## _wp1079

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### Introduction and recent macroeconomic performance
- Real GDP growth averaged 8 percent during 2004–08 with single digit inflation and a relatively stable currency.
- Sector shares (real terms):
  - Oil: about 10 percent of overall GDP.
  - Agriculture: 35 percent of real output.
  - Services: 50 percent of real output.
- Oil share in external and fiscal flows:
  - Oil accounts for about 95 percent of Sudan’s exports.
  - Oil accounts for over half of all government revenue.
- FDI and reserves:
  - FDI rose from about 3.5 percent of GDP in 1997 to almost 10 percent of GDP in 2008.
  - Within six months of the August-2008 reversal in world oil prices, foreign exchange reserves halved to 2 weeks of imports.

### Oil dependence and fiscal/external vulnerability
- Proven oil reserves and production outlook:
  - Proven oil reserves: good for about 20 years at current production rates.
  - Annual oil production projected to peak in 2011–12 and fall progressively thereafter.
  - Oil wealth estimated at 5–6 bn bbl at end-2008; oil wealth exhausted by 2030 under projections.
  - Price discounts assumed: US$5/bl for Nile blend and US$15–20/bl for Dar.
- Vulnerabilities and recent fiscal trend:
  - Fiscal balance and external balances highly sensitive to world oil prices.
  - 2009 fiscal deficit of the Government of National Unity (GoNU) expected to widen notably relative to 2008.
  - FDI and other inflows expected to slow in 2009–10 in wake of global financial crisis.

### Fiscal federalism, expenditure rigidities, and contingent risks
- Decentralization and transfers:
  - Subnational transfers surged from 1 percent to 10 percent of GDP during 2003–08.
  - Decentralization limited central control over a large part of expenditures (automatic transfers).
- Consequences:
  - Exacerbated procyclicality of general government fiscal policy.
  - Raised concerns over the quality of subnational spending.
  - Generated contingent fiscal risks for the central government.
- Political and external risks:
  - Limited access to concessional external finance.
  - High political uncertainty including elections in 2010 and the 2011 referendum.
  - Large unresolved external public debt burden and security/peace-related spending pressures.

### Fiscal performance, revenue trends, and financing
- Non-oil revenue and tax performance:
  - Non-oil revenues: at 10 percent of non-oil GDP—barely half the group median (comparators).
  - Non-oil tax/GDP ratio fell to 5 percent in 2008.
  - Ratio of non-oil revenues and grants to non-oil GDP at end-2008 = 8.5 percent (passively projected forward in some scenarios).
- Expenditure and financing dynamics (2000–08):
  - Government current expenditure tripled to over 20 percent of GDP.
  - Capital expenditures rose to 4 percent of GDP.
  - Financing: mainly oil revenues and domestic borrowing; foreign financing averaged less than ½ percent of GDP.
  - Resort to unconventional promissory notes and domestic arrears was common; arrears accumulation exceeded clearance in recent years.
  - Large arrears in 2007 pushed overall non-performing loan ratio above 50 percent in the banking system.

### Reforms, revenue administration, and subsidies
- Tax policy reforms:
  - Corporate income tax regime simplified in 2008; unified business profit tax rate at 15 percent across sectors.
  - Abolition of granting new income tax holidays; imposition of a 3 percent net profit tax on otherwise grandfathered exempt businesses.
  - VAT rate consolidated at 15 percent; telecoms VAT raised to 20 percent in January 2009.
- Remaining structural and administrative weaknesses:
  - Large stock of VAT and PIT exemptions persists; VAT revenue productivity is the lowest in the comparator group.
  - Revenue administration reforms (LTO, MTO, self-assessment) implemented on paper but incomplete modernization and integration (unique taxpayer IDs pending).
  - PFM reforms centered on budget classification and commitment control; multi-year budget planning and non-oil fiscal anchors remain elusive.
- Fuel subsidies:
  - One-time fuel price adjustment in mid-2006 left ex-refinery price at US$49/barrel; when world prices rose, Sudan incurred a fuel subsidy cost over 4 percent of GDP in 2007–08.
  - Fuel subsidy cost was 2.3 percent of GDP in 2008 (noted elsewhere in the text); subsidy poorly targeted and concentrated among wealthier urban groups.
  - Sudan became a net refined fuel importer in 2008.

