IV Fiscal Policy
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Ms. Nicole Laframboise
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Ms. Patricia Alonso-Gamo
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Mr. Alain Feler
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Mrs. Stefania Bazzoni
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Mr. Karim A. Nashashibi
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Sebastian Paris Horvitz https://isni.org/isni/0000000404811396 International Monetary Fund

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Language:
English
Print Publication Date:
06 Aug 1998
Keywords:
OP; government; reform program; public enterprise; Algeria's achievement; market economy; hydrocarbon GDP; incomes policy; tax effort; price liberalization; Consumption taxes; Income and capital gains taxes; Civil service
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Abstract

The transformation of Algeria from a centrally planned economy to a market economy was accompanied by a major reorientation of the government’s fiscal policy. Under the central planning system, fiscal policy focused mainly on allocating the rent extracted from hydrocarbon exports to maintain a large civil service, provide generalized transfers and subsidies, for both consumption and production, and undertake large nonpriority public investment projects. With the emergence of a market economy, the government endeavored to limit its role to the provision of public goods and services. In addition, the budget assumed a major role in the stabilization process by bringing about macroeconomic stability and releasing resources to the private sector through fiscal consolidation. On the structural side, the budget was strengthened by recasting the tax system to gradually reduce the dependence on hydrocarbon revenue and by reorienting expenditures to growth-promoting areas such as education and health, while improving the targeting of social safety nets to protect the most vulnerable groups from the costs of adjustment.

The transformation of Algeria from a centrally planned economy to a market economy was accompanied by a major reorientation of the government’s fiscal policy. Under the central planning system, fiscal policy focused mainly on allocating the rent extracted from hydrocarbon exports to maintain a large civil service, provide generalized transfers and subsidies, for both consumption and production, and undertake large nonpriority public investment projects. With the emergence of a market economy, the government endeavored to limit its role to the provision of public goods and services. In addition, the budget assumed a major role in the stabilization process by bringing about macroeconomic stability and releasing resources to the private sector through fiscal consolidation. On the structural side, the budget was strengthened by recasting the tax system to gradually reduce the dependence on hydrocarbon revenue and by reorienting expenditures to growth-promoting areas such as education and health, while improving the targeting of social safety nets to protect the most vulnerable groups from the costs of adjustment.

Attempts at Fiscal Adjustment Prior to 1994

Before 1986, notwithstanding favorable oil prices, Algeria had already experienced substantial fiscal deficits, which reflected mainly net lending to finance public enterprise investment. In 1986, these fiscal weaknesses were exacerbated when hydrocarbon revenue, which provided about one-half of total budget revenue, fell by more than 50 percent as a result of the drop in world oil prices without any countervailing exchange rate adjustment (Figure 2). This revenue contraction, only partially offset by a reduction in capital expenditure and net lending, resulted in a widening of the overall deficit from 10.7 percent of GDP in 1985 to 13.7 percent of GDP in 1988.

Figure 2.
Figure 2.

Fiscal Indicators

(In percent of GDP)

Source: Algerian authorities.1Including net lending, and operations of the Rehabilitation Fund.2Excluding net lending, and operations of the Rehabilitation Fund.

The persistence of large fiscal imbalances and the associated buildup of external debt prompted the government to undertake a more forceful fiscal adjustment in the context of the two IMF-supported programs of 1989 and 1991. This adjustment, coupled with a sharp increase in oil prices in the wake of the 1990–91 crisis, resulted in a surplus of 1.7 percent of GDP in 1991 (Table 4). On the revenue side, hydro-carbon revenue rose by about 12 percentage points of GDP between 1988 and 1991. The bulk of this increase, 9 percentage points of GDP, represented the impact of the depreciation of the Algerian dinar, while the remaining 3 percentage points resulted from higher world oil prices. Nonhydrocarbon revenue declined by nearly 7 percentage points of GDP, largely reflecting the poor performance of public enterprises and the contraction of profits transferred from the Bank of Algeria, stemming in part from its exchange rate losses on external debt. As a result of these divergent trends, the structure of budgetary revenues changed dramatically, increasing the share of hydro-carbon revenue in total revenue from 23 percent in 1985 to about 58 percent in 1993.

Table 4.

Summary of Central Government Operations

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Sources: Algerian authorities; and IMF staff estimates.

