Abstract

The public sector in Jordan has traditionally been very large, with central government expenditures averaging about 43 percent of GDP during 1972–94 (Chart 4.1). The public sector also encompasses local authorities, decentralized agencies, financial and nonfinancial public enterprises, and, until 1991, several extrabudgetary funds. Although no quantitative estimation is available for the operations channeled through these public sector entities, they are believed to be of significant magnitude. Purchases of military equipment through the Defense Fund, financed by foreign assistance, are not included in the central government accounts. Because of a lack of adequate data, the analysis in the following section will concentrate on the budgetary operations of the Central Government.

The public sector in Jordan has traditionally been very large, with central government expenditures averaging about 43 percent of GDP during 1972–94 (Chart 4.1). The public sector also encompasses local authorities, decentralized agencies, financial and nonfinancial public enterprises, and, until 1991, several extrabudgetary funds. Although no quantitative estimation is available for the operations channeled through these public sector entities, they are believed to be of significant magnitude. Purchases of military equipment through the Defense Fund, financed by foreign assistance, are not included in the central government accounts. Because of a lack of adequate data, the analysis in the following section will concentrate on the budgetary operations of the Central Government.

Chart 4.1.
Chart 4.1.

Fiscal Balance

(In percent of GDP)

Sources: IMF, International Financial Statistics, and various Recent Economic Development reports.

Although foreign grants from neighboring oil-exporting Arab countries were very large during 1975–88, accounting for about 12 percent of GDP, recourse to foreign and domestic debt financing was also large, averaging about 10 percent of GDP a year during the same period (Table 4.1). In the second half of the 1980s, with rising interest rates and later the depreciation of the Jordan dinar, fiscal policy turned out to be unsustainable, requiring an urgent and comprehensive fiscal consolidation effort.

Table 4.1.

Central Government Operations

(In percent of GDP)

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Sources: Jordanian authorities; and IMF staff estimates.

Excluding extrabudgetary expenditure and net lending.

Net lending data are available from 1978 onward and extrabudgetary data from 1985 onward.

Historical Background and Buildup of Public Debt

Origin of the Problem

Jordan’s high fiscal expenditure until the early 1980s—equivalent to almost half of GDP—was largely attributable to two major components—capital expenditure and military outlays—which together accounted for about 62 percent of total central government outlays and 32 percent of GDP over 1973–83 (Chart 4.2). Capital expenditures—a large part of which was financed from external sources—remained extremely buoyant between 1973 and 1983 (averaging 15 percent of GDP), and then declined to a more sustainable level of 9 percent on average between 1984 and 1988. Like most countries in the region, Jordan allocated substantial resources to national defense, which was extremely burdensome given the narrow production base of the economy. Military expenditures accounted for more than 10 percent of GDP during the 1970s and the 1980s,1accounting for much of the fiscal deficit and accumulation of foreign debt. Domestic fiscal revenue—21 percent of GDP on average between 1972 and 1988—was too low to finance such a high level of expenditure; moreover, its structure was unbalanced, with taxes on foreign trade providing nearly two-thirds of total tax revenue (Chart 4.3).

Chart 4.2.
Chart 4.2.

Expenditure

(In percent of GDP)

Sources: IMF, International Financial Statistics, and various Recent Economic Development reports.
Chart 4.3.
Chart 4.3.

Tax Revenue

(In percent of GDP)

Sources: IMF, International Financial Statistics, and various Recent Economic Development reports.

Jordan was able to sustain such a large public expenditure program because of large receipts of foreign grants, which despite some year-to-year fluctuations remained high until the regional crisis of 1990; and a low average interest rate on pnblic debt (significantly below the growth rate of the economy). Notwithstanding the sizable receipts of foreign grants, the overall fiscal deficit (including grants) averaged 10 percent of GDP during 1972–88 and made external borrowing necessary. Through 1983, interest payments on the external public debt were relatively modest, accounting for less than 2 percent of GDP during the period (Chart 4.4).

Chart 4.4.
Chart 4.4.

Nonmilitary Current Expenditure

(In percent of GDP)

Sources: IMF, International Financial Statistics, and various Recent Economic Development reports.

Thereafter, interest payments increased steadily in response to the rapid debt buildup and increases in world interest rates. They peaked to an unsustainable level of nearly 11 percent of GDP during 1990–91, on a commitment basis. The rapid increase in interest payments after 1988 also reflected in part the sharp depreciation of the Jordan dinar over 1988–89, which, together with other policy measures, was designed to address the balance of payments crisis that had developed.