### Quantifying fiscal adjustment — frameworks and objectives
- Two analytical frameworks:
  - Permanently sustainable non-oil primary balance (NOPB) “annuity” approach.
  - Dynamic general equilibrium neoclassical growth model (tax-rate focused).
- Objective: quantify size, speed, and composition of fiscal adjustment required for intertemporal solvency and intergenerational equity given projected oil revenue decline and existing public debt.
- Initial public debt:
  - Assumed at 83 percent of non-oil GDP at end-2008 (staff estimate).
  - Debt relief/serviceability scenarios considered: 100 percent, 75 percent, 50 percent, and 25 percent of initial debt stock.
- Adjustment speed scenarios:
  - Instantaneous (1), 0.50, and 0.25 (i.e., 100 percent, 50 percent, 25 percent of adjustment per year relative to target).

### A. NOPB approach — principal quantitative findings
- Required fiscal adjustment (NOPB/NOGDP) ranges from 4–10 percent of NOGDP depending on debt relief and speed of adjustment.
- Table-summary (textual) figures:
  - Average required adjustment in the NOPB/NOGDP ratio: 6.7 percentage points over the medium-term and 9.8 percentage points over the long term.
  - No debt relief: medium-term 6.9 percentage points and long-term 10 percentage points of NOGDP.
  - 75 percent debt write-off: medium-term 6.5 percentage points and long-term 9.5 percentage points of NOGDP.
- Impact of adjustment speed:
  - Under 25 percent adjustment per year (back-loaded), average medium-term adjustment over debt scenarios = 4.6 percentage points.
  - Under instantaneous adjustment, average medium-term adjustment = 8.6 percentage points.
  - Slower near-term adjustment raises long-run required adjustment only modestly (about 0.2 percentage points relative to instantaneous adjustment).
- Effect of high-return public investment:
  - Internalizing high-return public investment reduces the required adjustment by 1½ – 2 percent of NOGDP relative to unadjusted growth assumptions.
  - Even under optimistic debt relief and investment scenarios, a substantial medium-term fiscal effort remains: about 3 percentage points of NOGDP; long-term adjustment about 7 percentage points of NOGDP.
- Feasibility:
  - Overall medium-term adjustment need of about 3 percentage points of NOGDP is considered feasible via expenditure rationalization and revenue administration.
  - Long-term adjustment of 7–10 percentage points of NOGDP requires major structural change and sharp increases in non-oil tax take.

### Illustrative public investment case (Merawi Dam)
- Project details:
  - Capacity: 1,250 MW, completed in March 2009.
  - Project cost: US$ 1.8 bn; US$ 520 million funded from China.
  - Electricity cost from Merawi Dam: around 4 cents/kwh.
  - Cost of thermal energy (previous main source): 7.9 cents/kwh.

### B. General equilibrium tax-rate model — setup and key assumptions
- Model features:
  - Small open economy neoclassical growth model with capital accumulation; taxes on consumption, wage income, and capital income.
  - Government adjusts tax rates to satisfy intertemporal budget constraint given an exogenous expenditure path.
- Oil revenue path:
  - Three-step path (Years 1–5, 6–10, 11–20 averaged from macro framework); after period 21 oil revenue set constant at 2028 level.
- Calibration:
  - Structural parameters replicate initial steady state (average of 2005–2007).
  - All oil export revenues belong to government; roughly half of revenues directly linked to government expenditure (CPA-consistent federal arrangement).
- Tax timing scenarios:
  - Increases implemented in period 1 (immediate), period 6 (five years later), or period 11 (ten years later); rates then constant thereafter.
- Initial tax rates:
  - Initial steady state tax level set to 5 percent to render non-oil tax revenues of 7 percent of GDP (average 2005–07).
- Alternate scenarios:
  - Initial government liabilities of 20 percent of GDP or full debt relief.
- Simulated instruments:
  - (i) raise consumption tax (VAT) only;
  - (ii) raise both wage and capital income tax rates;
  - (iii) raise wage income tax rate only;
  - (iv) raise consumption and wage income tax rates;
  - (v) raise all tax rates.

### B. Tax-rate simulations — principal findings
- General conclusions:
  - Best to spread tax burden over many periods and tax bases; tax rates should be raised immediately.
  - Minimum required increase in tax rates (relative to steady state): between 5–7 percent if implemented immediately and across all tax types.
- Delay and liabilities:
  - Delaying tax increases raises economic costs non-linearly; increases required from period 6 to period 11 are substantially larger than those from period 1 to period 6.
  - Initial liabilities of 20 percent of GDP raise required tax increases significantly—equivalent to delaying consolidation by a couple of years.
- Composition:
  - Simultaneous increases in consumption and income taxes reduce required increases in any single tax relative to single-tax increases.
  - Raising consumption tax or wage income tax alone would require double-digit increases in that tax rate even when front-loaded (period 1).
- Headline illustrative outcome:
  - The model implies that if consumption and income taxes increased upfront and simultaneously, intertemporal solvency would still require a doubling of tax rates — summarized as “6.5 percent (although this still represents a doubling of rates).”

