It becomes obvious nowadays and more particularly in developing countries like Lebanon, that tax incentives are found to be used and carried out in a manner which undermines the intention of the tax law such as where a taxpayer has misused or abused the law. This is typically achieved where the course of action taken by a taxpayer is so blatant, artificial or contrived that it is only explicable by the desire to obtain a relevant tax benefit as it will be more after described in detail. It may occur as well where the tax incentive is so obsolete and outdated that it does not fulfill its true function of economic lever and meet the primary objective of the legislator.
Therefore, and in order to be efficient and achieve its purposes ultimately, such incentives should be well assessed by the authorities, as part of the general social and economic vision, with a view to enact comprehensive, proactive pay equity legislation in consideration therewith. This should be implemented along with a structural reform of our tax regime in view of making it more inclusive, fair and efficient. On that point four questions may be asked and answered in order to outline some of these issues and attempt to suggest some solutions.
- Can tax incentives have counterproductive effects and lead to results contrary to those targeted? What are the measures to prevent it?
It is now recognized that the tax strikes and modifies the pre-established order of things and has effects on the behavior of economic agents or on the market itself, and more particularly on production, consumption and circulation. It also triggers psychological reactions. It is for this reason that its use as a lever for purposes outside its ordinary function of covering public expenditures and charges must be carried out with great care and attention.
Indeed, using the fiscal instrument through incentives for interventionism and cyclical regulation may be useful in guiding the economy and developing it as to ensure some equity through the redistribution of wealth, however this use can also be counterproductive both at the institutional and organic level and at the sectoral level and thus lead to results contrary to those discounted.
- a) At the institutional and organic level (Macro):
First of all, it must be recognized that all the incentives and tax reduction policies granted for economic and social purposes, constitute today what are commonly referred to as “tax expenditures” and must be dealt with in the same way as budgetary allocations and expenditures. However, unlike the latter, they are much less measured, evaluated and controlled. It is often the case of tax exemptions and amnesties which cost and impact would only be known afterwards. It is a kind of waiver of revenues through the application of tax exemptions. This is exactly what occurred for example by reason of the several exemptions and discounts provided by the latest budget laws on penalties due by taxpayers on unpaid taxes and/or late payments as well as for the decrease of the registration fees on residential properties adopted by the Law No 79 dated 18/4/2018 (Budget 2018).
Moreover, these policies often contribute to the creation of bids in the exemptions that eventually neutralize if not to affect seriously the state budget and the situation of its public finances disabling or depriving other essential funding to development. Any favorable provision intended to encourage taxpayers to adopt a particular behavior could only be tax expenditure since it derogates from the present tax structure.
Finally, at this level, the multiplication of particular measures is clearly an element of complexity of the system that is harmful to both the taxpayers lost in this complex jungle and the tax agents who shall have to manage it. The means to hedge against the aforementioned adverse effects lies in a prior economic impact study and the establishment on an annual basis of a report, annexed to the Budget law and discharge bill (i.e. the Finance settlement bill that set out the financial results for each civil year and approve any differences arising out of results), which traces the evolution of tax expenditures by bringing up in a substantial and distinct way the initial projections, the updated evaluations and the observed results. In this regard, it will then be easy to encrypt the direct shortfall derived from a particular measure and the discounted counterpart to term (growth, employment, balance of payments, etc.).