An important feature of the economic environment of the 1980s was the combination of high interest rates in the world market and moderate economic growth in Jordan, which resulted in a more rapid growth in the debt-to-GDP ratio than would otherwise have been the case. This characteristic of the environment also meant that the Government’s solvency constraint—the condition that the value of outstanding public debt be no greater than the sum of the present discounted values of expected primary surpluses and high-powered money—became binding on the operation of fiscal policy. For example, in 1988, just before the balance of payments crisis, tax revenues amounted to some 11 percent of GDP and nontax revenues, to about 13 percent, while total expenditure remained at 41 percent of GDP, of which 7 percentage points were attributable to debt service and 9 percentage points to capital expenditures. With foreign grants equivalent to almost 9 percent of GDP, the overall fiscal deficit, including foreign grants, was 15 percent of GDP Reflecting the cumulative effect of such policies, the public debt ratio reached almost 100 percent of GDP in 1988 (Chart 4.5).

Chart 4.5.
Chart 4.5.

Debt-to-GDP Ratio

Sources: IMF, International Financial Statistics, and various Recent Economic Development reports.

Debt Accounting Framework

The growth of the public debt ratio can be decomposed into five major components based on the standard budget financing identity:2 (1) the structural component, as determined by the underlying structural fiscal balance depending on trends in revenue and expenditure; (2) the output variation component, reflecting movements in domestic economic activity compared with the trend output; (3) the evolution of interest payments; (4) the exchange rate effect; and (5) the annual discretionary fiscal impulse. The structural component is defined as the average primary deficit adjusted for variations in domestic output. The output variation component of the budget deficit reflects variations in revenue resulting from deviations in economic activity from its potential trend level.3 The fiscal stance can be defined as expansionary (contractionary) relative to the base year if the actual primary deficit exceeds (falls short of) the cyclically adjusted deficit, where the base year is a period in which actual and potential outputs are assumed to be equivalent and the fiscal stance is neutral. The fiscal stance, in this sense, measures the magnitude of the stimulus injected (withdrawn) through the budget into (from) domestic aggregate demand and beyond the primary deficit implied by the structure of budgetary operations in the base period. The exchange rate effect matters in countries where the proportion of public debt denominated in foreign currencies is large and where the exchange rates vis-à-vis currencies in which the external debt is denominated have fluctuated significantly.

Change in the stock of debt (D) on account of central government operations can be decomposed as follows:

DtDt1=(taga)YPtta(YtYPt)+rtDt1+FDt1.[(ERt1/ERt) - 1] -IBt,(1)

where ta and ga are, respectively, the average ratio of revenue and primary expenditure to GDP during 1975–88; Yt and YPt are nominal and potential GDP at current prices in year t; rt is the nominal implicit interest rate on public debt in year t; Dt is the net stock of public debt at the end of year t; FDt is the net stock of public debt denominated in foreign currency at the end of year t; ERt is the average nominal exchange rate (per unit of domestic currency); and IBt is the discretionary primary balance in year t. The appendix provides a detailed methodology.

The debt dynamics can be expressed in relation to GDP as:

Dt/YtDt1/Yt1 =(taga).YPt/Ytta .(YtYPt)/Yt+rt .Dt1/Yt1 +(FDt1/Yt1).[(ERt1/ERt) 1]IBt/Yt[gt/(1+gt)]{(1+rt).Dt1/Yt1+(FDt/Yt1).[(ERt1/ERt)1]},(2)

with gt representing the nominal rate of GDP growth in year t. The last two components of the right-hand side of equation (2) are essentially adjustment terms because output in the denominator relates to different years. These adjustment terms vanish if actual current output is used as the common denominator.

The right-hand side of equation (1) reflects the five aforementioned components, that is, the structural component, the output variation effect, interest payments, the exchange rate effect, and the annual discretionary component. The change in the debt ratio can, in a reduced form, be expressed as the opposite of overall fiscal balance (Bt, corrected for the exchange rate effect). In turn, the fiscal balance can he decomposed along the same line, as follows:

Bt=(taga)YPt+ta(YtYPt)rtDt1+IBt.(3)

The fiscal balance reflects the difference between structural revenue and primary expenditure, the cyclical output gap, the debt-service burden, and the yearly fiscal impulse.