Including excise duties on petroleum products.

Covers expenditures for food subsidies, agricultural price support, and cash transfers to the poor. Expenditures under the new public works program are not included.

Excluding the compensation for commercial banks’ foreign exchange losses on principal payments of external debt.

Including special accounts, net lending, and operations of the Rehabilitation Fund.

Including debt rescheduling proceeds blocked on account at the Bank of Algeria.

Includes external debt rescheduling proceeds.

On the expenditure side, a tight incomes policy and further cuts in investment outlays helped to reduce budgetary expenditure by 6 percentage points of GDP between 1998 and 1991. In particular, capital expenditure fell from 12.4 percent of GDP in 1988 to 6.2 percent of GDP in 1991. The contraction was particularly pronounced for education and economic infrastructure (see Figure 3). In addition, net lending was substantially curtailed, as legislation was introduced to halt treasury financing of new investments by public enterprises and of public housing for rent. These savings more than compensated for additional spending arising from two elements: (1) the increased cost of generalized consumption subsidies owing to the impact of exchange rate depreciation, and (2) the launching of a major restructuring program for public enterprises with the assistance of the World Bank Enterprise and Financial Sector Adjustment Loan. As part of this program, the 1991 budget law established a fund for the financial rehabilitation of public enterprises and banks. In 1991, this fund channeled 2.6 percent of GDP to recapitalize banks and public enterprises.3 Notwithstanding the adjustment in the overall balance, expenditure control weakened during 1989–91, and, as a result, budgetary arrears increased.

Figure 3.
Figure 3.

Capital Expenditures by Functional Classification

(In percent of GDP)

Source: Algerian authorities.

Progress in fiscal consolidation during the first phase of the adjustment was set back in 1992–93 when fiscal discipline was relaxed against the backdrop of civil strife. In particular, wages in the central administration were increased by more than 20 percent a year, raising the government wage bill by more than 2 percentage points of GDP between 1991 and 1993. More-over, in an attempt to stimulate economic growth, the authorities increased capital expenditure and net lending by 3.5 percentage points of GDP. The negative effect of these expenditure increases on the fiscal balance was exacerbated by a weak revenue performance even though, in 1992, additional taxes were introduced as part of an important reform of the tax system (see Box 1). Hydrocarbon revenue suffered from an overvalued exchange rate and unfavorable oil prices, while nonhydrocarbon budget revenue declined mainly owing to the import compression brought about by the introduction of an array of trade and payment restrictions, and the adverse impact of this compression on economic activity. Overall, the fiscal balance deteriorated from a surplus of 1.7 percent of GDP in 1991 to a deficit of 8.7 percent of GDP in 1993.

Fiscal Adjustment Since 1994

Substantial fiscal consolidation was achieved from 1994 onward, and the overall fiscal balance shifted from a deficit equivalent to 8.7 percent of GDP in 1993 to a surplus of 2.4 percent of GDP in 1997. The extent of fiscal adjustment is even more striking when measured in terms of the primary balance, which improved by 12.7 percentage points of GDP over the same period. Beyond the reduction in government absorption, the adjustment program implemented since 1994 succeeded in virtually eliminating the sources of quasi-fiscal deficits and increasing the ability of the Ministry of Finance over the medium term to use tax and expenditure policies as an efficient tool of macroeconomic management, thereby making the fiscal balance less vulnerable to fluctuations in world oil prices (Figure 4).

Figure 4.
Figure 4.

Revenue and Overall Balance

(In percent of GDP)

Source: Algerian authorities.

Revenue Developments

Between 1993 and 1997, budget revenues, which continued to be highly dependent on hydrocarbon receipts, increased by about 6 percentage points of GDP. This strong performance was the consequence of several key elements in Algeria’s adjustment program, including (1) the realignment of the exchange rate; (2) the increase in imports brought about by trade liberalization; and (3) the implementation of measures to strengthen the tax system and broaden the tax base.

Hydrocarbon revenues, in Algerian dinar terms, were more than three times higher in 1997 than they were in 1993. The bulk of this increase (75 percent) was due to the exchange rate depreciation. Hydrocarbon revenues were also boosted in 1997 by the increase in the world price of crude oil by up to $4 a barrel in 1996, remaining at that level in 1997, and by higher export volumes (7.6 percent). In addition, a mechanism was established to adjust the price of crude oil sold by the national oil company, Sonatrach, to domestic refineries in line with the evolution of world prices. This mechanism strengthened Sonatrach’s financial position and allowed the company to distribute higher dividends to the government. Overall, the increase in hydrocarbon budget receipts represented about 50 percent of the fiscal consolidation over 1993–97.

