## cr1876

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---

### Summary of the Literature on Tax Reforms — Objectives and Model Scope
- Purpose:
  - Contribute to understanding tax reforms in Morocco by quantifying potential effects of various reform scenarios on inequality and growth using a DSGE model adapted to Morocco’s specificities.
  - Capture impacts on growth, revenue, and fairness and assess parallel efforts to improve targeting and impact of public social spending.
- Model scope and structure:
  - Closed economy DSGE with four household types: informal sector workers, formal manufacturing and service workers, rural workers, and entrepreneurs.
  - Three goods: foods, manufacturing products, and informal services.
  - Includes housing market in urban areas and an informal sector.
  - Simulations are based on one percentage point changes from the baseline steady state and follow a perfect foresight path from the initial steady state to the new one.
- Reform scenarios simulated:
  - Increasing VAT rates and/or property tax rate.
  - Reducing exemptions and corporate tax rates.
  - Introducing a flat tax rate.
  - Enforcing personal income tax in the informal sector.
  - Strengthening the social safety net.

### Literature Synthesis — Growth, Distribution, and Tax Mix
- Relationship between tax reforms and growth:
  - Evidence is mixed; conventional wisdom in advanced economies suggests tax rate increases could dampen growth (McBride, 2012).
  - For developing economies, the relationship is inconclusive; weaker tax administration and enforcement may matter (Acosta-Ormaechea and Yoo 2012).
- Growth–equality trade-off and social safety nets:
  - Need to strengthen social safety nets to mitigate adverse distributional effects of tax reforms (Bird and Zolt, 2014; Lustig et al., 2012).
  - For poorest countries, shift to redistributive tax policies only after sufficient income-per-capita is reached (Ravallion, 2010).
- Tax classification and growth effects:
  - Progressive taxes (e.g., personal income tax), proportional taxes (e.g., property tax), and regressive taxes (e.g., consumption, trade taxes) have different growth/inequality impacts.
  - Cross-country analyses suggest income taxes tend to be detrimental to growth in advanced and emerging economies; shifting towards consumption and property taxes, revenue-neutral, can modestly increase growth (McBride, 2012; Acosta-Ormaechea and Yoo, 2012).
  - Some studies find that shifting from trade and consumption taxes to personal income tax, if revenue-neutral, may be detrimental to growth in some developing economies (McNabb and LeMay-Boucher, 2014).
- Other empirical points:
  - Tax reforms can reduce tax evasion and avoidance, improving fairness (Fjeldstad, 2014).
  - Property tax reforms may fail in developing economies because of higher administrative and land reform costs relative to revenue gains (Slack and Bird, 2014).
  - Tax mix implications for gender biases and tax administration efficiency (Grown and Valodia, 2010).

### Key Features of Morocco’s Tax System — Empirical Findings
- Aggregate revenue and trends:
  - Tax revenues declined from almost 24 percent of GDP in 2012 to 21.5 percent in 2016.
  - Drivers of the decline: (i) accelerated VAT refunds and lower VAT revenues due to lower oil prices; and (ii) lower “other revenues,” including from administrative fees, penalties, and transfers; large one-off “other revenues” observed in previous years ended.
- Tax base and exemptions:
  - Corporate and personal income and goods and services account for about 80 percent of tax revenues.
  - Total tax expenditure in 2016: about 3.2 percent of GDP (15.2 percent of tax revenue).
    - VAT-related tax expenditure: 1.5 percent of GDP.
    - Administrative fee tax expenditure: 0.6 percent of GDP.
    - Corporate income tax-related tax expenditure: 0.5 percent of GDP.
  - Number of exemptions in 2016: 407; about 30 percent related to consumption tax, 45 percent to income tax, remainder to administrative fees, excises, and customs duties.
  - Sectoral concentration of exemptions in 2016: agriculture and fishing benefited from 65.4 percent of them; real estate sector 23.6 percent.
- Tax rates and regime features:
  - VAT standard rate: 20 percent.
  - Reduced VAT rates mentioned in examples: medicine and utilities (7 percent), essential food items (10 percent), some processed food items and transportation equipment (14 percent).
  - Personal income tax rates: range between 0 and 38 percent across income brackets (regime in place since January 2010).
  - Corporate taxation: departed from unique 30 percent corporate income tax rate with corporate tax brackets introduced in the 2016 budget.
- Informal sector and tax enforcement:
  - Informal sector estimated at about 15 percent of total economic activity and about 22 percent of total employment.
  - More than 78 percent of informal sector production and about 73 percent of its labor force concentrated in the services sector (HCP 2009).
  - Example concentration of corporate tax revenues: 5 percent of firms produce more than 80 percent of total corporate tax revenues.
- Public transfers and targeting:
  - Share of households receiving public transfers rose from 10.8 percent in 2001 to 22.9 percent in 2014.
  - Geographic and distributional bias: bulk of increase benefited urban areas though most poor reside in rural areas.
  - In 2014, share of households receiving transfers by income quintile: bottom quintile 8.9 percent; top quintile 40.2 percent.
  - Average annual transfer amounts in 2014: poorest households 4,067 dirhams; wealthiest households 25,266 dirhams.

### Scenario Simulation Results and Transmission Channels — Selected Quantitative Outcomes
- Model transmission mechanism:
  - A tax reform changes marginal costs/benefits of agents (marginal utility, relative prices), triggering reallocation of consumption and production factors and affecting growth, tax revenue, and welfare.
  - Welfare effects assessed using standard welfare measures.
- Increasing VAT (marginal 1 percent changes reported):
  - A marginal increase in VAT rate (1 percent) on food raises government revenue by 0.9 percent.
  - A marginal increase in VAT rate (1 percent) on manufacturing goods raises government revenue by 0.8 percent.
  - GDP effects: GDP increases by 0.14 percent following an increase in VAT on manufacturing goods but declines by 0.03 percent after the increase in VAT rate on food.
  - Distributional effects: entrepreneurs would benefit the most from a VAT increase on manufacturing (their profits increase), while workers would generally be worse off.
- Implication:
  - Aligning the reduced VAT rate on manufacturing goods and services to the standard VAT rate could take advantage of both growth and revenue enhancing impacts, given Morocco’s high VAT rates and adverse growth effects of increased VAT on food.
- Other simulated scenarios (qualitative; detailed quantitative results not provided in excerpt):
  - Reductions in exemptions and corporate tax rates.
  - Increasing property tax rate.
  - Introducing a flat tax rate.
  - Enforcing personal income tax in the informal sector.
  - Strengthening the social safety net.

