just for social cohesion but for economic growth — an innovative and hard-working middle class is vitally important for both job creation and democracy. Study after study has shown how important it is for economic development that the population feels invested in the system.
The first priority is the reform of direct taxes to make them both fairer and more numerous. Increasing direct taxation for those in the higher income brackets would generate vital revenue for a government that faces a spiraling public debt and little to no growth in the coming years. Asking the rich to pay more in direct taxes, while keeping taxes low for those with lower incomes, would begin to make our society fairer.
Likewise, we have to start to close the loopholes that allow some of Lebanon’s most powerful businesses to avoid paying their fair share. Hugely profitable companies often use various techniques to pay very little tax, such as registering as a holding company, which allows for taxes as low as 4 percent. Taxes paid by the hugely profitable (but low job creating) real estate sector, for example, constitute just 2 percent of GDP, while real estate transactions constitute 25 percent of GDP. Even a small rebalancing of this would have a major effect on the deficit.
With this extra revenue, indirect taxes could be scaled back over time, making the system fairer for all. We need to provide more support to the poor and ask more from those with the broadest shoulders.
Critics will argue that the state’s deep inefficiency means increasing taxes will just increase corruption. But this attitude exacerbates an already vicious cycle; as the middle class flees and the rich opt out of the system altogether, the state slides ever further toward economic and political collapse.
These reforms would require a strong political consensus, which looks hard to achieve given politicians’ close ties with the wealthiest Lebanese class. In fact, many of those in the new government either have significant economic empires or are allied with them. Yet a stable and thriving Lebanese economy can only be reached with more equity and economic justice, and this has to include a reform of our tax system.