Nonhydrocarbon revenues as a share of GDP recovered from their low levels of 1992–93 mainly owing to the good performance of trade-related taxes. Custom duties and valued-added tax (VAT) on imports rebounded as a result of higher import volumes and the exchange rate depreciation as well as the removal of several exemptions and reduction of tariff dispersion. Nonhydrocarbon taxes registered at about a 1 percentage point improvement as a share of GDP from 1993 to 1997, despite the following improvements in the tax system: (1) an increase of the tax rate on reinvested profits from 5 percent to 33 percent; (2) a change in taxation for petroleum products consumed domestically; and (3) the reduction in exemptions on VAT, the increase in the VAT rates, and an increase in the central government’s share in VAT proceeds.4 The stagnation of the ratio of nonhydrocarbon taxes to GDP reflects the decline of the share of nonhydrocarbon GDP in total GDP owing partly to the recent increase in the relative price of oil on world markets and partly to the decline in manufacturing activity and related services. When measured in terms of nonhydrocarbon GDP, the tax effort increased between 1993 and 1997. Nevertheless, in the case of Algeria, nonhydrocarbon GDP is only a proxy for the tax base for nonhydrocarbon taxes (see Box 2).

Tax Reforms

In the early 1990s, Algeria had a complex and highly distorted tax system stemming from ad hoc measures introduced since independence to adapt the colonial tax system to a centrally planned economy. This system was substantially simplified and improved by the 1992 tax reform. Since then, other reforms have corrected some problems associated with the design of the new tax regime and introduced additional taxes in accordance with the needs of a market economy.

The 1992 reform improved both direct and indirect taxation.

  • Concerning direct taxes, a new corporate tax on all profits replaced several schedular taxes. In 1992, two main rates of taxation existed: 42 percent on profits distributed to shareholders and 5 percent on retained earnings. They were supplemented by seven other rates specific to some activities and many exemptions applied. Similarly, a unified personal income tax replaced a system of several schedular taxes and a surtax. The new tax scale, despite its 12 rates ranging from zero to 70 percent, provided a significant tax relief with respect to the previous system. In addition, a property tax was introduced together with official guidelines concerning the assessment of property values.

  • Concerning indirect taxes, the crucial element of the reform was the introduction of a value-added tax (VAT) with four rates ranging from zero to 40 percent. The VAT was simpler than the previous indirect tax system and allowed for a larger tax base, a substantial reduction in the highest rates, and the elimination of cumulative taxation, in particular for services. Some activities or sectors, such as exports, retail sales, agriculture, banking and insurance, and liberal professions, were not subject to VAT.

The 1992 tax reform was supplemented by the implementation of a new custom tariff of eight rates, ranging from zero to 60 percent. While the new tariff provided for a significantly higher taxation of finished products compared to the taxation of raw materials and intermediate goods, its introduction greatly reduced differences between the highest and lowest rates and allowed for the integration of a large portion of the compensatory tax1 in the tariff structure.

Since 1993, reforms have aimed mainly at improving the structure of the tax system introduced in 1992, in particular through the following measures:

  • A new Investment Code introduced, in 1993, a special treatment for investment in specific areas as well as a general regime granting tax benefits to both resident and nonresident investors for all sectors not specifically reserved to the state;

  • A wealth tax was introduced by the budget law for 1993 to replace a solidarity tax on real estate;

  • Individual and corporate income tax rates were restructured in 1994 to reduce the incidence of taxation and increase the tax base. In particular, the corporate tax rate was reduced from 42 percent to 38 percent (33 percent for reinvested profits) while the marginal rate for the personal income tax was reduced from 70 percent to 50 percent;

  • Excise taxes were introduced in 1994 on luxury goods;

  • The VAT was simplified in 1995 by eliminating the highest rate of 40 percent, leaving the maximum at 21 percent, and its coverage was progressively extended to include the banking and insurance sectors, professional activities, and petroleum products. In addition, as of January 1997, the rate of 13 percent was increased to 14 percent and a number of products subject to the special rate of 7 percent were shifted to the 14 percent rate.

