The ‘what ifs’ of Egypt’s new VAT law
In theory a VAT would streamline tax collection and bring in more revenue, but lax enforcement and inadequate punishments for evading it could do more harm than good
Courtesy: Laura Cugusi

Egypt’s Parliament approved a value-added tax law on Monday, following weeks of debate. The contentious law is one of a series of controversial reforms put forward as the country struggles with slow economic growth and soaring public debt.

While the exact details of the law will be laid out in forthcoming executive regulations, Parliament has agreed to an initial rate of 13 percent, to be increased to 14 percent in the next fiscal year. Officials also announced that 56 goods are exempt from the VAT in an attempt to ease the burden on the most economically vulnerable.

Whatever form these finer details take, the implementation of the law will have a major impact on Egyptians, but experts are divided about what that impact will be. Opponents of the VAT law argue that it will contribute to inflation and further burden poor Egyptians, while its proponents argue that this form of taxation has the potential to streamline tax collection and simultaneously to tackle the informal economy, thus providing Egypt with a much-needed increase in revenue.

Regressive or progressive taxation

According to Omneia Helmy, a professor of economics at Cairo University, the VAT is an important step in a series of economic reforms for which the medium-term benefits will outweigh the inevitable short-term burdens. For starters, the VAT will widen the tax base, and incorporate more types of services under it than the current general sales tax.

“The proposed VAT law will supposedly include all types of services,” Helmy says, adding that the widening of the tax base will in effect “create a money machine that brings in a lot more revenue for the government.”

Some raise questions about who, exactly, will be funding this money machine.

A VAT is generally considered to be a regressive taxation system that has the greatest impact on the most economically vulnerable strata of society because it claims a larger percentage of their income. As a person’s income rises, the portion of that income which is spent on VAT decreases, Helmy notes. The default model applies a tax on every stage of development a product will undergo as manufacturers transform it from raw materials to a tangible product, the final stage of which is the sale of said goods to the consumer who ultimately pays the VAT.

Lucas Blom, a lecturer at Leiden University’s law department in the Netherlands, says that the regressive nature of a VAT can be counteracted by exempting primary goods such as foodstuffs or taxing them at a lower bracket. To help ameliorate the tax burden on the poor, governments can also adjust other taxes to compensate for the increase in the prices of basic goods.

While Egyptian officials have announced that basic foodstuffs and other essential goods and services will be exempt from the VAT, Helmy believes there will still be indirect effects on the prices of basic commodities. “Even if they do not directly raise the prices of such goods it could still be reflected in the transportation costs and so on,” Helmy explains.

According to Salma Hussein, a researcher from the Egyptian Initiative for Personal Rights, the regressive nature of Egypt’s VAT law is limited by the exemptions. She found no evidence to suggest it would have an effect on costs associated with education, and notes that virtually every commodity consumed by the poor will either be either exempt or taxed at a lower rate. Medication and medical services will also be exempt from the VAT. She believes, however, that the government and parliament have deliberately chosen not to tackle the more important aspect of the law: enforcement.


Bookkeeping and enforcement

The largest challenges Egypt faces in the effective implementation of a VAT law are the sheer size of the informal cash economy and the government’s ability to enforce taxation effectively. According to Leiden University’s Blom, it is very important to raise the level of tax compliance and collection in a country with a large informal economy, and the first step in doing so must come from the government.

“The government must prove to its citizens that it is reliable, and is spending the taxes it does collect on improving society as a whole,” he explains. “Citizens generally have little desire to pay for taxes if they think it is being mismanaged or falling to corruption.”

To successfully implement a VAT, the government and the public sector would have to keep records of their transactions. This would mean that both businesses and individual professionals such as doctors, lawyers and accountants would need to issue invoices, thus formalizing much of the cash economy. According to EIPR’s Hussein the current draft law provides little incentive to issue invoices and maintain sales records.

“The law has many loopholes which the government and parliament are not addressing,” she contends. For example, “the law gives the minister and head of the tax administration the right to exempt any institution they see fit,” she says. A lack of strict, universal penalties incentivizes businesses to evade the tax and strips the law of its relevance.


Hussein does not believe the law itself will have a particularly pronounced impact on inflation, but rather blames other inflationary triggers such as devaluation of the currency and an inadequate enforcement of the law. Once a VAT law is implemented, Hussein fears that many businesses will take advantage of the weak enforcement to raise the prices of their goods and services without contributing to the tax itself. If the government is unable to effectively deal with cartels and monopolies, she adds, then many companies may take advantage of the situation to benefit themselves.

While in the long-term Cairo University’s Helmy believes a VAT would help incorporate more businesses and services into the formal economy, in the short-term at least there will be a crunch felt in particular by low and middle income earners. Small and Medium Enterprises — especially those that operate within the informal economy — would likely incur extra costs as they would have to hire accountants to oversee their books, or spend time and money to learn how to do it themselves properly. “If they manage to effectively tackle tax evasion and incorporate the informal sector to a large extent, it will help contain the inflationary pressures of the tax,” she explains.


Time and timing

Timing, as Blom argues, is very important to the successful implementation of new taxation systems. “The moment you implement a rigorous and invasive taxation system, then unrest usually follows,” he adds. Given the political and economic turmoil Egypt has faced over the last six years, and the initial impact the new VAT law is expected to have on the poor, there is the risk that mounting unrest and an economic downturn would follow thereafter. Such effects, Blom argues, would be most pronounced in industries where the increase in taxes is largest.

It will take years before the effects Egypt’s VAT law can be fully assessed. Helmy argues it will take a long time for the tax to even be implemented effectively, and more time still for the private sector to properly cope. “Every reform has to start somewhere,” Helmy says, “and its effects will not be seen immediately because both the tax administration and the private sector will need a lot of time and training.”

Luiz Sanchez 

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