Debt Dynamics and Sustainability of the Debt, 1975–88

Between 1975 and 1988, the ratio of outstanding central government debt to GDP increased from 68 percent to 95 percent (Chart 4.5; Table 4.2).4 A decomposition of annual fiscal balances indicates that, of the average annual fiscal deficit (excluding foreign grants5) of 20 percent of GDP during 1975–88, 17.6 percent of GDP was attributable to the structural primary deficit (Table 4.3, Charts 4.6 and 4.7). The injection of expansionary stimulus was particularly strong up to 1980, and declined substantially during the early 1980s. In response to the rapid accumulation of the debt burden and external financing constraints, the authorities started to tighten the stance of fiscal policy in the mid-1980s; accordingly, the fiscal impulse turned significantly contractionary from the mid-1980s. Interest payments on the outstanding public external debt, which was low (at about 1 percent of GDP) during the 1970s, increased significantly in the 1980s in line with the growing debt burden, accounting for 7 percent of GDP by 1988 and 10 percent of GDP by the end of the decade. Based on these considerations, the observed deterioration in the fiscal position between 1985 and 1988 would be attributable to the continued large structural primary deficit, economic slowdown, and markedly higher interest charges, rather than to discretionary fiscal policy.

Table 4.2.

Fiscal Sustainability

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Source: Jordanian authorities; and IMF staff estimates.

Reconstructed from 1989 debt figure, annual deficits, and exchange rate effect.

Excluding net lending and extrabudgetary expenditure.

Negative if depreciation.

Table 4.3.

Fiscal Impulse

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Sources: Jordanian authorities; and IMF staff estimates.

Assuming potential output annual growth rate is equal to the average observed growth rate over 1975–88; potential output in 1994 is such that the sum of output gaps is zero.

Excluding net lending, extrabudgetary expenditure, and grants.

Chart 4.6.
Chart 4.6.

Evolution of Debt-to-GDP Ratio

Sources: IMF, International Financial Statistics, and various Recent Economic Development reports.
Chart 4.7.
Chart 4.7.

Fiscal Impulse Breakdown

Sources: IMF, International Financial Statistics, and various Recent Economic Development reports.Note: The structural balance and the cyclical effects have been estimated for two subperiods, 1975–88 and 1989–94. As a result, there is a break in the series between 1988 and 1989.

The same budget identities can be used to measure the primary balance required to stabilize the ratio of public debt to GDP and to compare it with the observed primary balance. Stability of the debt-to-GDP ratio will be achieved if the primary surplus in percentage of GDP is as follows:

PBt/Yt=[(rtgt)/(1+gt)]Dt1/Yt1+(FDt1/Yt1)[1/(1+gt)[(ERt1/ERt)1](4)

Assuming no exchange rate effect on the valuation of the outstanding stock of foreign debt, the required primary balance will depend on the differential between the implicit interest rate on the public debt and the growth rate, both in nominal terms, and the current debt ratio. If the differential is positive, stabilization of the debt-to-GDP ratio requires a primary surplus of a magnitude proportional to the previous year’s debt-to-GDP ratio and to the size of this differential. If the differential is negative, stabilization can be achieved even with some primary deficit.

In Jordan, the implicit interest rate increased sharply during the 1980s because of a substantial shift in the composition of foreign debt toward debt on commercial terms. In 1980, over 80 percent of the outstanding external debt was owed to official bilateral creditors, primarily on concessional terms. By 1988, however, the share of external public debt owed to foreign banks and commercial companies had increased to 20 percent from 7 percent in 1980, as the availability of funds on more attractive terms from official creditors fell short of the Government’s financing needs. In contrast, interest rates on domestic debt were broadly stable.

The differential between the implicit interest rate and the growth rate was negative in the 1970s and through 1984 (Chart 4.8). Simultaneously, although the actual primary deficit remained high, it declined steadily through 1984 and remained stable thereafter through 1988. The combination of those two factors led to a contraction of the debt-to-GDP ratio between 1979 and 1983 and a steady increase from 1984 onward. In 1988, the debt-to-GDP ratio jumped by 36 percentage points to 95 percent of GDP. The large exchange rate adjustment that took place in 1988 explained about 80 percent of the increase in the debt ratio in 1988.

Chart 4.8.
Chart 4.8.

Implicit Interest Rate and Economic Growth Rate

(Percent changes)

Sources: IMF, International Financial Statistics, and various Recent Economic Development reports.