  • The import tariff was restructured in 1996 and 1997. The number of rates was reduced to five, ranging from zero to 45 percent.

1 An earmarked levy on imports and domestic production that provided resources for the Compensation Fund, an extra-budgetary fund in charge of administering consumption and production subsidies. This tax was eliminated by the 1994 budget law.

Expenditure Developments

Between 1993 and 1997, budgetary expenditures decreased by about 5 percentage points of GDP. This significant reduction, which affected both current and capital expenditures, reflected several policy actions undertaken to reduce expenditures—while improving their composition and transparency—including a tight incomes policy, price liberalization, and a better prioritization of public investment projects. Part of the savings from these actions was used to eliminate quasi-fiscal deficits and to reinforce the social safety net.

Current expenditures were reduced by 3.5 percentage points of GDP between 1993 and 1997, as a tight cap was imposed on most spending items despite the exchange rate depreciation and its impact on domestic prices. Personnel expenditure, which accounted for one-third of total expenditures in 1993, declined by 1.4 percentage points of GDP by 1997 in response to both a strict wage policy and a freeze on the size of the civil service (see Box 3). Important budgetary savings were also realized on current transfers mainly as a result of the elimination of generalized subsidies on basic food and petroleum products and the reduction of producer subsidies in the agricultural sector. In addition, spending on the social safety net was made more efficient through improved targeting (see Section VI). These savings offset the higher budgetary appropriations for interest payments, mostly on account of the impact of the exchange rate depreciation on external debt service (Figure 5). Moreover, with the objective of eventually eliminating quasi-fiscal deficits, implicit subsidies to the national gas and electricity company and the railroads were made explicit in the budget. At the same time, all expenditures for new public housing were incorporated into the budget instead of being financed through the public housing bank (Box 4).

Figure 5.
Figure 5.

Current Expenditure by Economic Classification

(In percent of GDP)

Source: Algerian authorities.

After their surge in 1993, capital expenditures and net lending were reduced by about 2.4 percent of GDP by 1997, notwithstanding the rise in investment costs caused by the Algerian dinar depreciation and the spending required to repair infrastructures damaged by civil strife. The large decline in capital expenditure in real terms also reflected a recognition of the low social rate of return of past investment. As for the reduction in net lending, it was mainly due to the decrease in the number of public enterprises’ investment projects, which were still partly financed through the budget because they had been launched prior to 1988.

Fiscal consolidation over 1994–97 also reflected the winding down of cash transfers channeled through the Rehabilitation Fund from 2.1 percent of GDP in 1993 to 0.7 percent of GDP in 1997. This reflected the government’s commitment to avoid recurrent bailouts of public enterprises and banks by accompanying financial restructuring with structural measures, including price liberalization and labor shedding. In addition, managers were made increasingly responsible for finding alternative financial resources for enterprise restructuring, such as sales of assets, capitalization from partnerships, and bank credit. This commitment culminated in the closure of the Rehabilitation Fund at the end of 1996 (though some disbursements still took place in early 1997). Beyond cash transfers, enterprise restructuring and the elimination of quasi-fiscal deficits resulted in a swap of government bonds for nonper-forming bank loans to public real estate management agencies. This operation took place in 1995 and amounted to DA 92 billion (about 4.7 percentage points of GDP).5 Furthermore, government bonds worth 1 percent of GDP were issued in 1996 to recapitalize commercial banks.

Despite these operations, the stock of domestic government debt decreased from about 45 percent of GDP in 1993 to about 22 percent of GDP in 1997. Beyond the fiscal surplus achieved in 1997, this reduction in domestic indebtedness was made possible by the availability of large amounts of foreign financing arising from the monetization of part of the external debt rescheduling proceeds. When both domestic and external obligations are taken into account, the stock of public debt decreased from 99 percent of GDP in 1993 to about 85 percent of GDP in 1997, despite the impact of the depreciation of the Algerian dinar.

Remaining Agenda for Fiscal Consolidation and Reform

To build upon its successful fiscal consolidation, Algeria faces several important challenges: (1) to maintain fiscal discipline in the face of expenditure pressures arising inter alia from high interest payments and growing social needs, such as in public housing; (2) to avoid the reemergence of quasi-fiscal deficits; (3) to reduce the dependency on hydrocarbon revenues and trade taxes; and (4) to reorient public expenditure so that it can provide the necessary underpinning for private sectorled growth and employment creation.