### Combined Reforms — Effects on Output, Investment, and Revenues (Section 13)
- Combined reduction in exemptions and corporate tax rates would:
  - Expand the tax base and reduce tax avoidance.
  - Increase investment through lower corporate tax rates.
  - Induce substitution effects (lower food consumption and higher manufacturing good consumption) via lower exemptions (e.g., in agriculture) and lower corporate tax.
  - Raise long-run output by 0.7 percent.
  - Increase government revenue by 0.3 percent, compensating revenue loss from the lower corporate tax rate.
- Broad-based property tax associated with increased tax rates would:
  - Encourage lower real estate accumulation and higher capital accumulation, increasing manufacturing production.
  - Generate an increase of 0.2 percent in long-run output.
  - Generate an increase of 0.9 percent in government revenues.
- Aggregate impacts of the proposed comprehensive tax reform:
  - Boost long-run growth by 1 percent by reducing corporate taxation and raising production incentives.
  - Enhance government revenues by 1.8 percent, helping reduce the fiscal deficit and creating additional fiscal space for investment and social spending.
  - Improve fairness and household welfare by addressing inequalities and making the tax system more progressive.
- Simulation framework notes:
  - The comprehensive reform scenario is used as the benchmark (set to 1 for output, tax revenue, food and manufacturing consumption); individual scenarios are compared to this benchmark.

### Policy Implications and Recommended Reform Package (Executive Summary)
- Recommended comprehensive tax reform package components:
  - Align the reduced VAT rate on manufacturing goods and services to the standard VAT rate.
  - Reduce tax exemptions.
  - Raise property tax.
  - Lower corporate tax rates.
  - Strengthen targeting of social programs (social safety nets).
- Rationale and design features:
  - Protect the most vulnerable while broadening the tax base, removing tax distortions, and better sharing the tax burden.
  - Broaden the tax base (e.g., by taxing self-employed and liberal professions, and introducing a broader-based property tax).
  - Remove tax distortions and better share the tax burden (e.g., through lower corporate tax rates).
  - Mitigate adverse distributional effects by protecting the poor (through better targeted safety nets).
  - Comprehensive and well explained reform strategy helps avoid poor sequencing, inconsistencies, and perceptions of unfairness that could undermine reform objectives.

### Annex I — The Model Economy: Structure and Key Equations
- Model overview:
  - Dynamic stochastic general equilibrium (DSGE) closed-economy model capturing Morocco's tax system and economic structure.
  - Four household types: I (informal), M (formal manufacturing & services), R (rural), E (entrepreneurs).
  - Three produced goods: f (foods), m (manufacturing products), s (informal services).
  - Multiple tax rates allowed: VAT, income, corporate tax, property tax, payroll subsidies; government redistribution through lump-sum transfers and food subsidies.
- Households:
  - Intertemporal utility for household type i ∈ {E,R,M,I}:
    - E_i Σ_{t=0}^∞ β_i^t [φ_f^i ln c_f^i_t + φ_m^i ln c_m^i_t + φ_s^i ln c_s^i_t + φ_h^i ln h_i_t + φ_l^i ln(1-l_i_t)]
  - Shares of each household in population: μ_i for i ∈ {E,R,M,I}.
- Informal worker households (I):
  - Budget constraint includes VAT on purchases at rates τ_f, τ_m, τ_s; personal income taxation modified by tax administration collection efficiency ξ ∈ [0,1].
  - First-order conditions (examples):
    - p_f^I_t c_f^I_t (1+τ_f) = φ_f^I λ^I_t
    - w^I_t l^I_t (1-ξ τ_w^I) = φ_l^I / λ^I_t
- Formal workers (M) and Rural workers (R):
  - Formal workers pay VAT, personal income tax, and property tax rate τ_h; housing adjustment costs AC_h included.
  - Rural workers own houses (exempt from property tax) and receive government food subsidy R_σ lowering effective food price; payroll tax rate τ_w^R (lowest payroll tax).
- Firms and entrepreneurs:
  - Food production: Y_f_t = μ_F (L_t^F)^{F_α} (n_t^f)^{1-F_α} z_F
  - Manufacturing: Y_m_t = μ_E (k_t)^{E_α} (n_t^m)^{1-E_α} z_E
  - Capital accumulation: k_t = (1-δ_k) k_{t-1} + [1 - ψ_k/2 ((i_t/k_{t-1}) - 1)^2] i_t
  - Investment adjustment costs AC_i = (ψ_k/2)( (i_t / k_{t-1}) - 1 )^2
  - Corporate tax rates: τ_w^F (agricultural, lower) and τ_w^E (manufacturing & services, higher).
- Government sector:
  - Government budget constraint and expenditure AR(1) dynamics: g_t = ρ_g g_{t-1} + (1-ρ_g) g where ρ_g ∈ (0,1).
  - Lump-sum transfers distributed by fixed GDP-share proportions γ_i.
  - Rural food subsidy: S_b_t = μ_R f Y_t R_σ.
  - Aggregate tax revenue expression includes VAT, property tax, income taxes on wages, profits, interest (detailed formula in text).
- Market clearing and aggregates:
  - Food market: C_f_t + L_t = Y_f_t.
  - Manufacturing goods used for consumption, investment, and government expenditure; manufacturing serves as numeraire.
  - GDP definition: Y_t = p_f_t Y_f_t + p_m_t Y_m_t + p_s_t Y_s_t.
  - Equilibrium defined by set of prices (r, p_h, p_s, p_m, p_f, p_p, k), allocations, and market clearing conditions.
- Calibration and data sources:
  - Calibrated to Morocco using 2007 and 2014 Household Surveys, national accounts, IMF and World Bank databases, Tax code; sectoral shares from EORA MRIO database.
  - Parameters inferred from optimality conditions and steady-state ratios; sensitivity analysis on adjustment cost parameters to match short-run volatility.