Shift in Fiscal Policy Stance, 1989–94

The authorities drastically shifted the stance of fiscal policy beginning in late 1988—in the context of IMF-supported adjustment programs—which helped reduce the Central Government’s fiscal deficit, excluding foreign grants, by almost 18 percentage points to less than 6 percent of GDP in 1994. Two-thirds of the fiscal consolidation was attributable to expenditure restraint and the remainder to an increase in revenue. Central government finances started to improve in 1989, as adjustment policies (including discretionary fiscal measures) were implemented. Despite the adverse effects of the 1990 regional crisis, which depressed economic activity and increased pressures on public services and social expenditure programs as a result of the large number of returnees, the fiscal deficit was reduced further in 1990 and 1991. In response to a strong economic rebound and adoption of sizable discretionary revenue measures, the Central Government’s public finances improved dramatically in 1992, The underlying fiscal deficit (excluding foreign grants) declined to about 7 percent of GDP, and, taking into account nonrecurrent revenue gains, the deficit decreased even further.6 Fiscal consolidation continued during 1993, albeit at a much slower pace.

Reflecting the discontinuation of grants from most countries in the region after the Gulf crisis, foreign grants declined by 5 percentage points over 1988–94 to 3.4 percent of GDP in 1994. As a proportion of total central government receipts, grants decreased from 26 percent in 1988 to 10 percent in 1994.

Debt Dynamics and Sustainability of the Debt Ratio

The evolution of the debt-to-GDP ratio largely mirrored the fiscal consolidation process that was started in late 1988. The debt ratio on account of central government operations, which peaked in 1990 at 126 percent of GDP, declined sharply in 1992 to 101 percent of GDP, and to 93 percent of GDP in 1994. A reversal in the interest-output differential, which turned significantly negative beginning in 1992, contributed to the observed debt reduction.

The primary fiscal balance sharply improved beginning in 1990 and became significantly positive in 1992, reflecting strong fiscal efforts and economic growth, the effect of the Government’s discretionary fiscal measures, and some favorable transitory factors. Overall, the primary fiscal deficit had almost vanished by 1992, compared with 21 percent of GDP on average through 1988. Despite higher interest rates, the differential between the average interest rate and nominal output became negative every year except in 1991, when output growth was sharply lower in the aftermath of the 1990 regional crisis. The significant improvement in the debt ratio occurred despite a substantial reduction in the inflow of foreign grants and the adverse effects originating from exchange rate depreciations in 1993 and 1994 (cumulatively, about 6 percent of GDP), as the Jordan dinar was de facto pegged to the U.S. dollar. Foreign grants declined steadily, from about 13 percent of GDP in 1989 to 3 percent in 1994 as traditional sources virtually stopped providing grants to Jordan after the regional crisis.

Overall, the turnaround toward a primary budget balance and the negative interest-output differential both indicated that, beginning in 1990, with the fundamental shift in the stance of fiscal policy, the debt ratio became sustainable and exhibited a marked declining trend. The structural improvement in the primary balance was attributable to favorable developments in revenue and expenditure, reflecting efforts to improve the elasticity of the tax system, broaden the tax base, and contain recurrent outlays.

Revenue Mobilization

Total revenue increased from 24 percent of GDP in 1988 to almost 30 percent of GDP in 1994, with tax revenue increasing by 5 percentage points (Chart 4.9). The increase essentially reflected frequent discretionary revenue-raising measures, as the structure of the tax system remained inelastic with respect to income. The revenue structure, however, improved, with a decline in relative terms of taxes on foreign trade; and administrative procedures for collecting taxes and arrears were tightened. Receipts from post and telephone services and profits from the Central Bank of Jordan were the most buoyant nontax revenue sources.

Chart 4.9.
Chart 4.9.

Revenue and Grants

(In percent of GDP)

Sources: IMF, International Financial Statistics, and various Recent Economic Development reports.

Taxes on Foreign Trade

Apart from the positive effects on the value of imports of the 1988 and 1989 exchange rate depreciations, the increase of receipts from customs duties resulted from higher import volume associated with the acceleration in the pace of economic activity and a tariff reform. Collection of import taxes was also boosted in the early 1990s by a shift in the composition of imports in favor of consumer durable goods, on which higher duty rates were levied. This shift was associated with the reflux of Jordanians from neighboring countries after August 1990. In addition, a temporary duty was levied on returnees’ cars from November 1991 to December 1992, boosting revenues by about 2 percentage points of GDP. Also behind the revenue increase was the removal in January 1990 of the ban, imposed in November 1988, on imports of some high-duty luxury items.