Tax Effort in Algeria: Looking at the Denominator

Is GDP a good measure of the tax base in an open economy? A common indicator used to evaluate a country’s tax effort in IMF programs is the ratio of government tax revenue to GDP at market prices. This denominator measures the market value of final goods produced in a country, or alternatively the sum of factor rewards (wages, profits, and rents) generated by domestic production plus indirect taxes. The use of GDP as a measure of the tax base for both direct and indirect taxes is justified in a closed economy. In such an environment, in fact, GDP equals income, which is the tax base for direct taxes, and absorption on which indirect taxes are levied.

In an open economy, however, the identity between product, income, and absorption ceases to apply and, therefore, using GDP as a proxy for the tax base, direct and indirect, can distort the analysis of the tax effort. This is so for two reasons. First, income can differ significantly from GDP because of net factor income and net transfers from abroad. Therefore, in an open economy, gross national disposable income (GNDI) may be a more appropriate measure of the tax base for direct taxes. Second, the sum of absorption and exports, on which indirect taxes are levied, can differ substantially from GDP depending on the importance of imports both in production and in consumption.

Thus, when GDP differs significantly from GNDI, or when imports are substantial, the standard analysis of tax effort on the basis of the tax to GDP ratio should be complemented by the calculation of two additional indicators, namely the ratio of direct taxes to GNDI at factor cost and the ratio of indirect taxes on absorption plus exports. These complementary measures would be all the more useful when exogenous shocks (e.g., changes in the terms of trade or in foreign financing) affect substantially the difference between the GDP and national disposable income.

How does this apply to Algeria, an economy with a substantial mineral rent? The hydrocarbon sector represents the central pillar of the Algerian economy. In 1996, it accounted for nearly 30 percent of GDP and contributed to 95 percent of export receipts and 62 percent of government budgetary revenues. How does such a high dependence on hydrocarbon export receipts affect the manner in which we analyze the tax effort beyond hydrocarbon budgetary revenues?

In a country like Algeria, neither GDP nor nonhydro-carbon GDP is an appropriate measure to evaluate nonhydrocarbon taxes. There are two main shortcomings in using total GDP. First, it includes the rent from the hydrocarbon sector that goes to the government budget as hydrocarbon revenue and is not part of the tax base for nonhydrocarbon direct taxes.1 Second, GDP does not include imports on which custom duties are levied and it includes oil and other exports, which are obviously exempt from indirect taxes. As for nonhydrocarbon GDP, it provides only a partial measure of nonhydrocarbon income because it excludes net factor income and net transfers from abroad. In addition, similarly to total GDP, it excludes imports and includes exports. The evolution of the ratios of nonhydrocarbon taxes to GDP and nonhydrocarbon GDP between 1994 and 1996 is shown in the table below. To evaluate the Algerian nonhydrocarbon tax effort in 1994–96, the ratio of income taxes over nonhydrocarbon GNDI at factor costs and the ratio of indirect taxes over domestic absorption have also been calculated:

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Imports of the state oil company are excluded from absorption because they are tax exempt. Exports are excluded from the denominator because they are not taxed in Algeria.

While the ratio of nonhydrocarbon taxes to GDP decreased from 1995 to 1996, the two complementary measures reveal that Algeria’s tax effort continued to increase over the same period reflecting sustained improvement in tax administration. Not only does GDP as a proxy for the tax base understate the actual tax ratio, but it may be misleading as to the direction and extent of the tax effort.

1 Hydrocarbon GDP includes a small amount of salaries that can be assumed away to simplify the analysis. The feed-back into the income stream of government expenditure from hydrocarbon revenue is fully captured by nonhydrocarbon GDP.