b) At the sectorial level (Micro): Any judgment on a political incentive stems from the capacity to measure the effectiveness of the provisions adopted, which means widely enough from the degree of achievement of the stated objectives. According to Haavelmo’s theorem, “the recovery of the economy shall be possible without any variation in the budgetary balance, the additional expenses being financed by an equivalent supplement of revenues and the national income increasing by the same amount”. Identifying and listing the measures derogating from the policies pursued, quantifying them and determining the beneficiaries by sector of activity and category of taxpayers allows the comparison of objectives and results through costs precisely evaluated. As such, several examples of counter productivity can be identified as for example; the reduction of taxes on the capital (distribution of dividends, interests, etc.) in order to promote productive investment through private financing may lead to opposite results since the beneficiaries of such measures, once their disposable income increased, would find it more useful to save than to invest or consume; which would be less stimulating and useful for the economic activity. Similarly, a policy of stimulating real estate activity by reducing or eliminating the registration and transfer duties and/or capital gains tax (betterment tax) and/or exempting from the VAT can lead to a surplus and to an inadaptability leading to a dangerous hub and consequently a sector crisis. The recent Lebanese and Emirati examples are just one example, to the same extent as were the subprime a couple of years ago in the US. Indeed, and owing to such policies, Lebanon get stuck today with hundreds of thousands of vacant apartments whereas other hundreds of thousands of citizens are deprived of ownership and cannot afford the high value of such apartments and connected inappropriate product range. Hence, the country ended up with this very significant recession and emergency situation triggered by the lack of adapted policies and development programs. Situation which had moreover a devastating effect on the development and growth since the real estate sector has always been during the last two decades an engine and a key driver of economic growth and job creation in Lebanon. Besides, some tax incentives enacted in the last century became obsolete, outdated and henceforth inappropriate and unsuitable to the changing environment. Among those, the permanent exemption from income tax that has been granted to the educational institutions since 1959 (article 5 of the Income Tax Law) and that was originally intended to combat illiteracy since it was vital that everyone receive an education and thus increase school registration in general. However and taking into consideration the eradication of illiteracy over the decades, the overall implementation of such exemption resulted in a departure from its original aim and in an selective use of it as a tax benefit and profitable tool which has led to school and private university multiplications without any serious control and therefore to a decrease of education’s level and concomitantly to the lowering/downgrading of the status of the public school and university.The counterproductive effects apply as well for other permanent or temporary tax incentives such as for maritime and aerial transportation companies that has created a monopolistic situation and unlawful competition in favor of the Middle East Airlines (MEA) with a permanent and unjustified increase of travel and transport rates. Indeed, the permanent exemption provided to the national company by virtue of the income tax law (article 5 of the Legislative-decree No 144 dated 12/6/1959 with its amendments) has granted the latter an abuse of a dominant position that has killed all competition and enabled excessive rates to be charged because of this dominant position. Another unjustified exemption still applying despite the flourishing and developed sector is provided by the Decree-Law No. 50 of July 15th, 1983 to Investment banks and Medium and long term credit banks (Specialized banks) whereas they are exempted from the income tax (17%) during the seven first financial years following the date of incorporation; in addition to an exemption afterwards up to a ceiling of 4% of the bank’s paid-up capital which is considered as a deductible charge. Needles to mention in fine the tax exemption applying on assignment of shares in Lebanese joint stock companies (SAL) which has entitled many evaders to transfer their assets and real estates to third parties assignees or heirs without any tax liability. Finally, featuring among the counterproductive effects, there is the issue of vested rights, owing to the profits thus acquired by certain groups of taxpayers or citizens, which will be difficult to be challenged as we are living the painful experience currently in Lebanon with the reconsideration of social privileges in the public sector or tax privileges in the private sector.
Hence, according to the eminent French Professor Maurice Lauré (the initiator of the VAT), the tendency is to increase the derogating measures, since the new provisions rarely correspond to the elimination of vested rights; with the further risk that their accumulation leads to “a tax system into ruin”. This led the latter to say that “taxes are instruments conceived to collect and not to guide” or “a scalpel, instrument with which we do not lead but we decide”.
Here too, the means to guard against the negative and counterproductive effects is based on the search for a preliminary impact study and a reliable statistical device with the result of sufficiently precise studies of the reactions of taxpayers on tax incentives. Moreover, the observation of tax experiments carried out in respect with groups of taxpayers or similar economic agents has shown its utility in order to measure with accuracy the effectiveness of tax incentives.
Not to mention also that these incentives must necessarily be coupled with factors other than the tax factor but also decisive such as the legislative and political stability, the quality of the infrastructure, the equipment and the workforce, the judicial fair and reliable system, (etc.).
- Positive discriminations as a regulatory tool and a tax equity factor.