### Structural Transformation and Labor Reallocation — Findings and Policy Priorities
- Motivation and key findings:
  - Weak growth performance linked to low TFP and human capital relative to emerging market peers.
  - Over the last decade, productivity gains within agriculture accounted for the bulk of aggregate productivity growth; about one third from labor reallocation.
  - Agriculture employed around 37 percent of workforce in 2017; share of agriculture in value added declined slowly.
  - Between 2000 and 2014, about 1.7 million jobs outside agriculture were generated, over half in construction and hospitality (low productivity sectors).
  - Stylized estimate: structural transformation could increase aggregate labor productivity by about 40 percent (Annex II).
- Institutional frictions and constraints:
  - Restrictive labor market regulations (fixed-term contracts, firing, working-hours flexibility).
  - High social security contributions raising labor costs.
  - Large informal sector (~15 percent of total economic activity).
  - Concentration of public investment through SOEs (more than half), with 40 percent corresponding to only four SOEs.
  - Human capital constraints: low education outcomes, high dropout rates, rural illiteracy (especially among women), overenrollment in social sciences vs technical fields.
- Empirical estimation of labor reallocation efficiency:
  - Cross-country error correction model (ECM) using a panel of 42 countries and 10 sectors (1960-2012) to estimate speed of sectoral labor reallocation and role of frictions.
  - Key estimation results:
    - Higher income countries close productivity gaps across sectors 2.4 times faster than lower middle income countries such as Morocco.
    - Mining and utilities fastest in attracting labor out of agriculture; manufacturing, trade and tourism have most persistent productivity gaps.
    - Factors associated with faster reallocation: lower payroll and income taxes, deeper financial systems, better governance and regulatory environment, higher educational attainment.
- Distance-to-frontier analysis and priority reform areas:
  - Priority indicators: judicial independence; bureaucracy costs; ease of property sales; severance payments; financial market development; secondary education enrollment (female).
- Policy recommendations to support structural change:
  - Improve business climate and governance; reduce bureaucracy costs; make judicial system more independent; improve coordination for SME expansion and worker training.
  - Improve access to finance and financial market development; SME credit guarantees; legal framework for collateral execution.
  - Reform education to raise human capital and female secondary enrollment; promote technical and vocational training; complementary infrastructure (transport, childcare).
  - Reduce labor market rigidities (severance, restrictions on fixed-term contracts); establish adequate safety nets.
  - Reduce informality through incentives for formalization and by lowering costs of formal employment.
  - Rebalance public investment away from concentrated SOE-dominated spending and improve product market competition.

*Prepared by Jean Frédéric Noah Ndela Ntsama, Hamed Ghiaie, and Gregory Auclair. Source: IMF staff calculations and analysis in "DISTRIBUTIONAL EFFECTS OF TAX REFORMS IN MOROCCO" (November 29, 2017). Source: Annex I and chapter text in CR1876.*

### 1. Summary of the Literature on Tax Reforms ___________________________________________________  4

### 1. Summary of the Literature on Tax Reforms

### A. Introduction and objectives
- Purpose:
  - Contribute to understanding tax reforms in Morocco by quantifying potential effects of various reform scenarios on inequality and growth using a DSGE model adapted to Morocco’s specificities.
  - Capture impacts on growth, revenue, and fairness and assess parallel efforts to improve targeting and impact of public social spending.
- Model scope and structure:
  - Closed economy DSGE with four household types: informal sector workers, formal manufacturing and service workers, rural workers, and entrepreneurs.
  - Three goods: foods, manufacturing products, and informal services.
  - Includes housing market in urban areas and an informal sector.
  - Simulations are based on one percentage point changes from the baseline steady state and follow a perfect foresight path from the initial steady state to the new one.
- Reform scenarios simulated:
  - Increasing VAT rates and/or property tax rate.
  - Reducing exemptions and corporate tax rates.
  - Introducing a flat tax rate.
  - Enforcing personal income tax in the informal sector.
  - Strengthening the social safety net.

### B. Literature summary (Box 1)
- Relationship between tax reforms and growth:
  - Evidence is mixed; conventional wisdom in advanced economies suggests tax rate increases could dampen growth (McBride, 2012).
  - For developing economies, the relationship is inconclusive; weaker tax administration and enforcement may matter (Acosta-Ormaechea and Yoo 2012).
- Growth–equality trade-off and social safety nets:
  - Need to strengthen social safety nets to mitigate adverse distributional effects of tax reforms (Bird and Zolt, 2014; Lustig et al., 2012).
  - For poorest countries, shift to redistributive tax policies only after sufficient income-per-capita is reached (Ravallion, 2010).
- Tax classification and growth effects:
  - Progressive taxes (e.g., personal income tax), proportional taxes (e.g., property tax), and regressive taxes (e.g., consumption, trade taxes) have different growth/inequality impacts.
  - Cross-country analyses suggest income taxes tend to be detrimental to growth in advanced and emerging economies; shifting towards consumption and property taxes, revenue-neutral, can modestly increase growth (McBride, 2012; Acosta-Ormaechea and Yoo, 2012).
  - Some studies find that shifting from trade and consumption taxes to personal income tax, if revenue-neutral, may be detrimental to growth in some developing economies (McNabb and LeMay-Boucher, 2014).
- Other points:
  - Tax reforms can reduce tax evasion and avoidance, improving fairness (Fjeldstad, 2014).
  - Property tax reforms may fail in developing economies because of higher administrative and land reform costs relative to revenue gains (Slack and Bird, 2014).
  - Tax mix implications for gender biases and tax administration efficiency (Grown and Valodia, 2010).