Government Wage Expenditure, 1985–96

General government wage expenditure1 averaged 12.7 percent of GDP over 1980–85 before reaching a peak of more than 16 percent of GDP in 1988 as a result of the introduction of a new salary scale in the civil service in 1986 and the reverse oil shock. This trend was reversed in 1989–90, when the government wage bill was brought down to 14.2 percent of GDP on account of the tight fiscal policy pursued during Algeria’s first IMF-supported program. This share continued to decline in 1991 despite a substantial increase in the government wage bill owing to the pass-through effect of the exchange rate devaluation on the GDP deflator. It started to rise again in 1992–93 owing to the relaxation of fiscal policy, compounded with the impact of weak oil prices and the increasing overvaluation of the Algerian dinar. Expenditure restraint, which has constituted a major element of Algeria’s stabilization program since 1994, has reduced the share of government wages in GDP to 11.2 percent in 1996. This share is marginally less than the 11.5 percent prevailing in Morocco and Tunisia. It remains well above the share of about 5 percent prevailing in some east Asian developing countries such as Thailand and the Philippines.

The evolution of government wage expenditures reflects employment and incomes policies. Civil service staff increased at an average of 3.3 percent a year from 1985 to 1995, with a slowdown in the 1990s. This slow-down has, however, been limited by the need to hire security personnel in the face of civil strife. As a result, government employment has continued to grow faster than the total population, and the size of the civil service, per hundred inhabitants, increased from 4.1 in 1985 to 4.4 in 1995. This level is more than the weighted average of less than 3 calculated for Jordan, Morocco, the Syrian Arab Republic, and Tunisia, which in turn is well above the weighted average of about 2.3 calculated for Indonesia, Korea, the Philippines, Singapore, Malaysia, and Thailand. The growth of the Algerian civil service is even more apparent when measured as a ratio of government employment to total employment, which rose from 23.4 percent in 1985 to 28 percent in 1995. Several steps were taken in 1996 toward reversing this trend, including a freeze in net recruitment and a strict enforcement of the retirement age at 60.

In 1986, despite the 50 percent fall in Algeria’s terms of trade, a new salary scale was introduced in the civil service resulting in an increase in nominal wages of about 14 percent including drift.2 The government’s wage policy was subsequently tightened, particularly in the context of the 1989 IMF-supported adjustment program. In 1990, however, the average government wage rose again by more than 10 percent owing to a general wage increase and new bonuses for workers with special skills. Incomes policy continued to be relaxed in 1991 and 1992 on account of a wage agreement concluded in December 1991 before the parliamentary elections. As a result, government wages increased on average by about 30 percent a year during this period. In 1993, despite a formal salary freeze, additional benefits were granted, thereby increasing the role of allowances in the government incomes policy. A major tightening of incomes policy has occurred in the context of Algeria’s ongoing adjustment program, as the general wage in the civil service was only increased twice by 10 percent between March 1994 and the end of 1996. As a result, real government wages fell by more than 30 percent from 1994 to 1996, whereas they had declined by less than 4 percent between 1985 and 1993.

1 General employment includes central and local governments and public institutions such as universities. 2 The wage drift in Algeria has been about 3 percent a year over 1985–95. This relatively high level reflects that most of Algeria’s government employees are young and in the lower civil service grades.

Over the medium term, Algeria needs to sustain fiscal balance or a small fiscal surplus for two main reasons. First, public finances need to be cushioned against volatility in the world oil prices. In particular, budget surpluses contribute to lower the domestic public debt-to-GDP ratio while allowing the buildup of adequate provisions for future payments on the rescheduled external debt. The government would thus be in a position to weather temporary revenue shocks in the event of lower oil prices. Second, the depletion of nonrenewable hydrocarbon resources would warrant converting part of the hydrocarbon revenue into alternative productive assets, partly by making more resources available for private sector investment—which is expected to constitute the main engine of growth in the future—and partly by constituting an investment fund, as has been done in other oil-producing countries such as Kuwait and Norway.

On the revenue side, authorities should focus efforts on tax reform, as increases in nontax revenues—expected to come primarily from privatization proceeds—are difficult to predict and likely to be short-lived. Fiscal reforms should strive to broaden the domestic tax base and increase the efficiency of the tax system. Notwithstanding the progress achieved in recent years toward the restructuring of the tax system, Algeria’s tax base outside the hydro-carbon sector remains narrow as reflected by a ratio of nonhydrocarbon taxes to GDP that is substantially lower than in neighboring countries (Table 5).

Table 5.

Comparative Tax Performance, 1995

(In percent of GDP)

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Excluding rents from petroleunn and other mineral resources, and privatization revenue.

ExcludingVAT on imports.