While maintaining their efforts to mobilize revenue, the authorities also launched in 1989 a program of gradual tariff reform that aimed at a lower, more uniform, and nondiscriminatory structure of protection among economic sectors. As part of this reform, they reduced the maximum cumulative import tax rate to 50 percent from more than 300 percent for all nonluxury imported goods. At the same time, however, to reduce the revenue effect of this reform, they increased the minimum effective tariff rate by levying an additional tax at a 5 percent rate—instead of the standard 3 percent rate—on imports that were exempted from other import taxes.

The authorities launched a second round of tariff reform in November 1994. Customs tariff rates on a limited range of products, in particular, in the transportation sector (new and used cars, trucks, and spare parts), were reduced. The tariff range was lowered to 70–200 percent from 125–320 percent for new cars; and to about 50–150 percent from 115–310 percent for used cars. (The ban on imports of used cars more than five years old has been maintained for environmental and other considerations.) Trucks, for which duties varied from 15 percent to 30 percent, are now exempted. The customs duty on spare parts was reduced to 10 percent from 30 percent. As a result of the various trade reforms undertaken in recent years, the maximum customs tariff rate declined to 50 percent (except that on cars, cigarettes, and alcoholic beverages).7

Taxes on Domestic Transactions

Between 1988 and 1994, the revenue from taxes on domestic transactions as a proportion of GDP increased to 6.4 percent from 3.5 percent. While the annual nominal growth rate of GDP averaged 11 percent over the period, revenue from these taxes increased by 23 percent on average.

Revenue from the consumption tax and excise duties—consolidated under the Consumption Tax Law of November 1988—almost doubled between 1988 and 1994, reflecting several increases in tax rates and extensions of the coverage of goods subject to taxation. The total yield of other taxes on domestic transactions, although of limited magnitude, grew rapidly over the same period as a result of increases in the property transfer tax rate and higher airport departure fees.

The coverage of the consumption tax was broadened in 1992, and with 21 items added in June 1993, the total number of items subject to the consumption tax rose to 106. In addition, the existing consumption tax on certain imported items was extended to their equivalent produced domestically, and certain specific rates were converted into ad valorem rates. Despite the coverage extension, the structure of the consumption tax remained heavily concentrated on a few products, with excises on cigarettes alone accounting for 44 percent of consumption tax receipts; the latter, together with receipts from excises on cement, soft drinks, steel bars, and lubricating oil, accounted for 80 percent of consumption tax receipts.

With a view to broadening the domestic tax base and making the tax system more elastic and more efficient, the authorities replaced the consumption tax with a general sales tax on June 1, 1994. It is levied on all imports, all manufactured goods, and some services produced or rendered locally by providers whose annual sales exceed JD 200,000.

The standard ad valorem rate of the general sales tax was 7 percent at its inception in 1994; a 20 percent rate is levied on a limited number of goods, such as perfume and electrical appliances. Specific rates continue to be levied on tobacco products, alcoholic beverages, soft drinks, cement, and a few other products. Exports are zero rated. The recent amendment to the general sales tax law broadened the tax base significantly and increased the basic rate to 10 percent.

Taxes on Income and Profits

Receipts from personal and corporate income taxes, which were less than 2 percent of GDP in 1988, increased to 3.2 percent of GDP by 1994. In 1994, about 60 percent of direct taxes were collected from corporations; individuals (partnerships and professionals) contributed 25 percent and salaried employees 15 percent. Dividends, interest, and capital gains were exempt from taxes.

Although the tax base was somewhat broadened in November 1989 when exemptions and deductions were reduced, the personal income tax remained characterized by numerous exclusions of income from tax and liberal exemptions, with the effect that relatively few individuals were actually subject to income taxation. There were ten income tax brackets, with a top marginal tax rate of 45 percent, and five different corporate tax rates based on activity (industrial, financial, other) and ownership (public, private).

Nontax Revenue

Nontax revenue as a proportion of GDP remained broadly stable, at about 13 percent of GDP during 1988–94. Fees, licenses, and charges for government services were increased substantially in 1986 and again in the subsequent three years. A royalty tax on phosphate and potash production was introduced in 1989. The operating surpluses from post and telephone services expanded continuously after 1988 because of increased coverage and rate increases.

