Investment Incentives, Marginal Effective Tax Rates and the Cost of Capital in Egypt

Although taxation is not the most important determinant of investment, it has a major impact on its competitiveness and its net profitability through its affects on the cost of capital and on the expected net profitability from a given investment. This paper attempts to assess the overall tax burden on capital by analyzing the impact of different aspects of the Egyptian tax system (corporate and non-corporate) on the cost of capital and hence on investment efficiency. The effects of the statutory tax rates, related tax incentives and tax administration are also considered along with various activity-specific and economy-wide factors that interact with taxes. A computerized model developed by Dunn and Pellechio (1990) is used to calculate Marginal Effective Tax Rates (METRs) on capital. The study shows that METRs in Egypt are relatively high as compared to statutory income tax rates and to the level of METRs in some MENA countries. Tax rates are further non-uniform, with the actual tax burden on firms varying according to legal form, economic activity, market orientation (domestic versus export), means of financing, types of assets and location. Therefore, if Egypt is to simultaneously promote investment and growth, it cannot avoid a reform of its tax system with respect to the treatment of capital. The reform will have to involve the reduction of tax rates, the unification of tax treatment of various investments, rationalization and targeting of tax incentives, and reforming tax administration.