Abstract

Fiscal consolidation has been a cornerstone of Egypt’s successful stabilization.9 Over the recent period, new revenue sources were tapped while expenditures were curtailed, particularly subsidies and investment. This section assesses Egypt’s current fiscal position: the evolution of the fiscal deficit and public saving compares favorably with other Middle Eastern and North African countries; on the revenue side, regional comparisons indicate low yields for taxes on personal incomes and consumption. A brief discussion of expenditure patterns is also presented and a baseline medium-term fiscal projection is outlined. The central conclusion is that the gradual structural decline of revenues is likely to continue, offset by reductions in projected debt service. To generate increased public saving and to develop a tax system suited to a dynamic private sector economy, further tax reform is likely to be required.

Fiscal consolidation has been a cornerstone of Egypt’s successful stabilization.9 Over the recent period, new revenue sources were tapped while expenditures were curtailed, particularly subsidies and investment. This section assesses Egypt’s current fiscal position: the evolution of the fiscal deficit and public saving compares favorably with other Middle Eastern and North African countries; on the revenue side, regional comparisons indicate low yields for taxes on personal incomes and consumption. A brief discussion of expenditure patterns is also presented and a baseline medium-term fiscal projection is outlined. The central conclusion is that the gradual structural decline of revenues is likely to continue, offset by reductions in projected debt service. To generate increased public saving and to develop a tax system suited to a dynamic private sector economy, further tax reform is likely to be required.

Current Situation and Regional Comparisons

The fiscal deficit for 1996/97 was about 0.9 percent of GDP (see Table 3), The primary balance (before interest payments) and the current balance (before capital expenditure and net lending) were similarly healthy, both at about 5 percent of GDP, The deficit is entirely domestically financed, mainly through sales of treasury debt and borrowing from the National Investment Bank (NIB).

Revenue accounts for about 26 percent of GDP. Profit taxes and transfers from the Egyptian General Petroleum Corporation (EGPC) and the Suez Canal Authority (SCA), at 5.2 percent of GDP, make up 20 percent of total revenue. Tax revenue (excluding the EGPC and SCA) makes up 55 percent of total revenue. The major tax sources are the general sales tax (GST) (4.5 percent of GDP), customs duties (3.2 percent of GDP), and the corporate income tax (2.9 percent of GDP). Expenditure accounts for about 27 percent of GDP, mainly current expenditure (21.2 percent of GDP). Of current expenditure. 58 percent, evenly split, goes on interest payments and the wage bill.

Table 3.

Cross-Country Comparisons of Central Government Operations

(In percent of GDP)

article image
Sources: IMF staff; and IMF, Government Finance Statistics.

Includes Suez Canal for Egypt.

Regional Comparisons

Compared with similar countries in the region, Egypt’s fiscal position in 1996/97 is sound. The overall and primary balances, except for Algeria, are the strongest, and the current balance (a measure of public saving) is the third highest. The reason why Egypt’s fiscal balance is comparatively strong is because it spends relatively less than (he regional average rather than raising more revenue. Only the Islamic Republic of Iran and Turkey spend less, but more than half of the countries raise more revenue.

Although Egypt raises the average amount of revenue for the region, the revenue sources are different. Most important, it raises relatively little tax revenue. The average tax revenue for the sample is 16.3 percent of GDP and Egypt only raises 13.9 percent of GDP, Of the countries with less hydrocarbon revenue, only Turkey and Pakistan raise (marginally) less tax revenue. Countries such as Israel, Morocco, and Tunisia all raise at least 20 percent of GDP from this source. The principal reason for low tax revenue is low yield from taxes on personal incomes and consumption.

Egypt’s taxation of goods and services, through the GST and excises, raises only 4.5 percent of GDP compared with an average of 6.5 percent for the region, while Israel and Morocco both raise over 10 percent of GDP from this source. The GST was introduced in 1991, amalgamating many ad hoc excise duties and production taxes, and led to a revenue increase of about 1.5 percent of GDP. Nonetheless, Egypt still receives less revenue per percentage point of the standard rate than all the other major regional countries except Pakistan. Also Egypt’s standard rate of 10 percent is the lowest, which, combined with a narrow base, mainly explains its low yield (see Table 4).