### C. Key features of Morocco’s tax system (empirical findings)
- Aggregate revenue and trends:
  - Tax revenues declined from almost 24 percent of GDP in 2012 to 21.5 percent in 2016.
  - Drivers of the decline: (i) accelerated VAT refunds and lower VAT revenues due to lower oil prices; and (ii) lower “other revenues,” including from administrative fees, penalties, and transfers; large one-off “other revenues” observed in previous years ended.
- Tax base and exemptions:
  - Tax base is relatively narrow and skewed: corporate and personal income and goods and services account for about 80 percent of tax revenues.
  - VAT exemptions: several items (e.g., some foods items, medicine) are exempted.
  - Income tax base narrow: many liberal and independent professions, and many firms (about 64 percent), avoid it.
  - Total tax expenditure in 2016: about 3.2 percent of GDP (15.2 percent of tax revenue).
    - VAT-related tax expenditure: 1.5 percent of GDP.
    - Administrative fee tax expenditure: 0.6 percent of GDP.
    - Corporate income tax-related tax expenditure: 0.5 percent of GDP.
  - Number of exemptions in 2016: 407; about 30 percent related to consumption tax, 45 percent to income tax, remainder to administrative fees, excises, and customs duties.
  - Sectoral concentration of exemptions in 2016: agriculture and fishing benefited from 65.4 percent of them; real estate sector 23.6 percent.
- Tax rates and regime features:
  - VAT standard rate: 20 percent.
  - Reduced VAT rates mentioned in examples: medicine and utilities (7 percent), essential food items (10 percent), some processed food items and transportation equipment (14 percent).
  - Personal income tax rates: range between 0 and 38 percent across income brackets (regime in place since January 2010).
  - Corporate taxation: departed from unique 30 percent corporate income tax rate with corporate tax brackets introduced in the 2016 budget.
- Informal sector and tax enforcement:
  - Informal sector estimated at about 15 percent of total economic activity and about 22 percent of total employment.
  - More than 78 percent of informal sector production and about 73 percent of its labor force concentrated in the services sector (HCP 2009).
  - Example concentration of corporate tax revenues: 5 percent of firms produce more than 80 percent of total corporate tax revenues.
- Public transfers and targeting:
  - Share of households receiving public transfers rose from 10.8 percent in 2001 to 22.9 percent in 2014.
  - Geographic and distributional bias: bulk of increase benefited urban areas though most poor reside in rural areas.
  - In 2014, share of households receiving transfers by income quintile: bottom quintile 8.9 percent; top quintile 40.2 percent.
  - Average annual transfer amounts in 2014: poorest households 4,067 dirhams; wealthiest households 25,266 dirhams.

### D. Scenario simulation results and transmission channels
- Model transmission mechanism:
  - A tax reform changes marginal costs/benefits of agents (marginal utility, relative prices), triggering reallocation of consumption and production factors and affecting growth, tax revenue, and welfare.
  - Welfare effects assessed using standard welfare measures.
- Key simulated outcomes (examples reported):
  - Increasing VAT:
    - A marginal increase in VAT rate (1 percent) on food raises government revenue by 0.9 percent.
    - A marginal increase in VAT rate (1 percent) on manufacturing goods raises government revenue by 0.8 percent.
    - GDP effects: GDP increases by 0.14 percent following an increase in VAT on manufacturing goods but declines by 0.03 percent after the increase in VAT rate on food.
    - Distributional effects: entrepreneurs would benefit the most from a VAT increase on manufacturing (their profits increase), while workers would generally be worse off.
  - Implication drawn:
    - Aligning the reduced VAT rate on manufacturing goods and services to the standard VAT rate could take advantage of both growth and revenue enhancing impacts, given Morocco’s high VAT rates and adverse growth effects of increased VAT on food.
- Other scenario types (simulated but detailed quantitative results not provided in excerpt):
  - Reductions in exemptions and corporate tax rates.
  - Increasing property tax rate.
  - Introducing a flat tax rate.
  - Enforcing personal income tax in the informal sector.
  - Strengthening the social safety net.

### E. Policy implications and recommended reform package (from executive summary)
- Recommended comprehensive tax reform package components:
  - Align the reduced VAT rate on manufacturing goods and services to the standard VAT rate.
  - Reduce tax exemptions.
  - Raise property tax.
  - Lower corporate tax rates.
  - Strengthen targeting of social programs (social safety nets).
- Rationale:
  - Protect the most vulnerable while broadening the tax base, removing tax distortions, and better sharing the tax burden.
  - Comprehensive and well explained reform strategy helps avoid poor sequencing, inconsistencies, and perceptions of unfairness that could undermine reform objectives.

*Prepared by Jean Frédéric Noah Ndela Ntsama, Hamed Ghiaie, and Gregory Auclair. Source: IMF staff calculations and analysis in "DISTRIBUTIONAL EFFECTS OF TAX REFORMS IN MOROCCO" (November 29, 2017).*

### 13.      A combination of lower exemptions and lower corporate tax rates would boost

### 13.      A combination of lower exemptions and lower corporate tax rates would boost

### Effects on output, investment, and revenues
- Combined reduction in exemptions and corporate tax rates would:
  - Expand the tax base and reduce tax avoidance.
  - Increase investment through lower corporate tax rates.
  - Induce substitution effects (lower food consumption and higher manufacturing good consumption) via lower exemptions (e.g., in agriculture) and lower corporate tax.
  - Raise long-run output by 0.7 percent.
  - Increase government revenue by 0.3 percent, compensating revenue loss from the lower corporate tax rate.
- A broad-based property tax associated with increased tax rates would:
  - Encourage lower real estate accumulation and higher capital accumulation, increasing manufacturing production.
  - Generate an increase of 0.2 percent in long-run output.
  - Generate an increase of 0.9 percent in government revenues.
  - Operate through house prices as a key channel affecting incentives for home ownership versus renting.

