What happens when a country outgrows its laws? When nearly a third of the workforce labors in the shadow market and 90 percent of residences go unregistered? To start, collecting taxes becomes a headache.
As Egypt’s population swelled over the past few decades, the tax system sank into a largely ungovernable morass, with compliance shrinking to dismal levels. Such was the state of things in 2005 when Ashraf Al-Arabi joined the Ministry of Finance as the minister’s chief advisor on tax policy.
“The relationship between the taxpayers and the tax administration used to be a worst case scenario, he told Daily News Egypt during an interview in his sprawling Nasser City office, seated at a desk crowded by a half-dozen telephones – testament to what he jokingly called “the Egyptian prestige.
Much of his work at the ministry has aimed to snip red tape, build a “culture of trust with taxpayers and simply get people to sign up, he said. Over the past two years, his team has advanced a phalanx of reforms, slashing corporate and personal income taxes, revising stamp dues and property taxes and, recently, excising tax exemptions for treasury bills.
“What we’re trying to do is change the culture, Al-Arabi said. “Whenever we have a gray area in the law we try to make it black and white.
There is still a long way to go, as Al-Arabi readily admitted. According to “Doing Business in Egypt 2008, a report published by the World Bank and International Finance Corporation (IFC), Egyptian tax law ranks 150 out of 178 countries on the ease of payment.
But there are signs of progress, Al-Arabi said. After one year of reforms, the number of returns filed leapt from 1.4 million to 2.4 million, he said; the next year they shot to 3.1 million. Total revenue rose from LE 1.4 billion, to LE 4.4 billion and to LE 7.4 billion last year, a jump from 7 to 9 percent of gross domestic product.
“It’s getting better every day, Al-Arabi said. “It’s a very exciting time here in Egypt for someone like me.
A 2005 cut in corporate taxes was one of the earliest and most substantial reforms pushed by Youssef Boutros-Ghali’s ministry, pitched with the theory that lower taxes could boost revenue by getting more people to comply.
The law eliminated a range of corporate tax holidays and set tax rates at 20 percent for all businesses, a large drop from the previous rates, which were either 32 or 40 percent depending on how much money the firm made. The act aimed to reduce paperwork and other transaction costs, said Monal Abdel Baki, an economics professor at the American University in Cairo. “This was very helpful to corporations, she said. “Investors were very happy.
But according to the IFC report, this was not universally the case.
“Changing from administrative assessment to self-assessment meant a whole new way of doing business for the tax authority, the report wrote of the reform. “There was a perceived loss of control, and mid-level management had to be convinced that the changes were positive.
Taxpayers, newly responsible for calculating their own fees, were perplexed, the report claimed; the average number of pages required for returns shot from 25 to 42. “Several sections of the form were left blank, because the taxpayers did not know how to complete them and many tax officers were unable to explain the changes.
A massive public awareness campaign ensued, including 400 advisory visits, 230 seminars and 2 million answered phone calls, according to the finance ministry. Despite the turmoil, corporate returns jumped from 1.7 million to 2.5 million, the IFC report said.
Other reforms, while less prominent, have been important. In 2005, the Finance Ministry pressed another bill that rearranged the customs, or stamp tax. The World Trade Organization recommended this reform – or “inflicted it, in Abdel Baki’s words, due to many developing nations’ displeasure with the accompanying regulations – earlier in the year as a way for countries to comply with changing membership requirements. The bill cut the number of categories triggering the stamp tax from 27 to six and lessened the average tax from 14.6 to 8.9 percent.
Al-Arabi said Boutros-Ghali would like to see the stamp tax abolished eventually, but as it now nets about LE 8 billion per year, such measures will have to wait.
One of the Finance Ministry’s most recent goals is the makeover of the sales tax. Officials would like to adjust the current setup to a value-added system, a model designed in France in the 1950s that taxes each rung of the distribution ladder rather than the final sale alone, a process that in theory discourages evasion.
“This will make it comparable to any good law applied in any modern tax system in European countries, Al-Arabi said. “We will be able to introduce this law as soon as the economy is really allowing us.
He said the ministry is planning on submitting the proposal to parliament by November, though inflation – expected to hit 20 percent in the coming months – is too high to consider installing it right away.
Real estate taxes are also changing as the Egyptian housing market continues to bustle. A new law will set dues at 12 percent of a unit’s annual rent.
Practical snags here are clear: Nearly 90 percent of residential units are unregistered in Egypt, said Abdel Baki, adding that the state estimates it will take four years to register a significant number. The process will likely begin with high-rent developments on the North Coast and in the satellite cities of Sixth of October and New Cairo, she said.
The reform – which will exempt units with annual rent less than LE 2,800 – has sparked some controversy in regards to fixed-income renters, often senior citizens living in inherited homes, whose property values have appreciated beyond their means.
“The People’s Assembly is asking the Minister of Finance to take these people into consideration, said Abdel Baki. “This [the reform] should not mean you have to ask them to sell off their property and move to a shantytown simply not to pay taxes.
The general mood of change is not without its discontents. The most recent tangle came when the state revoked tax exemptions on treasury bills as part of a larger packet of price hikes early this month.
The removal spooked some foreign investors, who interpreted it as a prelude to a capital gains tax, which the Cairo and Alexandria Stock Exchange (CASE) has historically avoided.
“A couple of days back one of the officials at the Ministry of Finance said, ‘for the time being, there’s nothing of the sort,’ Abdel Baki said of a possible capital gains tax. “This term, ‘for the time being,’ resulted in an immediate panic in the market.
The presence of non-Egyptian investors in the CASE ranges from a quarter to a third, Abdel Baki said. “If one quarter of your funds just flees the country, this is going to result in huge declines.
The ministry has since scurried to mollify investors, saying such a tax is not in question. While investment seems to have calmed, the incident showcased the fragility of the Egypt’s nascent, though quickly blooming exchange.
The most daunting hurdle to the tax administration remains the sheer scope of the informal sector, where Al-Arabi said 2.5 to 3 million businesses run.
Some analysts guess that nearly 8.2 million Egyptians work beneath the state’s radar, over a third of the country’s workforce of 22.5 million.
Such figures suggest recent reforms have been an active first step, but far from the last.
Al-Arabi said the government now collects returns covering about 12.5 million people through corporate and individual taxes. “Compared to the number of inhabitants in Egypt, we consider this a low number, he said. “This will take some time.