Table 4.

Regional Comparison of VAT and GST Rates 1

(In percent)

article image
Source; IMF.

Data refer to 1997 or 1996/97,

G = goods; S = services.

M = import and manufacturing stage;W = wholesale stage; R = retail and wholesale stage.

For Egypt and Jordan, excludes excise revenue classified under the GST.

Revenue yield for each percentage point of the standard rate.

Selected services are taxed

The base for GST is narrowed by exclusion of wholesale and retail trade and exemptions for services and is significantly narrower than most GST and VAT bases in the region, except for Jordan and Pakistan. The higher GST rate of 25 percent only brings in about 5 percent of GST revenue yet adds considerable administrative complexity, as well as making the GST less neutral. While other countries in the region (except Israel and Morocco) have a higher rate, most countries of the Organization for Economic Cooperation and Development (OECD) do not, reflecting the VAT’s role for revenue generation compared with the income tax’s role for redistribution. Egypt also levies many excises in the form of special GST rates for which no input credit can be claimed.10

The comparatively low yield for personal income tax is particularly striking: Egypt raises only 0.7 percent of GDP compared with 3.4 percent for the region, while tax rates are comparable with the regional average (see Table 5). As an illustrative example, if Egypt were to raise the average amount of personal income tax for the region, the budget would gain 2.7 percent of GDP in revenue, or alternatively, all stamp taxes, fees, and local government levies could be eliminated without affecting revenue. The erosion of corporate income tax yield through extensive tax incentives is discussed in Box 1.

Table 5.

Regional Maximum Corporate and Personal Income Tax Rates1

(In percent)

article image
Sources; International tax summaries; and IMF.

Higher rates may apply to selected sectors, for example, banks.

A rate of 50 percent applies to individual business income.

Egypt spends relatively less than other countries in the region.11 On average, other countries’ spending is 3.6 percent of GDP or higher, mainly on current expenditure. More noticeable still is that Egypt’s current primary expenditure is almost 5 percent of GDP lower than the average for the region; only Turkey and Pakistan spend less. Comparing the components of primary current expenditure is difficult, but the main explanation seems to be relatively low outlays on transfers and subsidies, (reflecting Egypt’s recent reforms) and to a lesser extent, on civil service.

Medium-Term Outlook

Over the last few years, expenditure has been declining faster than revenue. An IMF staff assessment of prospective fiscal developments assuming broadly unchanged policies from 1997/98 fiscal year, detailed below, indicates that over the next five years, revenue will continue to fall; but the rate of expenditure reduction will slow, leaving the overall balance broadly stable (see Table 6).

Table 6.

Summary of Government Operations1

(In percent of GDP)

article image
Sources: Data provided by the Egyptian authorities; and IMF staff estimates

Includes the central government, local governments. General Authority for Supply of Commodities, and investment expenditure (and its financing)of the public authorities; not of public sector companies.

Excludes foreign-financed defense expenditure. Total defense expenditure estimated at $3.5 billion.

Revenue

Total revenue is likely to decrease 3 percentage points from 25.7 percent of GDP in 1996/97 to 22.7 percent of GDP by year 2001/02, mainly due to lower EGPC and SCA remittances and stamp taxes.

Income taxes from sources other than the EGPC, SCA, and the CBE 12 are likely to remain broadly stable in relation to GDP. Both the corporate and personal components have been constantly around 3.0 percent of GDP since 1992/93, reflecting their naturally buoyant bases. Improvements to corporate income tax legislation are under consideration, however, including: (!) the elimination of interest expense to the extent of exempt interest income; (2) the elimination of the system of “additions and discounts,” a presumptive withholding tax, to be replaced by within-year estimated advance payments; and (3) granting tax deduction for loan-loss provisions.13

Taxes on goods and services (GST revenues) around year 2000 are likely to increase marginally in the next couple of years then fall back. The extension of the GST to the wholesale and retail sectors in 1998 should secure about 0.5 percent of GDP of additional revenue with the increase spread over the next couple of years. For 1997/98, the gain will be largely offset by granting input credit to new capital goods, although benefits should show up in 1998/99.