### Recommended reform package components and design
- The simulations inform a recommended comprehensive tax reform strategy to enhance tax revenue, boost growth, and improve fairness.
- An optimal tax reform package should combine several key reform components:
  - (i) aligning the reduced VAT rate on manufacturing goods and services to the standard VAT rate,
  - (ii) reducing tax exemptions,
  - (iii) raising property tax,
  - (iv) lowering corporate tax rates, and
  - (v) strengthening safety nets.
- Additional design features:
  - Broaden the tax base (e.g., by taxing self-employed and liberal professions, and introducing a broader-based property tax).
  - Remove tax distortions and better share the tax burden (e.g., through lower corporate tax rates).
  - Mitigate adverse distributional effects by protecting the poor (through better targeted safety nets).

### Aggregate impacts and welfare
- The proposed comprehensive tax reform would:
  - Boost long-run growth by 1 percent by reducing corporate taxation and raising production incentives.
  - Enhance government revenues by 1.8 percent, helping reduce the fiscal deficit and creating additional fiscal space for investment and social spending.
  - Improve fairness and household welfare by addressing inequalities and making the tax system more progressive.
- Simulation framework notes:
  - The comprehensive reform scenario is used as the benchmark (set to 1 for output, tax revenue, food and manufacturing consumption); individual scenarios are compared to this benchmark.

### Conclusion and policy message
- Morocco would benefit from designing and implementing a comprehensive approach to tax reform that combines the elements listed above.
- Such a strategy could:
  - Address inequalities and support growth while preserving revenue mobilization.
  - Improve fairness by making the overall tax system more progressive.
  - Boost long-term growth by 1 percent and enhance government revenues by 1.8 percent.

*Source: IMF staff calculations.*

### Annex I. The Model Economy

### Annex I. The Model Economy

### Model overview
- Dynamic stochastic general equilibrium (DSGE) model of a closed economy designed to capture the main features of Morocco tax system and economic structure and to simulate tax reforms.
- Four household types: informal sector workers (I), formal manufacturing and service workers (M), rural workers (R), and entrepreneurs (E).
- Three produced goods: foods (f), manufacturing products (m), and informal services (s).
- Model allows multiple tax rates for VAT, income, corporate tax, property tax, and payroll subsidies; government redistribution through lump-sum transfers and food subsidies.

### Households: preferences and structure
- Households derive utility from consumption, housing, and leisure; consumption basket composed of f_c (food), m_c (manufacturing products), and s_c (services).
- Population normalized to unit; households live infinitely.
- Intertemporal utility (for household type i ∈ {E,R,M,I}):
  - E_i Σ_{t=0}^∞ β_i^t [φ_f^i ln c_f^i_t + φ_m^i ln c_m^i_t + φ_s^i ln c_s^i_t + φ_h^i ln h_i_t + φ_l^i ln(1-l_i_t)]
- Shares of each household in population: μ_i for i ∈ {E,R,M,I}.

### Informal worker households (I)
- Informal workers are self-employed producing services; rent houses from entrepreneurs.
- Budget constraint (expression (3.2) in text) includes:
  - Consumption of f, m, s at prices p_f^I_t, p_m^I_t, p_s^I_t.
  - Rent r_t^h at rental price p^r_t.
  - Labor unit cost Is_t = I_z * p_s_t (productivity I_z and service market price p_s_t).
  - Government lump-sum transfer Γ^I_t.
  - VAT on purchases at rates τ_f, τ_m, τ_s for food, manufacturing goods, services respectively.
  - Personal income taxation modified by tax administration collection efficiency ξ ∈ [0,1] for the informal sector.
- First-order conditions (consumption, housing, leisure):
  - p_f^I_t c_f^I_t (1+τ_f) = φ_f^I λ^I_t  (3.3)
  - p_m^I_t c_m^I_t (1+τ_m) = φ_m^I λ^I_t  (3.4)
  - p_s^I_t c_s^I_t (1+τ_s) = φ_s^I λ^I_t  (3.5)
  - p^r_t h^I_t = φ_h^I λ^I_t  (3.6)
  - w^I_t l^I_t (1-ξ τ_w^I) = φ_l^I / λ^I_t  (3.7)
- Implication: optimal consumption and labor choices depend on VAT and income tax rates and on tax collection efficiency ξ.

### Formal manufacturing and service workers (M)
- Live in urban areas, buy/sell houses, pay VAT, personal income tax, and property tax rate τ_h.
- Budget constraint expressed in (3.8) includes labor income (w^M_t), lump-sum transfer Γ^M_t, housing adjustment costs AC_h^M_t.
- Housing adjustment cost: AC_h = (ψ_h/2) ( (p_h_t h_t^M - h_{t-1}^M p_h_{t-1})^2 ).
- First-order conditions:
  - p_f^M_t c_f^M_t (1+τ_f) = φ_f^M λ^M_t  (3.9)
  - p_m^M_t c_m^M_t (1+τ_m) = φ_m^M λ^M_t  (3.10)
  - p_s^M_t c_s^M_t (1+τ_s) = φ_s^M λ^M_t  (3.11)
  - Intertemporal housing condition (3.12) (links current and expected marginal utilities, property tax, housing price, and adjustment costs)
  - Labor condition: w^M_t l^M_t (1-τ_w^M) = φ_l^M / λ^M_t  (3.13)

### Rural workers (R)
- Live in rural areas, work on farms, own houses (exempt from property tax), receive government food subsidy R_σ that lowers effective food price.
- Frictions limit migration; rural/urban population shares stable.
- Budget constraint (3.14) includes wage w^R_t, lump-sum transfer Γ^R_t, payroll tax rate τ_w^R (lowest payroll tax), and subsidy R_σ.
- First-order conditions:
  - p_f^R_t c_f^R_t (1-σ + τ_f) = φ_f^R λ^R_t  (3.15)
  - p_m^R_t c_m^R_t (1+τ_m) = φ_m^R λ^R_t  (3.16)
  - p_s^R_t c_s^R_t (1+τ_s) = φ_s^R λ^R_t  (3.17)
  - Labor condition: w^R_t l^R_t (1-τ_w^R) = φ_l^R / λ^R_t  (3.18)
- Implication: VAT increases change relative prices and consumption baskets; food subsidies directly affect effective food price and food consumption.