Expenditure

During 1989–94, the average increase in central government expenditure and net lending was limited to 5.7 percent, and, accordingly, total expenditure as a proportion of GDP declined by 12 percentage points to 35 percent in 1994. This reduction was achieved notwithstanding strong pressures on expenditures from several sources. In particular, exchange rate adjustments during 1988–89 led to the subsidization of food staples and higher interest payments on foreign debt, and the 1990 regional crisis led to strong pressures on recurrent expenditures. Supplementary expenditures had to be incurred during 1990–91, to respond to the needs of the large number of Jordanian workers returning from neighboring countries (especially for housing and education, and emergency stockpiling of food supplies) and increased military preparedness. However, the authorities succeeded in accommodating these pressures without significantly hindering ongoing efforts to contain expenditures. Extrabudgetary expenditure was stopped, net lending became negative, and both current and capital expenditures decreased as a proportion of GDP.8

Since 1992, current expenditure has been fully covered by total domestic revenue, whereas a significant shortfall existed in the late 1980s. Progress in changing the composition of expenditure, however, has been mixed. On the one hand, military outlays have been reduced by about 3 percentage points of GDP, and food subsidies have also declined. Gross lending to public enterprises and decentralized agencies has been significantly curtailed. Capital expenditure was reduced to 6.4 percent of GDP in 1994—a level broadly in line with the absorption capacity of the Jordanian economy. On the other hand, the wage bill increased from 6.5 percent in 1988 to 6.9 percent in 1994, to compensate for the sharp decline in real wages during 1988–91; the share of public pensions in total outlays also increased significantly during this period.

Wages and salaries, which constitute the largest component of civilian expenditure, accounted for 25 percent of total current fiscal outlays and almost 7 percent of GDP in 1994. Between 1991 and 1994, civilian employment increased by 15 percent to 118,500 employees. Over the same period, the total wage bill grew by almost 60 percent in nominal terms and by 40 percent in real terms. Pension outlays for both civil servants and military personnel increased by 1 percentage point of GDP between 1988 and 1994, owing to increases in the number of beneficiaries and the average level of pension. The long-term sustainability of pension arrangements also remains questionable.

Recent and Forthcoming Structural Reforms in the Fiscal Area

The current level of total domestic revenue in relation to GDP (almost 30 percent) is broadly satisfactory and is comparatively high among developing countries at about the same level of development. There is a need, however, for further decisive efforts to enhance revenue elasticity and the efficiency of the tax system and to reduce dependence on nontax revenues. Additional structural improvements in the tax system would help avoid the frequent and politically difficult discretionary revenue measures implemented to offset the inelasticity of the existing tax system. They would also help reorient the tax system to the changing structure of the economy away from a system based on imports to one based on broader domestic consumption. On the expenditure front, further action is needed to contain the civilian and military wage bill (including pension liabilities) and food subsidies. A number of key policy actions have recently been adopted by the Jordanian Parliament:

  • In September 1995, the Parliament adopted several amendments to the general sales tax, with a view to improving the efficiency of the tax system. The main amendments increase the standard rate to 10 percent; replace the positive list of services subject to taxation by a negative list with limited exemptions; allow for voluntary registration of taxpayers; and provide for introducing a supplementary duty on selected luxury, or socially undesirable, products in order to protect revenue in the context of the next stage of external tariff reform.

  • The direct tax system was also reformed in September 1995. The improvements included eliminating tax holidays (except for investments in less-developed areas); limiting tax deductibility to net interest payments; reducing the number of tax rates and the maximum tax rates for both personal and corporate income taxes; rationalizing corporate income tax rates, with a view to treating all corporate sectors equally, by establishing three flat corporate tax rates of 15 percent for companies in “encouraged” sectors (mining, industry, hotels, and hospitals), 35 percent for banks and financial institutions, and 25 percent for all other companies; encouraging capital accumulation by imposing a withholding tax of 10 percent on distributed profits; and broadening the tax base by reducing and simplifying exemptions and applying uniform standard deductions for all wage earners.

  • In the next stage of external tariff reform, numerous customs fees and charges will be combined into one consolidated tariff structure; the number of tariff rates will be reduced; nontariff barriers will be lowered through the elimination of import-licensing requirements and import monopolies; and the maximum consolidated tariff rate will be further reduced. The intended introduction of supplementary (excise) duties within the framework of the general sales tax will pave the way for reducing maximum duties without reducing tax revenue. These supplementary duties should be applied equally on both domestic and imported goods and imposed on a limited range of items selected on the basis of equity, health, and environmental considerations.