AII indirect taxes on domestic transactions.

Direct taxes on income and profits are the weakest tax category in Algeria. They are mostly levied on wage earners and, at 2.7 percent of GDP, account for a substantially lower share of revenue than in comparable countries. This share reflects in part the bias introduced by using total GDP as a proxy for the basis tax when it is calculated in terms of nonhydro-carbon disposable income; the ratio rises to 4.1 percent (see Box 2). It also stems from the low profitability of the industrial and construction sectors, which consist mainly of public enterprises in need of further restructuring and privatization. Although profit taxes are expected to improve slowly following a pickup in economic recovery, a strengthening in tax administration will be necessary to ensure tax compliance, in particular by the growing private sector. This will require authorities to establish an effective audit system, and tax return processing and accounting procedures that could detect tax evasion quickly and trigger appropriate actions.

The ratio of customs revenue to GDP in Algeria is broadly in line with levels achieved by most other middle-income countries of the region. However, the need to open the economy to international competition will require further tariff reductions and a consequent decline in trade taxes. In particular, the expected agreement with the European Union on a Free Trade Area will likely involve the phasing out of tariffs on imports from the European Union by 2010. As imports from the European Union account for about two-thirds of Algeria’s imports, a Free Trade Area with the European Union would imply a gradual loss of trade-related tax revenue of about 2.5 percentage points of GDP.

In 1995, indirect taxation on nonmineral domestic transactions yielded about 5 percent of GDP compared with an average of almost 8 percent of GDP in comparator countries; only the Syrian Arab Republic and Egypt have lower ratios (Table 5). Narrowing this gap would require enhancing the efficiency of the tax system through further improvements in the VAT system, for instance by reducing the number of rates from three to two. This reduction could increase VAT proceeds and contribute to the elimination of some tax credits. Furthermore, notwithstanding the new taxation introduced in January 1996 on domestically consumed petroleum products, the price of gasoline in Algeria—at about $1.05 a gallon—and those for other petroleum products are still below those prevailing in neighboring countries such as Morocco and Tunisia (Table 6).

Table 6.

International Comparison of Petroleum Products’ Prices

(Prices in U.S. dollars per gallon, end-1996)

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Ex refinery price in Italy for Mediterranean delivery on a CIF basis.

On the expenditure side, the authorities ought to be able to achieve further savings without sacrificing the quality of public services. The wage bill could be reduced further by scaling back the excessive size of the civil service and by narrowing the government’s involvement in service provision, while strengthening health services in rural areas and the education system to enable it to provide the training and skills that the private sector requires. In addition, there is scope for enhancing efficiency of capital spending at the sectoral level.

Quasi-Fiscal Deficits: The Algerian Experience

Origin of Losses

Algeria’s quasi-fiscal deficits originated primarily from losses of public enterprises and public agencies, reflecting a legacy of state economic planning and the burdening of public enterprises with social objectives.

Food-importing agencies. Constrained for many years by a system of administered prices, which did not provide sufficient resources for external debt servicing, food-importing agencies financed their imports through foreign borrowing, assuming the ex-change rate risk. The depreciation of the Algerian dinar exacerbated their debt-service obligations, which could not be met with future profits since price increases, made possible by price liberalization, were limited by competing private sector imports. In 1995, the cutoff of external financing forced food-importing agencies to resort to domestic bank credit both to finance large debt repayments—which had been guaranteed by the banks—and ongoing import operations, crowding out other borrowers.

Public real estate agencies. Housing is mostly financed by the only mortgage bank, the Caisse nationale d’epargne et de prevoyance (CNEP). Deposits mobilized by the CNEP have to a large extent been lent to public real estate agencies to finance the construction of public housing for rent instead of financing private housing acquisition on commercial terms. Until 1994, the impact of poor rent collection and low levels of rents on the financial situation of the public real estate agencies was partially offset by administered prices imposed on public construction companies, which assumed part of the quasi-fiscal deficits. With the liberalization of construction prices, the public real estate agencies became unable to service their debts to the CNEP, hampering its ability to finance housing construction.

Gas, electricity, and railroad services. Sonelgaz and the Societe nationale des transports ferroviaires have been providing for many years gas, electricity, and rail-road services at administered prices below economic costs. Both enterprises were undercapitalized, and their difficulties were exacerbated by high capital expenditures and the burden of infrastructure maintenance imposed on them by the government. These expenditures and losses were financed by accumulating both domestic and external debt that could not be serviced, particularly after the depreciation of the Algerian dinar.