### Entrepreneurs (E) and firms
- Two firm types: agricultural (rural) and manufacturing & service (urban).
- Food production f_t^Y uses land and rural labor with Cobb-Douglas:
  - Y_f_t = μ_F (L_t^F)^{F_α} (n_t^f)^{1-F_α} z_F  (3.19)
- Manufacturing & services production uses capital and urban labor:
  - Y_m_t = μ_E (k_t)^{E_α} (n_t^m)^{1-E_α} z_E  (3.20)
- Capital accumulation law of motion (3.21):
  - k_t = (1-δ_k) k_{t-1} + [1 - ψ_k/2 ((i_t/k_{t-1}) - 1)^2] i_t
- Investment adjustment costs for firms: AC_i = (ψ_k/2)( (i_t / k_{t-1}) - 1 )^2.
- Entrepreneurs’ income components: corporate profits (π_F_t, π_E_t), rent from informal workers, interest from government bonds.
- Corporate tax rates: τ_w^F (agricultural firms, lower) and τ_w^E (manufacturing & services, higher).
- Entrepreneurs face VAT, personal income tax, corporate tax on profits.
- Entrepreneur budget constraint summarized in (3.22) with consumption, housing, rents, land costs, bond holdings, transfers Γ^E_t, and taxes.
- First-order conditions for entrepreneurs include consumption Euler, housing conditions, bond condition, capital and labor FOCs (3.23)–(3.32).

### Government sector and fiscal instruments
- Government budget constraint (3.33):
  - S_t b_{t-1} + g_t + r_t b_{t-1} + G_r_t + T_t = Γ_t + … (expression reflects bonds, expenditures, food subsidies S_b_t, lump-sum transfers Γ_t; see (3.33) in text)
- Government expenditure follows AR(1)-type path (3.34):
  - g_t = ρ_g g_{t-1} + (1-ρ_g) g  where ρ_g ∈ (0,1)
- Lump-sum transfers distributed across four households by fixed GDP-share proportions γ_i for i ∈ {E,R,M,I} (expressions (3.33) and (3.34) in text).
- Rural food subsidy: S_b_t = μ_R f Y_t R_σ (3.35) (government subsidy parameter σ applied to food)
- Total tax revenue components include VAT, property tax, income taxes on wages, profits, interest; aggregate tax revenue expression given in (3.36) (detailed term-by-term formula in text).
- Government revenue item G_r_t includes grants and voluntary contributions treated as an AR(1) stochastic variable.

### Market clearing and aggregates
- Goods market clearing:
  - Food market: C_f_t + L_t = Y_f_t (3.44)
  - Services/informal: C_s_t = μ_S z_I_t Y_s_t (3.45)
  - Manufacturing: C_m_t + i_t + g_t + other uses = Y_m_t (3.46)
- Manufacturing goods used for consumption, investment, and government expenditure; manufacturing serves as numeraire.
- GDP definition (3.47): Y_t = p_f_t Y_f_t + p_m_t Y_m_t + p_s_t Y_s_t
- Labor market clearing:
  - n_t^R μ_R = n_t^F μ_F  (3.48)
  - n_t^M μ_M = n_t^E μ_E  (3.49)
- Total capital stock: K_t = μ_E k_t  (3.50)
- Equilibrium defined by set of prices (r, p_h, p_s, p_m, p_f, p_p, k), allocations, and market clearing conditions.

### Calibration and data sources
- Model calibrated to Morocco’s economy and long-run properties using steady-state matching and reverse-engineering structural parameters from non-linear decision rules.
- Data sources: Morocco’s 2007 Household Survey (and when available 2014 Household Survey), macroeconomic variables from national accounts, IMF and World Bank databases, and Tax code (VAT rates, income tax, property, capital gains).
- Sectoral shares in output and household consumption derived from EORA Multi-Region Input-Output (MRIO) database.
- Calibration approach:
  - All parameters (except adjustment costs) inferred from optimality conditions and steady-state ratios.
  - Sensitivity analysis on adjustment cost parameters to match short-run volatility.
- Calibrated parameters table provided in original material (not reproduced here).

*Source: Annex I. The Model Economy (CR1876).*

### References

### References

### Motivation
- Stimulating productivity growth and job creation are among Morocco's main economic challenges.
- Growth accounting shows weak growth performance is explained by low productivity growth linked to relatively low levels of total factor productivity (TFP) and human capital compared to emerging market peers (Figure 1).
- Job creation and labor force participation are lower compared to peers while physical capital levels are closer to international benchmarks.
- Prepared by Khalid ElFayoumi, Anta Ndoye, Sanaa Nadeem, and Gregory Auclair.

### Structural transformation in Morocco — key findings
- Structural transformation is defined as the reallocation of labor resources from low to higher productivity sectors and can raise aggregate productivity.
- Over the last decade, productivity gains within the agricultural sector accounted for the bulk of aggregate productivity growth in Morocco, while about one third of the gains came from labor reallocation from low to higher-productivity sectors (structural transformation).
- Agriculture continued to employ the largest share of Morocco’s workforce, around 37 percent in 2017, and the share of agriculture in total value added has decreased slowly.
- Between 2000 and 2014, the Moroccan economy generated about 1.7 million jobs outside of agriculture, over half of which were in two low productive sectors: construction and hospitality.
- Agriculture accounts for the largest contribution to “within-sector” productivity in recent years; this contrasts with Asian and Latin American countries where “structural” and/or “within” contributions from manufacturing have been large.
- A stylized estimate shows structural transformation could increase aggregate labor productivity by about 40 percent (Annex II). This assumes labor productivity levels and employment shares completely equalize between sectors and no further “within” productivity growth.
- Movement of labor has largely been from agriculture into low-productivity growth sectors.

