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AUC research papers suggest progressive tax scale, other reforms to reduce income inequality in Egypt

How can Egypt change its tax system to bring about both economic growth and greater equitability

Sherine Abdel-Razek , Thursday 1 Feb 2018
Cairo
Pedestrians walk along a street in downtown Cairo (Photo: Reuters)
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Egypt’s tax system has many flaws that not only limit its contribution to boosting economic growth, but also deepen inequality, with most of the burden being shouldered by those on lower incomes.

Tax revenue represents only 12.5 per cent of GDP, as compared to 20 to 25 per cent on average in countries within the same income group. And while there are five income-tax brackets ranging from LE7,200 to LE200,000 annually, these brackets are not organised on a progressive scale.

This results in a single tax rate of 22.5 per cent for those with an annual income ranging between LE200,000 and LE621,000, considered the highest-income stratum in Egypt.

As a result, the contribution of those in the highest income brackets is only 1.3 per cent of the total tax revenue. Indirect taxes such as consumption taxes, the bulk of which come from lower-income brackets, contribute 40 per cent of the total tax revenue.

While there is no reliable data on how wealth is distributed in order to know how fair the tax system is, the annual Global Wealth Report issued by the Swiss Credit Suisse Research Institute includes Egypt among 12 countries with extreme inequality and one of the nine countries with the most rapid growth in inequality of wealth.

Working on policies that aim at striking a balance between economic growth and equitable development, Alternative Policy Solutions, a one-year-old American University in Cairo (AUC) research project, has issued two papers on how to reform the tax regime in a way that increases revenues while adopting fairer taxation for different income brackets.

“The sharp and rapid concentration of wealth in the higher-income brackets has the negative consequences of hindering economic growth, increasing speculation, and prompting imbalances in the balance of payments, in addition to the social consequences of the widening gap among social classes,” states a paper entitled “Towards a Wealth Tax in Egypt”.

The paper highlights recommendations by the IMF and the Organisation of Economic Cooperation and Development (OECD) to impose a tax on net wealth (after deducting debt), including movable assets such as securities, as a means to overcome problems with the tax system.

This wealth tax, imposed on both movable and immovable assets, would replace the current property tax which in its current form has failed to meet projected yields. The actual collected revenues of the property tax in 2015/2016 came in at only 68 per cent of the projected figures. On average, this tax represents only one per cent of GDP.

“Following a progressive tax rate that starts at one per cent for the segment that owns more than $1 million, and then grows until it reaches five per cent for the segment that owns more than a $1 billion, could generate triple the current property tax revenue,” notes the paper.

On the road to achieving this policy, Egypt should start reforming existing taxes on profits, the most important of which is the real estate tax. Real estate represents 68 per cent of total wealth in Egypt, and such taxation would not impact growth or productive investment.

The paper calls for adopting more transparent and practical criteria for the valuation of properties, establishing a unit to resolve disputes over valuations, and replacing tax exemptions with tax credits (deductions in taxes rather than in taxable income).

The paper also recommends reinstating the inheritance tax, which was annulled in the mid-1990s. For the authors of the paper, this is a more equitable tax than that on real estate as the tax burden is distributed on heirs and changes according to their numbers rather than by the size of inherited assets.

Another paper issued by the AUC project is entitled “The Stock Market: Efficiency and Equitability” and calls for increasing taxes on stock-market transactions. According to the paper, capital gains and dividends from stocks are not currently taxed, despite being included under taxable sources of income under the income tax law. In March 2017, the cabinet froze the imposition of a capital-gains tax until May 2020.

This was due to the belief that the stock exchange is one of the primary channels through which investors’ money is transferred to the real economy. It was assumed that lowering tax rates would stimulate this channel, the paper said.

“The aim of low taxes is to encourage economic growth, but they don’t do this,” Samer Attallah, an advisor to the Alternative Policy Solutions project, said. “Low taxes on transactions encourage speculative activities and do not help to direct investments and capital to the real economy.”

To reverse this situation, the paper calls for imposing a unified capital-gains tax on profits as a means to discourage hot money transactions. It also calls for imposing a stamp duty even when capital-gains tax is imposed. This would be while leaving room for the possibility of calculating the duty as a deductible acquisition cost in the medium and long term when calculating taxable profits.

“We need to attract long-term investment while increasing the cost of speculative activities,” Attallah said. Egypt introduced a 10 per cent tax on capital gains in July 2014, but suspended it for two years in 2015. It then extended the freeze for another three years in 2017. Last year saw the introduction of a stamp duty on stock-exchange transactions for both buyers and sellers. Investors have to pay LE1.25 duty on each LE1,000 worth of transactions in the first year, rising to LE1.5 in the second year and LE1.75 in the third.

“The stock-exchange taxes do not aim at limiting investment but at directing it to activities with better developmental and economic outcomes, as well as limiting the negative effects of speculation,” Attallah said.

* This story was first published in Al-Ahram Weekly  

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