The proposed salary scale introduces an increase in spending of roughly $1.4 billion in public sector salaries. These funds will come from various taxation schemes, one of the most controversial being an increase in taxes on banks. The proposed bill would firstly increase the tax on depositors’ interest income from 5 to 7 percent. Secondly, it would increase the tax on banks’ interest revenues from various government securities from 5 to 7 percent and disallow deducting these sums from the banks’ income tax bills. Finally, banks would pay 17 percent income tax instead of the current 15 percent. The proposed bill has caused much controversy not only in the ranks of Parliament, but also among economists and members of civil society. Executive invited Ghassan Dibah and Nassib Ghobril to argue opposing sides in this debate.
Here is Nassib Ghobril’s take on this issue.
First, contrary to the prevailing cliché, the Lebanese banking sector does not live on an island in isolation from its operating environment. In fact, any banking sector in the world is the most affected sector by the deterioration in its operating environment, as banks lend to all segments of the economy. Given that Lebanese banks have lent heavily to the private sector, they have felt directly the impact of the economic stagnation as reflected by the steady rise in non-performing loans from 3.7 percent of total loans in 2011 to 3.8 percent in 2012 and to 4 percent in 2013. Indeed, private sector loans totaled $47.5 billion at the end of March 2014, which is equivalent to about 104 percent of GDP, more than twice the 49.5 percent of GDP ratio for the Emerging Europe, Middle East and Africa region. More specifically, Lebanese banks extended $20 billion in loans to Lebanese corporates, small and medium enterprises and households between 2008 and 2013, which has contributed to the social and economic wellbeing of citizens.
Second, contrary to another cliché, the Lebanese banking sector is not constantly generating astronomical profits. In fact, the prevailing economic stagnation since 2011 has hurt banks’ profits and profitability, as the return on average assets of the top 14 banks in the country has regressed from 1.14 percent in 2011 to 1.1 percent in 2012 and to 1 percent in 2013, which is a low return by both regional and emerging markets standards. Also, the top 14 banks’ return on average equity, a key measure to attract new investors and retain existing shareholders, regressed from 13.2 percent in 2011 to 12.9 percent in 2012 and 11.8 percent in 2013. Other factors that have increasingly affected banks’ income include the reduced number of lending opportunities due to the prevailing domestic and regional uncertainties, as well as the rising cost of compliance. It would be very inappropriate to raise taxes in this unfavorable environment.
Third, the proposed measures include a tax increase from 5 percent to 7 percent on the interest that accrues on deposits. This tax would punish thousands of Lebanese senior citizens and retirees whose sole source of income is the interest revenues that their lifetime savings generate. The tax increase may consist of two percentage points, but it is effectively a 40 percent increase in the tax rate. As a result, the tax hike will reduce retirees’ income, while the increase in the cost of living has already reduced their purchasing power. The multiplier effect of this tax increase will result in lower consumption and, therefore, reduced VAT receipts to the treasury. Another potential impact of this tax hike is a slowdown in deposit growth.
Fourth, the other taxes on the banking sector include an increase of the tax rate on the banks’ interest revenues from several categories of government securities from 5 percent to 7 percent and an increase of the banks’ income tax from 15 percent to 17 percent, in addition to the elimination of the deductible component of the tax on interest rate deposits. These tax hikes may look like simple increases of two percentage points each, but the banks’ real income tax rate would jump to 33.4 percent given the effect of the double taxation of revenues and profits. This would reduce overnight the net income of banks and, therefore, the level of dividends they distribute to shareholders. In turn, this would force banks to look for aggressive cost cutting measures that could include freezing recruitment, laying off employees, reducing bonuses and limiting salary raises, among others. It could also compel banks to raise interest rates on loans of all kinds, which would hurt companies, consumers, households and the economy overall.
Fifth, beyond the direct impact on the banking sector, the misdirected decision to target a successful sector with arbitrary taxes can only backfire on the entire economy and on the country’s brand image. The tax hikes on the banking sector are bound to reduce investor interest, discourage entrepreneurship and risk taking, and divest projects to economies with a more stable and transparent tax system. They would also raise legitimate questions by investors and businesses: Would the politicians’ insatiable appetite to continue spending make them target another successful sector of the economy with punitive taxes? If the instinctive approach to public policymaking consists of indiscriminate tax hikes, is there any serious political will to improve the country’s investment climate and its business environment? Would the calls to stop wasteful spending, fight tax evasion and tackle corruption remain lip service for political expediency? In short, this haphazard approach to taxation is a gratuitous favor by Lebanese politicians to competing banking sectors and economies in the Arab world and in emerging markets.