### Required fiscal adjustment: magnitude, timing, and sequencing
- Both models indicate medium-term fiscal adjustment need between 4–8 percent of non-oil GDP.
- Minimum medium-term adjustment of 4 percent of GDP arises in NOPB approach under:
  - an annual adjustment rate of 25 percent, and
  - a de facto serviceable debt stock equivalent to 25 percent of the total.
- Table 1 reported average required medium-term adjustment = 6.7 and average required long-term adjustment = 9.8 (as reported in the source).
- Sequencing recommendations:
  - Front-load tax increases.
  - Back-load expenditure reductions.
  - Optimal sequencing depends on politico-economic constraints, electoral cycle, expenditure rigidities, and capacity for voluntary tax collection.

### Tax policy findings and reform priorities
- Diagnostic findings:
  - Low overall tax/GDP ratio relative to other oil producers.
  - Low share of income taxes; high share of taxes on international trade.
  - Personal income tax design issues:
    - Threshold for paying personal income tax is about 3½ times per capita income—the highest in the sample.
    - Persons over 50 years of age are exempt from PIT.
    - PIT is relatively less progressive with small gap between lowest and highest rate-paying thresholds.
- VAT problems:
  - Low revenue productivity due to weak compliance and wide-ranging exemptions.
  - Share of VAT-exempt imports rose from 40 percent to 60 percent in 2008.
  - Major VAT exemptions: imports by foreign oil companies and many public/public-private companies; capital goods; water, electricity, commercial rentals, in-city transportation; agricultural products.
  - Recommendation: institute a VAT refund system instead of broad capital goods exemptions.
- Revenue administration priorities:
  - Improve self-assessment, operational integration of VAT-income tax offices, structural improvements in taxation chamber, and compliance and recovery.
  - Significant additional revenues expected from improved compliance and recovery.

### Expenditure policy, petroleum pricing reform, and social protection
- Fuel subsidy and pricing reform:
  - Fuel subsidy costed 4 percent of GDP a year in 2007–08 (one-third of this cost is subsidizing imported refined products).
  - Current regime: extensive government control via SPC with regulated distributor and retail prices.
  - Problems: increases fiscal procyclicality, hides subsidy costs, accrues to richer quintiles, encourages smuggling, distorts environmental taxation.
  - Reform options: move to an automatic (semi-automatic) pricing mechanism using moving averages or trigger rules; choose appropriate benchmark (import-parity CIF or export-parity).
  - Advantages: reduce procyclicality, depoliticize pricing, protect budget while smoothing volatility; transition should include measures to limit impact on the poor.
- Social protection and mitigation (Box 2):
  - Trade-offs: full pass-through risks inflationary expectations and reduces poor households' real incomes; blanket subsidies/tariff reductions are poorly targeted and fiscally costly.
  - Balanced response features:
    - Reasonably high pass-through to induce consumption and production responses.
    - Subsidy reform to free fiscal resources for pro-poor spending.
    - Synchronized short-term measures (drawdown of strategic grain reserves, targeted transfers, food-for-work, school lunches, temporary reductions in distortionary taxes on staples).
    - Medium-term: targeted cash transfer programs indexed to poverty-relevant inflation measures; link transfers to school attendance and primary healthcare as capacity improves.
  - Targeting observations:
    - Rural food producers may be less adversely affected than urban/semi-urban poor.
    - Special attention to children, pregnant women, elderly, and unemployed.
  - Higher food prices offer an opportunity to boost agricultural production; avoid mandated price controls, export restrictions, forced procurement; focus on market information, infrastructure, storage, and customs facilitation.

### Conclusions and policy recommendations (summary)
- No feasible adjustment strategy without significant broadening of the non-oil tax base.
- Core policy priorities:
  - Enlarge non-oil tax base by tightening generous VAT and personal income tax exemptions and strengthening tax administration.
  - Front-load tax effort; back-load expenditure rationalization where politically feasible.
  - Implement petroleum pricing reform toward semi-automatic formulas and appropriate benchmarks to reduce procyclicality.
  - Reorient expenditures away from ill-targeted fuel subsidies (costed 4 percent of GDP a year in 2007–08) toward well-targeted social safety nets.
  - Anchor fiscal policy in non-oil indicators and strengthen multi-year budget planning and ORSA use.
- Even with optimistic debt relief and high-return public investment, substantial medium-term and long-term fiscal efforts remain (medium-term on the order of 3 percentage points of NOGDP feasible through administrative and expenditure measures; long-term around 7–10 percentage points of NOGDP requires major structural tax and expenditure reforms).