Further structural reform measures are to be implemented in several other areas, including, in particular, food subsidization. Better targeting, cross-subsidization, a higher cost-recovery rate for subsidized prices, and the complete elimination of some subsidies, in combination with favorable international commodity price developments, helped lower the budgetary cost of subsidies from 3.3 percent of GDP in 1990 to 1.0 percent in 1994. However, generalized price subsidies have persisted for wheat, and the targeting of means-tested subsidies needs to be improved. A significant increase in commodity prices combined with the steady population growth rate could jeopardize the savings achieved between 1990 and 1994. The authorities are thus considering reforming the current generalized food subsidy program by charging full prices to consumers while protecting low-income households through direct cash transfers based on family income. Such a scheme should enable the authorities to generate net budgetary savings (about 0.5 percent of GDP, based on current costs) and also prevent waste and smuggling of subsidized products.

Appendix: Methodology of Debt Dynamics Accounting Framework

Jordan’s successive large fiscal imbalances have led to a large stock of debt. To analyze the debt dynamics, the growth of the public debt ratio can be decomposed into five elements:

  • the structural trend in revenue and expenditure,

  • cyclical fluctuations,

  • the discretionary fiscal impulse,

  • the evolution of interest payments, and

  • an exchange rate effect.

The purpose of this appendix is to describe the methodology used in assessing the relative weights of factors behind debt dynamics in Jordan, and the magnitude of the fiscal consolidation effort required to stabilize the ratio of public indebtedness to output. Notation will be as follows:

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Instead of a “base-year” approach, which is used most often to estimate trend values, a methodology based on “average values” has been designed. In the absence of reliable proxies, such as the utilization rate of fixed investment or the unemployment rate, potential output is assumed to grow at a constant rate, equal to the average growth rate observed from 1975 to 1988. Once the growth rate is known, the initial level of potential output must be determined. A solution would have been to assume that potential output was equivalent to actual output in the base year 1974. However, because of the concave shape of actual output function over time, this would have led to an almost permanent excess of actual output over potential output, disturbing the cyclical component. Therefore, the level of potential output in 1974 has been adjusted in such a way that the undiscounted sum of the differences between actual and potential output became zero.

Decomposition of Debt Dynamics

The starting point is that the change in the stock of debt in domestic currency is the opposite of the budget balance, which has a positive value if in surplus. In addition, a correction must be made for exchange rate variations, which affect the value of the inherited stock of foreign-financed debt. Exchange rate variations also affect the budget balance through various channels, such as foreign interest charges or external grants, but these effects are not singled out in the following analysis. To ignore the exchange rate effect, as debt dynamics studies often do, is a major drawback when significant exchange rate adjustments have occurred. The exchange rate pertinent to this analysis is the average one vis-à-vis currencies in which foreign liabilities are denominated, using weights of the outstanding foreign debt.

DtDt1=Bt+FDt1[(ERt1/ERt)1].(A.1)

Then the budget balance is decomposed into two parts: the primary balance and interest payments. Interest charges depend upon the outstanding stock of debt and the current average interest rate on that debt. It is assumed that the current deficit does not lead to interest payments during the current year.

Bt=PBtrtDt1.(A.2)

In turn, the primary balance can be decomposed into its components: total revenue and total primary expenditure.

PBt=TtEt.(A.3)

Tax revenue during a given year can be broken down into a structural component, a cyclical effect, and a discretionary component. In the absence of discretionary measures, tax revenues are assumed to be a function of the observed output and the average tax pressure ratio. To isolate the structural component from the cyclical effect, potential output can be substituted for observed output to capture the structural tax revenue, and the difference is deemed to be the cyclical effect.

Tt=taYt+IT=taYPt+ta(YtYPt)+ITt.(A.4)

Primary expenditure can be decomposed in a similar way, but it is assumed that there is no cyclical effect, that is, that noninterest expenditures are, in the absence of discretionary measures, a function of potential output and the average expenditure-to-GDP ratio.