While total GST revenue as a share of GDP will be boosted by GST extension to the trading sector, it will, however, be eroded by the comparatively weak growth in landed import value (on which slightly less than half of the GST was collected in 1995/96). By year 2001/02, GST revenue is likely to be the same as in 1996/97.

Budgetary contributions from the EGPC will continue to decline, although at a slightly lower rate. Domestic sales revenue is likely to be buoyant. Even without price increases, domestic sales have been growing faster than nominal GDP. A continued reduction of implicit subsidies for petroleum products, as the government intends, will help boost these receipts. In contrast, export proceeds will continue to decline. With only minor increases in volume and fairly stable prices, export proceeds will continue to stagnate in U.S. dollar terms and decline in relation to GDP. In total, EGPC’s contribution to the budget could fall from 3.2 percent of GDP in 1996/97 to 2.5 percent of GDP in 2001/02.

The prospects for Suez Canal Authority remittances and revenues also look weak. Remittances have been broadly constant in U.S. dollar terms and have fallen as a share of GDP from 3.8 percent in 1991/92 to 2.0 percent in 1996/97.14 The stagnant remittances (in U.S. dollar terms) reflect stagnant SCA revenues which in turn indicate a number of factors: (1) greater competition from the SUMED pipeline,15 the land route, and the Cape route; (2) larger vessel size (many vessels cannot pass through the Canal or pay less per ton); and (3) foreign direct investment (e.g., the number of automobile carriers has fallen). To combat these factors, the SCA instituted a scheme to give reductions to vessels on voyages where the canal route is relatively less advantageous, kept other transit dues unchanged since 1994, and has been working with Jordan to increase traffic between the Suez Canal and Aqaba. There is also an ongoing project to increase the Suez Canal’s draft. Nevertheless, these factors are only likely to maintain the current revenue levels. The SCA remittances will thus likely continue to fall, from 2.0 percent of GDP in 1996/97 to 1.5 percent of GDP by 2001/02.

Corporate Tax Incentives

Egypt’s extensive system of tax holidays and other incentives means many companies do not pay income tax. The system creates a number of compelling problems. Tax incentives are inequitable and inefficient, creating effective tax rates that vary both between and within sectors. They also involve a large revenue loss and arbitrary and ambiguous distinctions about what qualifies and what does not. Moreover, they are not that important in investment decisions. Economic stability, infrastructure, natural resources, trained labor, clean government, and a stable, simple, and certain tax system are all more important. Many foreign countries subject the untaxed income to their own income tax, thus transferring money from the Egyptian treasury to the foreign treasury.

Important benefits could be obtained from streamlining the design of the incentives. Tax holidays, the major incentive granted in Egypt, are particularly inefficient and costly. Loss-making firms do not benefit, and highly profitable investments are attracted that are likely to have been invested anyway. Tax holidays also tend to favor some specific sectors, benefit old firms and extensions more than new firms, and are difficult to abolish. Automatic tax credits and accelerated depreciation have considerable advantages compared with tax holidays. They benefit only new investment activity, encourage longer-term investment, are easier to control, monitor, and administer, and, most important, they benefit each tax-paying firm equally regardless of the extent of their profits.

Despite cutting import tariffs in recent years, Egypt still relies relatively heavily on import duties. The maximum rate of 55 percent (with higher rates applying to automobiles, tobacco, and alcoholic beverages) is high, and, combined with the minimum 4 percent import surcharge and extensive quality controls, the system hinders the development of international trade (see Section X for a comprehensive discussion of trade liberalization issues). Taxes on international trade (customs duties) will continue their recent decline over the next two to three years, as further general tariff cuts are scheduled for July 1998; beyond this there may be further tariff cuts due to the impact of an EU partnership agreement. Import growth is expected to pick up by 2001/02; import duties should contribute roughly the same share of GDP as in 1996/97.

