Pandora’s Budget

Tax hikes loom as the Lebanese government faces up to $51 billion in debt

By Sami Halabi

Among the more developed countries of the world it is customary to hold the nation’s constitution as sacrosanct, with governments that violate it swiftly shown the door by way of the ballot. The Lebanese constitution, on the other hand, is more a set of rough guidelines that successive governments have invoked when it suited their purposes, ignoring the tedious elements, such as those that deal with drafting the national budget.

Articles 81 to 86 of the constitution specifically lay out the process for Lebanon’s government to pass a budget. Accordingly, the budget for any year should be proposed by the Council of Ministers, Lebanon’s cabinet, during the second regular session of parliament in October of the preceding year. Negotiations can then be extended until January, at which point, if no agreement is reached, “the Council of Ministers may take a decision, on the basis of which a decree is issued by the president.” This enacts the budget as it was submitted to the Parliament.

“When the constitution states such an article, that means that neither the cabinet nor the parliament can violate it,” said Wassim Mansouri, lawyer and constitutional expert. “What has been happening for years now is that they have been violating this.” According to Mansouri, no legal body can actually punish these constitutional violations because none has jurisdiction to do so; that includes Lebanon’s Constitutional Court, which only deals with issues relating to the elections, not the actual constitution. What successive governments have been doing instead of adhering to the constitution is to follow the rule of the “provisional twelfth,” whereby the government spends the same amount each month as they did in the most recently approved budget — meaning the one passed in 2005.

“Now you tell me that it is mentioned in the constitution, but at that time they did not know that there would be [this amount] of political wrangling,” said Raya Hassan, Lebanon’s finance minister allied with the parliamentary majority. “If there is no budget the only way a country can spend is by the principle of the provisional twelfth, otherwise how would you be able to spend?”

Now that Lebanon has a cabinet, without the excuse of pending elections or a lack of quorum to put off the issue, Hassan has been handed the prickly task of drafting the budget and managing some $51 billion in public debt.

But new projects require new money and that does not grow on olive trees.

Perhaps the most controversial proposal on the table is increasing Lebanon’s value added tax (VAT) from 10 percent to 12 or 15 percent, part of the reforms proposed at the Paris III donor conference, in which Hassan was heavily involved before becoming the finance minister. The proposal is highly unpopular with many segments of society and across the political spectrum.

According to a study by the Lebanese Economics Association (LEA), an increase in VAT by 2 percent would more than double the percentage of the population living below the extreme poverty line from 3 percent to 6.6 percent. People who live in “extreme poverty” are defined as earning less than $2.40 per day and being unable to meet basic food and non-food needs.

A 5 percent rise in VAT would send 8.9 percent of Lebanese into extreme poverty. The number of people living at or under the “upper poverty line” (defined as earning between $2.40 and $4 per day) would also be expected to increase, from the current rate of some 28 percent of Lebanese, to between 30.9 percent (with a 2 percent VAT increase) and 34.7 percent (with a 5 percent increase). What makes matters worse is that most of the revenues from any VAT increase would not come from the poor — it will just create more of them.

“VAT is imposed on consumption, so the more they consume the more they pay; but the poor people don’t consume that much, they don’t really pay a lot of it,” said Jad Chaaban, acting president of the LEA  and co-author of the report. “The problem is whenever they spend a bit more they are immediately subject to the tax.”

While Hassan has not officially announced that she is planning to include a VAT increase in the next budget, she does concede that there is little more she can do to increase government revenues in Lebanon.

“You have very limited room today to think of any revenue measure except VAT,” said Hassan, who spoke to Executive on condition that figures from the budget would not be released.

In case she does decide to propose an increase, Hassan said she intends to “exempt” those living in extreme poverty and offer upper poverty Lebanese “mitigating” measures. One is exempting certain products from the VAT, and Hassan insisted Lebanon has the largest exemption base on earth.

According to the LEA, the exemptions on food items, which constitute almost twice the percentage of household spending for the poorest families (18 percent) than for the wealthiest (9.2 percent) “appear to be progressive.” However, other exemptions, such as those related to education and books, are “highly regressive.”

Then there are the more striking items which aren’t exactly the target investments of a pauper’s portfolio. Yachts and other excursion boats longer than 15 meters and owned by non-Lebanese are exempt from VAT, as is gambling, air transport, precious stones, sale and rent of built property, as well as banking and financial services. Hassan’s explanation for these exemptions was that they are also exempt in other countries for reasons that are both economic and technical.

The other way

Marwan Iskandar, an economist and managing director of MI Associates, said delaying a VAT increase “can be justified” in part, if the government’s treasury account surplus ($4.3 billion at the end of February) is used to cover half of this year’s projected deficit of some $4.2 billion, according to Byblos Bank. He suggested that the rest of the money could be generated from increasing revenues resulting from general economic growth, as tax revenues have grown 48.7 percent in the last two years. At the end of 2009, government revenue stood at some $8 billion, $5.98 billion of which came from tax revenue. Moreover, Iskandar pointed to another source of funds as being the $480 million currently tied up in the Beirut municipality’s account, due to political wrangling between the mayor and the mouhafiz, or provincial governor. He also reckons that some of the pledges from Paris III can still be secured, but doubts the seriousness of many of the donors since the pledges were made before the onset of the global financial crisis.