Et=gaYPt+IEt.(A.5)

Substituting (A.4) and (A.5) into (A.3) and replacing the difference between the discretionary tax and expenditure elements by a discretionary fiscal balance element yields the following result:

PBt=(taga)YPt+ta(YtYPt)+IBt.(A.6)

In turn, substituting (A.6) into (A.2) gives:

Bt=(taga)YPt+ta(YtYPt)+IBtrtDt1.(A.7)

Finally, substituting (A.7) into (A.1), the result is:

DtDt1=(taga)YPtta(YtYPt)IBt+rtDt1+FDt1[(ERt1/ERt)1].(A.8)

The five components of the right-hand side of equation (A.8) are the five aforementioned elements: (1) the structural component, (2) the cyclical effect, (3) the discretionary component, (4) the interest charges, and (5) the exchange rate effect.

The debt dynamics can be expressed in ratios to GDP:

Dt/YtDt1 =(ta -ga).YPt/Yt -ta .(Yt -YPt)/YtIBt/Yt+rtDt1/Yt1+(FDt1/Yt1)[(ERt1/ERt)1][gt/(1+gt)]{(1+rt)Dt1/Yt1+.(FDt/Yt1)[(ERt1/ERt)1]}.(A.9)

The last two components of the right-hand side of equation (A.9) are adjustment terms attributable to the fact that output in the denominator relates to different years. The adjustment term vanishes if actual current output is used as a common denominator.

Stabilization of Indebtedness

The same budget identities, with the same limited data requirements, can be used to measure the primary balance required to stabilize the indebtedness ratio and to compare it with the observed primary balance.

Substituting equation (A.2) into equation (A.1) gives:

DtDt1=PBt+rtDt1+FDt1[(ERt1/ERt)1].(A.10)

Dividing all terms by Yt, or, equivalently, by Yt–1(1 + gt), and rearranging leads to:

Dt/YtDt1/Yt1=PBt/Yt+[(rtgt)/(1+gt)Dt1/Yt1+(FDt1/Yt1)[(1/1+gt)][(ERt1/ERt)1].(A.11)

Therefore, stability of the debt-to-GDP ratio will be achieved if the primary surplus in percentage of GDP is as follows:

PBt/Yt =[(rt -gt) /(1 +gt)].Dt1 /Yt1 +(FDt1/Yt1)[1/(1+gt)].[(ERt1 /ERt) - 1].(A.12)

Assuming no exchange rate effect on the valuation of the outstanding stock of foreign debt, if the differential between the implicit interest rate on public debt and the growth rate, both in nominal terms, is positive, stabilization of the debt-to-GDP ratio requires a primary surplus whose magnitude is proportional to the preceding year’s debt-to-GDP ratio and to the size of this differential. If the differential is negative, stabilization can be achieved even with some primary deficit.

The time series for public debt has been constructed by adding the successive cash deficits. The implicit interest rate on public debt is equal to interest charges paid during a given year divided by the stock of debt at the end of the previous year.

1

The figure does not include pension payments for military personnel or purchases of military equipment through the Defense Fund, generally secured from external sources under various bilateral military aid programs.

2

Peter Heller, Richard Haas, and Ahsan Mansur, A Review of the Fiscal Impulse Measure, Occasional Paper No. 44 (Washington: International Monetary Fund, 1986).

3

Primary expenditures are assumed not to be affected by cyclical fluctuations—a reasonable assumption given the absence of an unemployment insurance scheme in Jordan. Instead of using a “base-year” approach, as is most often the case when estimating trend values, the methodology used here is based on average values.

4

For the purpose of this empirical analysis, central government debt is defined to be limited to obligations arising from fiscal deficits accumulated over a certain period of time. Accordingly, the stock of outstanding debt and its accumulation—based on the analysis presented in this section—are different from the corresponding figures noted in other sections of this paper.

5

Foreign grants, seen as a financing item, are excluded from total revenue. This can bias the fiscal balance downward, given that part of the grants have financed expenditure—in particular, capital expenditure—which would not have taken place otherwise. Extrabudgetary operations, however, are excluded because no information prior to 1985 is available. Net lending and equity participation are also excluded.

6

Equivalent to 3.5 percent of GDP, mainly as a result of the introduction of a customs duly on cars imported by Jordanians returning from abroad.

7

This rate, however, excludes various fees and surcharges. Including these, the maximum effective tariff rate would be 70 percent, except for a few luxury items.

8

Until 1991, total expenditure included extrabudgetary expenditure, of an unknown nature, measured as the difference between the financing available to the treasury and the recorded cash deficit.

Strategy for Adjustment and Growth