Remedies Adopted

Since 1994, to eliminate these quasi-fiscal deficits, the government has adopted a four-pronged strategy consisting of:

  • liberalization of domestic prices and gradual increases in rates and rents toward their equilibrium levels;

  • implementation, in the context of performance contracts, of structural reforms, including the privatization of most food-importing agencies and public real estate agencies;

  • budgeting of any residual subsidy, as well as the maintenance costs of the rail network in the case of Societe nationale des transports ferroviaires and rural electrification in the case of Sonelgaz; and

  • swap of DA 279 billion of bank debt, incurred by the food-importing agencies, the public real estate agencies, and utilities for long-term government bonds.

In the past, the civil service was used as an employer of last resort, resulting in overemployment and an excessive wage bill, as well as a disproportionate number of administrative staff compared to specialized staff. A number of years of wage restraint have led to a substantial decline in real wages together with wage compression, and further decline and compression might negatively affect incentives and performance in the civil service. Thus, wages could be selectively raised provided savings were achieved by reducing the number of civil servants. To this end, two main actions would be necessary: (1) a reduction in the number of activities in which the central government is involved by privatization or devolution of some service provision to the private sector; and (2) an increase in the productivity of the civil service, with the adoption of revised salary scales and more modern technology.

At the sectoral level, the most recent Public Expenditure Review conducted in collaboration with the World Bank6 identifies three main sectors in which policy actions are needed: health, education, and transportation, which together accounted for about 30 percent of total expenditures in 1996. In all these sectors, the adjustment requires a two-pronged strategy. In the short term, increased efficiency could be achieved through (1) better use of existing human resources and physical capacity; (2) redirection of expenditures in favor of maintenance and supplies; and (3) introduction of user’s participation in cost-sharing. In the medium term, the challenge will be to limit the role of government and to redirect the provision of public services, particularly education, toward the changing needs of the economy brought about by greater competition and integration with the global economy.

Increasing the efficiency and effectiveness of government spending would also require an improvement in public expenditure management. As pointed out by the Public Expenditure Review, Algeria’s budget law still has limited coverage; in particular, it excludes the treasury’s special accounts operations. Furthermore, the budget presentation does not provide for a consistent treatment of current spending (which is broken down by ministry) and capital expenditure (which follows a sectoral breakdown). In addition, the budget preparation process has suffered from several shortcomings such as insufficient coordination between the preparation of the current budget, for which the Ministry of Finance is responsible, and the investment budget,7 for which the Ministry of Planning is responsible; and the lack of a medium-term framework to guide the allocation of budget resources among ministries. Finally, the mechanisms of budget execution and monitoring still favor conformity to budgetary regularity rather than the quality control of expenditure. Actions that could be taken to remedy these weaknesses include (1) devolving to the Ministry of Finance the sole responsibility for the formulation and implementation of the current and investment budgets; (2) extending the coverage of the budget law to include all treasury accounts movements; (3) breaking down all government expenditure on both a sectoral and ministerial basis; and (4) improving public expenditure monitoring and evaluation.

Finally, although Algeria’s demographic trends remain overall favorable, there is a growing imbalance emerging in the social security system, resulting reportedly from difficulties in collecting social security contributions, mainly from public enterprises. The deficit was covered in 1997 by a special allocation from the supplementary budget approved in July 1997. In 1998, both social security contributions and budgetary allocations were increased. Looking ahead, the system will need to be reviewed and proposals made to ensure its long-term financial viability and thus eliminate its potential burden on the budget.

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Cover Algeria
Algeria
Stabilization and Transition to Market
ISBN:
9781557756916
ISSN:
0251-6365
Publication Date:
06 Aug 1998
Publisher:
International Monetary Fund
DOI:
https://doi.org/10.5089/9781557756916.084
Pages:
92
Figure 2.

Fiscal Indicators

(In percent of GDP)
Figure 3.

Capital Expenditures by Functional Classification

(In percent of GDP)
Figure 4.

Revenue and Overall Balance

(In percent of GDP)
Figure 5.

Current Expenditure by Economic Classification

(In percent of GDP)