“[The government] have no right to tax us when they have assets which are underutilized,” said Iskandar. “They need to think about how they can activate the economy. The solution is not in taxation. The solution is attracting major investments in essential, important projects.”

He stressed the need to develop Lebanon’s water, oil refining and exploration potential — a prospect that is harrowing to others.

“Today we are not taking care of our agriculture, environment or industry,” said the LEA’s Chaaban. “If we find oil we will never take care of it; we’ll become more of a banana republic.”

Talk of increasing taxation seems even less warranted when many of the staples of good financial management are still not in place.  According to the finance ministry, last year the government transferred 4.3 percent of GDP ($1.5 billion dollars) to Électricité du Liban (EDL), the state-owned electricity company, with 94.4 percent of that figure going to reimburse the Kuwait Petroleum Company and Algeria’s Sonatrach, Lebanon’s fuel and oil suppliers, for gas and fuel oil purchases.

Hassan said the country’s primary expenditures were split equally between salaries, debt servicing and the cost of EDL. That being the case, one would think that the government would hedge against any future increase in fuel costs as major airlines do to predict their future financing options. However, the Lebanese government still does not have a program to hedge its fuel purchases, which totaled $1.55 billion in 2009.

“It could be something that needs to be explored but today you have structural problems that you need to address irrespective of hedging against an increase in fuel prices. We don’t even have cost recovery; we are not [even] at this stage,” said Hassan in reference to EDL.

Tax evasion is also rampant in Lebanon, with many businesses and individuals keeping two sets of books, one for themselves and one for government auditors. The government has made some headway in terms of tax collection, with the ratio tax collectors to the general population being within internationally accepted bounds, according to the LEA’s Chaaban. But public auditing methodology is outdated, still following Lebanon’s decades-old public accounting law. The finance ministry is now beginning to implement a risk compliance audit system, whereby auditors are not required to assess each and every business — a task that caused public audits to lag behind their respective tax years — but study only segments of the economy that are prone to tax evasion.

An indebted surplus

Ultimately, the issue of Lebanon’s public debt is what weighs heaviest on the budget, with interest payments constituting the largest expenditure item in 2009 at some $3.8 billion. In late-February a media frenzy ensued in Lebanon over the financial management of the governments treasury account, the national equivalent of a personal current account. It was then that the account was found to contain a $4.3 billion surplus [6,500 billion Lebanese lira], while at the same time the VAT increase was being floated as an idea to increase government revenue.

“I didn’t understand the logic behind this and neither did many people in the banking sector,” said Nasib Ghobril, chief economist and head of research at Byblos Bank.

The LEA’s Chaaban added that: “If you hold this [borrowed] money and you don’t invest it you are paying [interest] on it anyway, you have to invest it in the right way. They want to keep it as a buffer which doesn’t make sense.”

Responding to such criticism last month, Hassan called a press conference where she stated that the surplus was “pre-funding” that would not increase the amount of payments at the end of the year and would be used as a buffer to pay off future debt for a period of three months.

Back to basics

While media reports have quoted the level of expenditures in the upcoming budget at anywhere from $10 billion to $13.6 billion, the finance ministry has remained tight-lipped on a final figure. Aside from enacting procedural reforms, many other options are also on the table, including raising taxes on interest profits in the banking sector and levying higher taxes on Lebanon’s booming real estate sector.

“Taxation serves as a correction facility for sectors that have gone out of control,” said Chaaban. “You cannot keep taxes low on real estate investment. It’s a crime. It’s wrong.”

Quite predictably, real estate executives have balked at the proposal of raising taxes on their operations. Currently taxes in Lebanon specific to real estate fall on consumers, not developers.

As Executive went to print, Hassan confirmed that individual ministerial budgets had been set. In the end however, any budget that does emerge will not be one based on performance because, with the exception of the education ministry, the finance ministry has yet to implement a performance-based budget using key performance indicators (KPIs) to evaluate expenditures.

Not having such a system in place to appraise a ministry’s performance is tantamount to floating money down a river and hoping it arrives where it is intended. The lack of standards also neuters the public’s ability to judge their ministers’ performance come election time. Making matters worse, state-owned entities like the Regie Libanaise de Tabacs et Tombacs, the body which controls the tobacco trade, and Ogero, the incumbent fixed-line telecom operator, are granted unmonitored lump sum payments by the finance ministry, with any surpluses later annexed to the treasury after these entities close their books.

Lastly, entities such as the Central Fund for the Displaced, the Council for the South, and the Council for Development and Reconstruction are funded outside the budget and approved by special laws and ministerial decrees. While there is some financial rationale behind this, given that some foreign financing must adhere to donor guidelines and not government ones, Hassan believes that the amount of government spending outside the budget could exceed 20 percent of total spending.

With so much at stake, so much being wasted and structural reforms only beginning to emerge, the prospects for Lebanon’s public finances are far from rosy. If no new budget is passed — as has been the case for the last five years — no new major government projects can take place in the country; meaning Lebanon’s people and businesses will have to remain content with the country’s decrepit infrastructure, among a multitude of other failings.

Without a budget, “We will not [be] able to do much,” said Hassan. Indeed if the status quo does persist, Hassan may find herself submitting next year’s budget before this year’s — at least then, it might be constitutional.

First published in Executive Magazine’s April issue.