Tax incentives are inherently derogatory and therefore generate discrimination. Such inequality rupture may nevertheless be constitutionally accepted as a source of redistribution and equity. Thus, it is accepted that “the principle of equality” does not prevent the legislator from enacting incentive measures for the creation and the development of an activity sector concurring with the public interest, by granting tax advantages. It also assists to promote certain sectors such as the agriculture suffering from a basic handicap and unequal opportunities and circumstances compared to other sectors. Thus, and agrarian and land tax was adopted in Lebanon by virtue of a Law enacted on 20/12/1951 but was never applied and its effects and entering into force were suspended by various legislative-decrees as of the legislative-decree No107 dated 13/6/1959 till the legislative-decree No 40 du 22/2/2007, owing to the deplorable and unfortunate situation of the agricultural sector in Lebanon which does not exceed 4% of the GDP. In fact, the overall economic and financial situation of the rural world, the risks linked to the numerous climatic and biological hazards on which the humankind has very few grip and the constraints resulting from the international competition, particularly from subsidized countries, can justify exemptions and other favorable provisions for this vital sector.In addition, it is worth mentioning that a tax reduction or exemption from a sector or category of taxpayers can be offset by the increased business performance and increased revenues and consumption capacity that will re-establish definitely and by the imposition itself the basic equilibrium.On the other hand and with regard to the principle of equity (or equality), it does not mean an equilibrium “exponential” treatment but should allow “positive” discrimination according to the contributive capacities of each, family or professional situations. It requires ultimately from all taxpayers the same effort according to the famous principle of equality of all before the tax. This principle can take actually two forms: vertical equity that seeks to reduce disparities in the living standards between households and that is intended to be distributive and with equal sacrifice. Whereas the other form consists in a horizontal equity that states that two people in the same situation should have the same rights and obligations. It stands against any kind of discrimination, with a major reserve however, that no individual should benefit from an exemption or a tax privilege that is not accessible to people in a similar situation.Nevertheless, the desire for a social reform and the reduction of inequalities through taxation brings up, as in economic matters, a gap between stated objectives, the means implemented and the results achieved. The idea of equity is first of all unequally perceived and accepted. In addition, many malfunctions appear which obliterate the efficiency and the finality of these measures and which run counter to the concepts of tax justice and equity and this, by the excessive use of the mechanisms of incentive (ex: unequal taxation of wealth and labor income, differentiated opportunities for tax evasion and tax fraud, multiplication of particular categories of taxpayers, etc.).In this regard, we must reconcile the considerations of equality and efficiency. The redistribution or the access to the income for the most deprived persons should not be provided in the form of encouragement to assistantship, inactivity or isolation. Nor should it subsidize massively activities relatively unproductive. It needs to be targeted and directed in the direction of an initiation to work, train, save and invest to ensure a sustainable income that drives growth and consumption and sustainable economic development of the nation and creates jobs. The effective opportunity to access a job is one of the fundamental rights that must be ensured and maximized.
- What are the correlations between tax incentives for savings and tax incentives for investment and promotion of innovation?
There is no doubt that the common goal of most developing countries today is to address the deficit of their balance of payments and low savings, in a way to promote private investment. In this regard, these countries use a range of incentives open to both local economic agents and foreign investors to attract foreign capitals and to carry out projects that will serve to enhance the state of the infrastructures and to modernize them, to develop the territory, to create jobs, to bring in foreign exchange, to stimulate growth and finally to increase budgetary revenues.
Among the indicated measures: the partial or total exemption of the profits or at least the exemption of the part that is likely to be reinvested. Moreover, we can mention other measures such as the signing of tax treaties with the countries concerned and the establishment of investment codes which include tax provisions promoting the investment as well as benefits that may be contractually agreed or on an administrative license. These exemptions and benefits will vary depending on the nature and amount of the investment contemplated. The overall is to reassure the investor with long-term commitments, including the stabilization of tax burdens for a fixed period.Free zones are also another means of achieving the above-mentioned objectives since they ensure, on the one hand, the possibility of securing jobs, planning the territory for the purpose of a sustainable development, achieving priority economic objectives. On the other hand, for the investor, it entitles him to reduce taxation and get rid of complications and legislative and bureaucratic constraints.Internally, savings and investment stimulation can occur from a double point of view: on the one hand, by the ability to save, which results from the reduction of the tax burden and therefore from the increase of the available portion of income that can be used either directly or through banks and financial corporations or collective funds for productive investments. Likewise, this ability to save will also be largely dependent and tributary on the manner in which the remuneration of savings will be taxed.
Secondly, this stimulation of saving will take shape at the level of the companies themselves with respect to the distributed incomes and self-financing capacities. The following would allow the companies to benefit from private savings for their development. However, it would be necessary, as a precondition for incentives and exemptions, to ensure that the agents are willing to save in a context of a productive investment and that the entrepreneurs are willing to invest the money saved. Hence, it is worth specifying that the incentive of savings and investment can also be achieved a contrario by a tax surcharge of the distributed or capitalized amounts (i.e. which emerge from the economic circuit). It is also clear that the tax policy of saving and investment incentives should not have the influence of a short term recovery as a unique consequence and strategy.
Finally, among the concerns that have emerged recently, the necessity of the intervention of the State appears in news fields that are of great importance such as the environment or innovation.
This situation led to the setting up, as in France, under the Madelin law, of special fiscal provisions in the form of preferential measures or tax expenditures. In this respect, we can cite the case of individuals who undertake participative investments (Crowdfunding) and who can benefit from a tax reduction (IR).
In addition to the foregoing and to the same extent, one of the proposals of the French National Conference of 2013 on this matter was to create a “Entrepreneur-Investor” account intended to avoid systematic annual taxations. It would be provided for that purpose, a suspension of taxation of capital gains in case of reinvestment and globalization and a compensation of capital gains and losses recorded in the account.
- How to increase revenues in order to reduce the fiscal deficit although being fair and equitable?