Other taxes will continue to decline in importance, reflecting their inelastic base and a more diversified economy. The main “other taxes” are stamp taxes, which are levied on a myriad of transactions.16 Half of these taxes are specific and have not been regularly raised in line with inflation. Assuming continued erosion at recent rates, revenue from this source is likely to fall to 2.3 percent of GDP in 2001/02 (down from 2.6 percent in 1996/97 and 3.0 percent in 1993/94). Other nontax revenue is also expected to continue to decline. The most important categories, fees, interest income, and self-financed investment of the public authorities are unlikely to keep pace with nominal GDP growth. Profit transfers from public enterprises (excluding EGPC, SCA, and the CBE) are likely to decline as the most profitable enterprises are privatized.

Expenditure

Total expenditure is likely to decrease by 3.2 percentage points in the next five years; from 26.6 percent of GDP in 1996/97 to 23.4 percent of GDP by 2001/02. A key factor will be the continued reduction in interest payments (see Figure 8). Having declined from a peak of 9.5 percent of GDP in 1993/94 to 6.2 percent of GDP in 1996/97, interest payments could fall a further 1.7 percentage points to reach 4.5 percent of GDP by 2001/02. The total debt stock will also fall over the period 1996/97–2001/02 from 95 percent of GDP ($70 billion) to 73 percent of GDP ($73 billion). This fall in both interest payments and declining debt stock mainly reflects the growing economy—both the nominal debt stock and interest payments rise—and the average interest rate moderates only slightly.

Figure 8.
Figure 8.

Actual and Projected Debt Stock and Interest Payments

(In percent of GDP)

Source: Data provided by the Egyptian authorities; and IMF staff estimates

Primary current expenditure will also continue to fall, but much slower than in the past. The wage bill outlays on materials and supplies and other current expenditure are all expected to be constant in terms of GDP. Some further savings are likely to come from pension fund payments, defense outlays, and subsidies (mainly reflecting the stagnant international price of wheat). Also, spending on health, education, and the SFD is projected to be maintained at the current level of 4.5 percent of GDP (see Section VII). Investment expenditure, despite the New Valley project, projected to cost about a billion pounds (or about 0.4 percent of GDP) annually for the next five years beginning from 1997/98, will be kept constant at about 5.5 percent of GDP.

Fiscal Balances

The overall balance is not likely to change significantly over the next four to five years. The current fiscal balance will move broadly in line with the overall balance, but because primary expenditure is only marginally reduced while revenue falls strongly, the primary balance will decline considerably, falling by 1.4 percentage points of GDP by 2001/02.

In the context of the overall macroeconomic framework, the risks to the fiscal projections are limited. On the revenue side, the main risks would be from delays in extending the general sales tax. More substantial risks lie on the expenditure side. Interest payments are projected to decline strongly, which rely on a continued decline in domestic interest rates, strong real GDP growth, and considerable privatization proceeds. Subsidy and defense spending are also vulnerable to increases in world wheat prices and developments in the security situation. The projections also assume only limited budgetary financing of the New Valley project.

Are the baseline projected fiscal balances sufficient to achieve Egypt’s medium-term objective of sustained, high growth? At about 1 percent of GDP and with the financing from noncentral bank sources, the overall deficit is consistent with the inflation and current account objectives. If financing is predominantly from domestic sources, the low levels of borrowing are unlikely to increase domestic real interest rates and thus crowd out domestic borrowing and investment. Similarly, foreign financing, because of the stability of the exchange rate and the sustainable level of debt stock, is unlikely to lead to debt-servicing problems.

Both the debt stock and interest payments are likely to decline over the medium term in relation to GDP (see Figure 8). The combination of a primary surplus and a real growth rate above the real interest rate implies a steadily declining stock of debt in relation to GDP. As the primary balance is expected to remain well in surplus, there is no pressing need to bolster it, other than to accelerate debt repayment. There is a good reason to increase the level of government saving, approximated by the current fiscal balance. As Section II explains, achieving a sustainable growth rate of about 7 percent by 2001/02 requires a significant increase in investment and domestic saving. Specifically, domestic saving needs to rise by about 4 percentage points of GDP by 2001/02. The current fiscal balance, however, is projected to be constant over this period. This increase in total saving may well occur but is far from certain. By improving the public sector’s contribution, the government could significantly help achieve Egypt’s ambitious medium-term economic goals.

Beyond Stabilization. Toward a Dynamic Market Economy
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    Actual and Projected Debt Stock and Interest Payments

    (In percent of GDP)

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