Salah El-Amrousi sees pitfalls in the new income tax law Following two months of intermittent debate, the People's Assembly has approved the new law for income taxes. Aside from minor re- wording, the assembly approved the law as it was presented by the government. The law's architect, Finance Minister Youssef Boutros- Ghali, had insisted that the law must not be tampered with as it was a package deal with delicate consequences and a symbol of the country's new economic thinking. The law, however, was widely criticised with some going as far as questioning its constitutionality. The opposition came from both the right and left wings, businessmen and trade unionists. There are a number of bombshells in the law, particularly in the clauses abolishing tax exemptions for new investment, which would most heavily affect industrial investment and much of the investment in new cities and in tourism. Many fear the abolition of tax exemptions would affect Egypt's ability to attract foreign investment. The loss in revenues through tax reduction (from 40 per cent to 20 per cent on businesses) would be offset by economic growth, we are told. Taxes would boost rather than curtail private initiative and confidence will be restored between tax authorities and the taxpayers. This is supposed to happen through new mechanisms for determining taxes, initiatives to curb tax evasion, and ways for settling outstanding tax disputes. The government reassures us that tax procedures are now simpler and better. But where is the truth in all that? Is it, for example, true that the reduction of taxes could generate an increase in tax revenue? Critics do not seem convinced, many noting that it is odd for a country that suffers from a massive public deficit to reduce tax rates. It is unlikely, critics say, that investment and economic activity would pick up immediately, bringing about an instant rise in revenues. If ever, revenues may increase in the medium term; namely, in three to four years. At worst, the tax reduction may not boost investment, but consumption. The reason for the pessimism is that major obstacles to investment, such as high interest rates, still persist. The abolition of tax exemptions for new investment may, after all, affect business start-ups. We are told the new tax is treating everyone the same. Commercial and industrial activities, new investment and existing business, big and small capital, rich and poor, all are treated similarly. Is this actually good? Does the law, for example, truly stimulate investment? As the law halved the tax rate, from 40 per cent to 20 per cent, it dropped tax exemptions offered by earlier laws. The existing tax exemptions are to be discontinued after a transitional period for existing projects. As for start-ups for which the exemptions are already in place, they are still allowed to enjoy their exemptions for a while, so long as they begin operations within three years. The abolition of tax exemptions, which for 30 years have been the main tool of investment incentives, is an admission by the government that its economic policy of the past three decades was a failure. Advocates of the new law have admitted the failure of the old policy of incentives, accusing businesses of abusing the law by disbanding companies no longer benefiting of tax exemptions and starting new ones. The so-called new taxing system is obviously the brainchild of neo-liberal thinking, which is nothing but a revival of 19th century thinking; the assumption here is that taxes (and tariffs) are best when neutral. In other words, incentives are to be abolished for emerging projects, especially industrial projects. This neo-liberal thinking is not based on any particular developmental strategy, nor is it interested in promoting industry in particular. It is useful to compare Egypt with countries that share some of its characteristics. East Asia and Eastern Europe have little in common. Southeast Asian countries went through an industrial transition period in which businesses needed government intervention on their side. Eastern Europe did not undergo such transition, for its countries already had a functioning industrial base upon the introduction of a market economy. The problem with Eastern Europe's industry was inefficiency and low productivity caused by bureaucratic stagnation and political despotism rather than by central planning and public ownership as some claim. Eastern European countries are still struggling with liberal policies. All of them have yet to exhibit the spectacular successes once seen in East Asia. Egypt's circumstances are closer to those of East Asia in the transitional period than they are to those of Eastern Europe today. Eastern Europe does not need strategies to boost industry because they already have industry. Arab countries with neo-liberal policies do not seem to have industry in mind. Egypt is different. We need to develop our industry. Those who champion the new law have not mentioned the entire truth about Southeast Asia. In Southeast Asia (South Korea and Taiwan in particular), the tax exemptions were not applied alone but as part of a package involving many other measures of state intervention. The state offered tax exemptions, tariff protection, and easy credit by state-run banks, sometimes even at negative real interest rates. The state also intervened directly in technology transfer as well as research and development. In Egypt this was not the case. The tax exemption policy was a failure because it was not combined with the more essential factors in the state development policy. Our brand of protectionism was geared toward protecting an industry that was backward, low in productivity and disconnected from international developments. Now the government has reduced tariffs but at the same time abandoned any true strategy for industrial development. The state is now implementing a free trade strategy coupled with high interest rates. If anything this would discourage investment, particularly ones of an industrial nature. One should make a distinction here between passive and active incentives. At best, tax exemptions offer a passive incentive. What tax exemptions do is leave businesses with more profit; what they do not do is help investors make a profit. Tax reductions do the same as the government under the new system forsakes half of the tax to businesses. Still there is no positive incentive involved, no means of favouring new investment, stimulating industry rather than trade, or of encouraging one sector of industry to grow. Active incentives are what we need. Active investments are more a function of the state of the economy than the surrounding legalities. A dynamic economy offers the prospects of high profits. To make an economy dynamic, however, we need the intervention of the state and the implementation of a package of custom-made measures. Let us take the Chinese example. At present, China is nearly as attractive to investment as the US. And yet, China offers full tax exemptions of three years at most, compared to 10 years in Egypt, and only to companies that export their entire production, with the exemptions reduced to 50 per cent, then 30 per cent and then ending within seven years. China is considered one of the countries which places high obstacles on foreign investment flow and still remains attractive to investors. Some have cited China's example as an argument in favour of the abolition of exemptions, but obviously Egypt is not China. Foreign investment goes to China despite, not because of, its lack of incentives. Those who wrote the tax law were aware of how little it encourages new investment. This is why they added some new incentives in the body of the law. One important incentive was a higher rate of depreciation on equipment and buildings. The new law allows businesses to deduct 30 per cent of expenditures on new and used equipment in the first year, with full depreciation allowed within four years, as opposed to 10 years in the old law. This could be helpful, but more so to business expansions than to start-ups. As for the preferential treatment given to purchasers of used equipment, it is a doubtful step, for it could adversely affect productivity. The law ends tax exemptions to new businesses, but it allows 10 year exemptions for land reclamation projects and five year exemptions for livestock, poultry, fishing and fisheries. This is obviously done out of concern for food supplies, but if legislators were so sure industry could do without tax exemptions, why did they feel the need to make those exceptions? Among other reasons it is because, as Counsellor Mahmoud Fahmi, former chief of the Egyptian stock market said, the new law harms development, hampers new investment, and impairs housing and reconstruction.