### Institutional frictions and constraints
- Several institutional frictions hinder labor reallocation, including:
  - Restrictive labor market regulations, notably on fixed-term contracts, firing, and working-hours flexibility (Figure 5).
  - High social security contributions that raise labor costs and discourage formal employment, particularly for young people.
  - A large informal sector, estimated by the national statistics office to be around 15 percent of total economic activity.
  - Concentration of public investment: more than half of public investment is channeled through state owned enterprises (SOEs), of which 40 percent corresponds to only four SOEs (World Bank, 2017).
- Human capital constraints:
  - Low human capital levels and education outcomes; Moroccan students score subpar on international tests, with high dropout rates and persistent rural illiteracy, especially among women.
  - Overenrollment in social science fields at universities at the expense of technical careers leads to skills mismatches.
  - Average education level by sector is strongly correlated with productivity, making education a key determinant of labor reallocation.
- Sectoral and firm-level frictions documented in the literature (Box 1) include:
  - Firm level: labor market regulations; credit frictions and banking regulations; trade costs; presence of large SOEs; a large informal sector.
  - Sector level: customs protection, currency devaluation practices, revealed comparative advantage in natural resources, barriers to entry, and monopoly powers.
- Excessive labor regulations can prevent wage alignment with productivity and discourage efficient reallocation; lower educational attainment can prevent movement toward higher productivity sectors.

### Empirical estimation of labor reallocation efficiency
- Methodology:
  - A cross-country error correction model (ECM) of relative employment and value added shares across sectors is used to estimate the speed of sectoral labor reallocation and the role of institutional frictions (Annex I).
  - The panel dataset comprises 42 countries and 10 sectors over the periods 1960-2012, using GGDC 10-sector data.
  - Estimation methods include fixed effects and system generalized method of moments (GMM) to address endogeneity and dynamic panel bias.
  - Reform variables include IMF (2008) indices of de jure reforms and liberalization in real and financial sectors, and other structural reforms; supplemented with Economic Freedom and Fraser index measures.
- Key estimation results:
  - The speed of labor reallocation varies by income level and sector (Table 2, Annex 1).
  - Higher income countries close productivity gaps across sectors 2.4 times faster than lower middle income countries such as Morocco.
  - Mining and utilities are the fastest in attracting labor out of agriculture, while manufacturing, trade and tourism have the most persistent productivity gaps.
  - Factors associated with faster labor reallocation and less persistent productivity gaps:
    - Lower payroll and income taxes as well as severance payments.
    - Deeper financial systems.
    - Better governance and regulatory environment.
    - Educational attainment.
  - For low income countries, higher female enrollment in secondary education and stronger market competition are particularly important.
  - For manufacturing, stronger product market competition, less government support for SOEs, and stronger public investment are significantly linked with faster job creation and smoother labor movement from agriculture.

### Distance-to-frontier analysis and reform priorities
- A distance-to-frontier analysis highlights frictions related to governance, labor, finance, and education as priorities for Morocco.
- Indicators flagged as priority reform areas include:
  - Judicial independence.
  - Bureaucracy costs.
  - Ease of property sales.
  - Severance payments.
  - Financial market development.
  - Secondary education enrollment rate, particularly for females.
- Data notes for Figure 9:
  - Last Reported Year: Cumulative drop-out rate, 2012; Financial: Entry barriers/pro-competition, 2005; Net enrollment rate, secondary, both sexes, 2012; Financial: Security Markets, 2005; Domestic Finance: (Composite), 2005; Financial Privatization, 2005; Banking Supervision, 2005; Gross enrollment ratio, secondary, female, 2012; Regulatory Quality, 2012; sale of real property, 2012; Judicial independence, 2012; Bureaucracy costs, 2012.
  - Note: Labor indicators are not widely available for Morocco. The results are based on Schindler and Aleksynska 2011.

### Policy implications and recommendations
- To facilitate labor reallocation and structural change, Morocco needs to:
  - Improve business climate and governance (reduce bureaucracy costs; improve judicial independence; ease property sale restrictions).
  - Improve access to finance and financial market development.
  - Reduce labor market rigidities, including reforms to severance and restrictions on fixed-term contracts and firing.
  - Reform education to raise human capital and address gender gaps in secondary enrollment; promote technical and vocational training to reduce skills mismatches.
  - Reduce informality through incentives for formalization and by lowering costs of formal employment.
  - Rebalance public investment channels away from concentrated SOE-dominated spending and improve competition in product markets.
- These reforms target the institutional frictions identified as slowing sectoral labor reallocation and would support higher structural transformation and aggregate productivity growth.

*International Monetary Fund PDF: cr1876 - References*

### 11.      Morocco has improved substantially on several indicators since the end of the

### 11.      Morocco has improved substantially on several indicators since the end of the observation period in 2012, but more remain to be done

### Improvements since 2012
- Efforts made to simplify administrative procedures for businesses and improve school enrollment rates.
- Reforms undertaken to improve capital market financing and infrastructure and to strengthen the regulation and supervision of financial intermediaries.
- Selected structural indicator comparisons (2000-12 Average | Latest | Best observed | Scale (worst to best)):
  - Bureaucracy costs: 5.3 | 5.3 | 10.00 to 10
  - Judicial independence: 4.9 | 4.5 | 9.80 to 10
  - Regulatory restrictions on the sale of real property: 6.9 | 7.6 | 10.00 to 10
  - Regulatory quality: -0.2 | 0.5 | 2.2 | -2.5 to 2.5
  - Cumulative drop-out rate to the last grade of primary education, both sexes (%): 20.4 | 11.2 | 0.8 | 100 to 0
  - Gross enrolment ratio*, secondary, female (%): 48.5 | 63.5 | 100.0
  - Net enrolment rate, secondary, both sexes (%): 47.6 | 56.2 | 99.7 | 0 to 100
  - *Note: Calculated as the percent ratio of females to males. A ratio of 100 is desirable, representing equal female and male enrollment.