Usually the easiest way to increase revenues is to focus and target on easy-to-collect taxes such as VAT, customs duties at the border and selective high-yielding excise taxes. However those taxes are regressive and very far from the desired objective of fairness and equity. Therefore, all efforts must now focus and stress on the modernization of fiscal institutions and the broadening of the tax base. Besides, mobilizing revenues more efficiently implies a broad consensus on several measures or steps that should first and foremost be adopted. The most important and fundamental of these measures is to combat tax evasion and fraud as well as to incorporate the informal sector into the formal economy, wherever feasible.
Given that the structures of our economy have not changed sufficiently, that the corruption remains endemic, that the inequalities have worsened and that our growth is uneven and never leads to sustainable development, the government may adopt as starting points, for the establishment of a modern system and an efficient tax policy, a number of guiding principles. The first of these principles focuses on broadening the tax base through an efficient struggle against fraud, tax evasion and smuggling. This can only be achieved through the intelligent and gradual orientation of the informal sector towards the formal sector as aforesaid by providing concomitantly to those in a precarious situation, a clear and simplified legal device as well as the necessary social coverage. It would be necessary, in the same way, to distinguish between those who are fleeing taxes and must be duly controlled and sanctioned, and those who make real losses and suffer in order to survive in a competitive market with unequal weapons. To this end, it would be necessary to make sure that the administration is no longer judge and party at the same time, that is to say entitled to elaborate the texts, to apply them and to control the execution as it is currently the case.
The struggle against fraud and tax evasion also depends mainly on seeing that the economic activity generating the tax base is within the reach of the authority of the state and involves necessarily other complementary important measures. These include, inter alia, tackling several loopholes in the current tax system such as the schedular taxes and bank secrecy as well as the weakness of the notification procedures in view to apply on the midterm the tax identification number for each resident, whether national or foreigner, and the general income tax with progressive measured rates. Needless to precise that the aforementioned measures need to be accompanied by an implementation of algorithms and remote of computer groupings of taxpayers’ accounting data, by means of computer interface links and thus, in order to highlight the flaws and to pursue the recalcitrant.
In addition, the tendency of resorting permanently to tax rebates and amnesty should be abandoned inasmuch it affects equity and fairness and causes fiscal civic-mindedness. The result of this will be that taxpayer compliance should improve henceforth with a perception that most are complying and those who do not comply experience adverse consequences.
Hence and through broader taxation the governments could raise additional revenues in an equitable manner to fund inclusive growth as well as social and infrastructure programs, create jobs and fight inequality. This should occur in parallel with an effort of tax harmonization through the regrouping of disparate fiscal provisions in a General Tax Code. It would also be appropriate to extend the scope of the VAT to all the economic activities, to reorganize its ceilings and rates and to guarantee its neutrality and equity, particularly at the level of the products of first necessity which should remain exempted at a 0% rate.
In conclusion, it must be pointed out that any judgment on an incentive policy is based on the effectiveness of the adopted provisions, which is to say largely on the degree of achievement of the stated objectives. The way to prevent it and to succeed is based on the research of a preliminary impact study and a statistical system with reliable thematic data. In addition, there are sufficiently precise studies of the taxpayers’ reactions that must be done. These data should be the necessary preliminary for all analyzes and reflections with an econometric model in order to measure the impact of the change of each factor on the income, the inflation, the consumption or the tax revenues. It is a fundamental tool for preparing the decision.
It goes without saying that Lebanon is requested today to demonstrate transparency and accountability in its use of public funds and true willing to proceed to serious reforms. The international organizations and doors at the CEDRE conference in April 2018 highlighted the importance of targeting fiscal and expenditures reforms to achieve stability and secure revenues to help the country exit its fragile situation and avoid collapse. It is indisputable that the choice of either the policy or steps that should be adopted taxation wise should be guided by the country specific circumstances as well as by operational and practical constraints; taking into account the significant analytic challenges involved in the choice of priorities and urgent needs. Therefore, we have reasons to believe that the Lebanese authorities focus currently on tax revenue collection as an urgent need to cover the several operating costs and aggregate expenditures. The targeting is on the one hand, on easy-to-collect taxes as customs duties at the border and selective high-yielding excise taxes. On the other hand, on measures aiming to broaden the tax base by increasing the number of registered taxpayers and improving compliance with tax obligations along with the rebuilding or modernizing of organizational structures and basic processes of the administration. At a later stage and once the country becomes more stable, the objective should stress on the modernization of fiscal institutions and in depth fiscal reforms as well as through medium-term revenue and expenditures strategies; taking into consideration certainly the country-specific circumstances and conditions at that time. This will undoubtedly help combatting corruption and improve public perceptions of fiscal institutions.
The challenge is huge but stimulating, and we have good reasons to consider deservedly today that the time is no longer to postponed but to action.