### Conclusion: role of addressing frictions
- Addressing frictions promotes labor reallocation toward higher productivity sectors, raising aggregate productivity growth and employment.
- Reduced structural frictions support the effectiveness of sectoral policies.
- No one-size-fits-all policy prescription; reform priorities depend on:
  - productivity gaps between sectors,
  - income level,
  - fiscal situation,
  - cyclical position,
  - scale of particular policy distortions.
- A more flexible labor market may have a dampening short-term effect on growth and employment and should be coupled with:
  - more effective active labor market policies,
  - other growth-enhancing structural reforms to limit job losses and negative growth impact.

### Policy recommendations for Morocco
- Governance
  - Continue to streamline business regulations and tax codes.
  - Reduce bureaucratic red tape and discourage corruption.
  - Make the judicial system more independent.
  - Improve coordination among public and private players, especially SMEs, to support firm expansion and worker training and yield productivity and wage gains.
- Finance
  - Continue shift to more risk-based and forward-looking supervision.
  - SME credit guarantees could address obstacles to SME credit access and improve domestic finance.
  - A new legal framework for collateral execution could accelerate NPL resolution and increase recovery rates, improving domestic financial conditions.
- Education
  - Improve quality of education and reduce skills gaps between the education system and needs of high-productivity sectors to support job creation.
  - Invest in female education to help movement of workers from agriculture and informal sectors toward higher-productivity service and manufacturing sectors.
  - Complementary investments (transport, infrastructure, childcare facilities) can increase female labor force participation in secondary and tertiary sectors.
- Labor regulation
  - Relax hiring and firing costs by easing restrictions on fixed-term contracts and layoffs to better integrate young workers.
  - Establish adequate safety nets for the unemployed.

### Annex I — Error Correction Models (ECM) for Labor Reallocation and Job Creation: Method
- ECM framework follows Ngai and Pissarides (2007): long-run equilibrium where employment shares follow value added shares; frictions create wedges between observed allocations and long-run optimal allocation.
- Key variables (relative to agriculture): N (labor share), P (sector price level), A (sector TFP), Ω (sector weight in consumption).
- Optimal adjustment rule derived from minimization of a myopic quadratic cost function with parameter ߢ (ratio of marginal cost of adjustment to marginal cost of being away from equilibrium).
- Speed of adjustment ߣ lies between 0 and 1; closer to 1 implies faster adjustment and lower friction costs.
- Baseline ECM specification (short-term and long-term dynamics) includes:
  - X_t controls: growth rate of GNP per capita, population growth rate, constant and linear trend fixed effects (sector × country).
  - Z_t controls: index for global business cycle, a global linear trend, countries’ GNP per capita growth rates, and population growth rates.
- Structural frictions introduced via interaction with speed of adjustment: ߣ = ߣ_1 + ߣ_2 * (gap size) + ߣ_3 * (structural indicator). Higher ߣ_s implies slower labor reallocation.

### Annex I — Results: Baseline ECM (Labor Reallocation)
- Dependent variable: Δlog(N_i)
- Table 1: Results: Baseline ECM: Labor Reallocation — Explanatory variables: Estimate
  - Relative value added Growth Δlog(SVA_i): 0.281*** (Without Gap Size) | 0.278*** (With Gap Size)
  - Relative sectoral prices growth Δlog(P_i): 0.0409*** | 0.039***
  - Deviation from long-run target (gap) (gap_{t-1}): -0.137*** | -0.139***
  - (Deviation from long-run target)^2: --- | 0.074***
  - GDP per capita growth rate gpcΔ: 0.0646*** | 0.0636***
  - Population growth rate popΔ: 0.347*** | 0.282***
  - Global business cycle index: 0.000 | 0.000
  - *** Significant at 1 percent
- Table 2: Baseline ECM: Labor Reallocation by Subgroup — Estimates (all significant at 1 percent)
  - Income groups:
    - High income: 0.278
    - Upper middle income: 0.206
    - Lower middle income: 0.115
    - Low income: 0.055
  - Sectors:
    - Mining: 0.178
    - Utilities: 0.148
    - Construction: 0.117
    - Government services: 0.115
    - Transport, Storage and Communication: 0.108
    - Manufacturing: 0.103
    - Trade, Restaurants and Hotels: 0.102

### Table 3 (summary)
- Table 3 compares the effect of structural indicators across five categories—education, governance, labor regulations, product market regulations, and trade and openness—on adjustment speeds.
- The higher the value of ߣ_s, the slower the speed of labor reallocation.

### Annex II — Measuring Sectoral Distortion in Morocco
- Sectoral distortions defined as the difference between employment and value added shares of a sector in relative terms.
- In Morocco, distortions are driven mainly by the agriculture, construction and trade sectors and are large compared to other countries.
- Further structural change could increase labor productivity by almost 40 percent.
- Noted empirical relationships:
  - When value-added share equals labor share for all sectors, structural change no longer contributes to growth.
  - Given disparities between relative value added and employment shares in Morocco, structural transformation can make a large contribution to growth.
  - Average years of schooling is strongly correlated with sector productivity levels; low or unequal human capital constrains labor movement across sectors and is an important determinant of distortions.
- Sectoral distortion index referenced (1990-2010) and sectoral distortions in Morocco by industry (1999-2015) illustrate magnitudes (index, 0 = no distortion).
- Morocco: Average Years of Schooling by Sector (by census round) shows sectoral differences in human capital accumulation.

*Source: IMF staff estimates; content from chapter text and annexes in the provided PDF.*

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_Source: https://www.imf.org/-/media/files/publications/cr/2018/cr1876.pdf_