*Source: _wp1079*

### 1. Required Fiscal Adjustment Under Various Debt Relief and Adjustment

### 1. Required Fiscal Adjustment Under Various Debt Relief and Adjustment

### Introduction and recent macroeconomic performance
- Real GDP growth averaged 8 percent during 2004–08 with single digit inflation and a relatively stable currency.
- In real terms, the oil sector accounts for only about 10 percent of Sudan’s overall GDP; agriculture and services account for 35 percent and 50 percent, respectively, of real output.
- Oil now accounts for about 95 percent of Sudan’s exports and over half of all government revenue.
- There was a sizeable influx of foreign direct investment (FDI) in the oil sector; overall FDI climbed from about 3.5 percent of GDP in 1997 to almost 10 percent of GDP in 2008.
- Within six months of the August-2008 reversal in the rising world oil price trend, foreign exchange reserves had more than halved to an uncomfortably low level of 2 weeks of imports.

### Oil dependence and fiscal/external vulnerability
- Sudan’s macroeconomy has become highly dependent on oil sector developments, especially the world price of oil.
- Sudan’s proven oil reserves are limited—good for about 20 years at current production rates—and the faster-than-expected maturity of the higher-quality Nile blend wells since 2006 has called into question the sustainability of fiscal and external balances going forward.
- The 2009 fiscal deficit of the Government of National Unity (GoNU) is expected to widen notably relative to 2008.
- Figures in the source illustrate crude oil price projections (2007-2010), net international reserves (2007-2010), current account balance (2007-2010) and fiscal balance (2007-2010) under September 2008 and January 2009 scenarios.

### Fiscal federalism, expenditure rigidities, and contingent risks
- Decentralization accelerated after the 2005 Comprehensive Peace Agreement (CPA), with subnational transfers surging from 1 percent to 10 percent of GDP during 2003–08.
- Fiscal federalism has limited central government control over a large part of expenditures, i.e., automatic transfers to subnational governments.
- The increased devolution of resources has been indispensable for sustaining peace but has:
  - exacerbated the procyclicality of general government fiscal policy;
  - raised concerns over the quality of subnational spending;
  - become a source of contingent fiscal risk for the central government.
- Sudan has limited access to concessional external finance and faces high political uncertainty, including uncertainties over parliamentary and presidential elections in 2010, and the status of the South following the 2011 referendum.
- A large unresolved (external) public debt burden, and security and peace-related spending pressures, further reinforce the complexity of the fiscal situation.

### Fiscal performance, revenue trends, and financing
- Although Sudan’s particular risks suggest the need for a larger fiscal buffer, actual fiscal performance since 2000 has generally lagged that of other oil producing countries.
- Appendix III comparison with a group of 18 oil producers shows:
  - Sudan’s non-oil revenues—at 10 percent of non-oil GDP—were barely half the group median.
  - The non-oil tax/GDP ratio fell to 5 percent in 2008.
  - The positive gap between Sudan’s non-oil primary balance (NOPB) and its comparators began narrowing in 2005 and was eliminated by 2008.
- Over the 2003–08 period, current expenditure tripled, to over 20 percent of GDP, financed mainly by oil revenues.
- With gross bank financing largely offset by net oil revenue stabilization account (ORSA) savings, and foreign financing averaging less than ½ percent of GDP, resort to unconventional promissory notes and outright domestic arrears was also common.
- In the wake of the global financial crisis, FDI and other inflows are expected to slow in 2009–10.

### Reforms, revenue administration, and subsidies
- Structural fiscal reforms undertaken in the context of successive IMF staff-monitored programs include:
  - Simplification of the corporate income tax regime in 2008.
  - Abolition of the granting of income tax holidays to new investors.
- Remaining challenges noted:
  - The stock of outstanding VAT and PIT exemptions remains large.
  - Revenue administration reforms have been impressive on paper but have not translated into revenue yield, due to the lack of a comprehensive modernization and restructuring strategy.
  - PFM reforms have centered on budget classification and commitment control, but multi-year budget planning and anchoring of fiscal policy in non-oil indicators have been elusive goals.
- Despite a large one-time adjustment in fuel prices in 2006, the fuel subsidy cost over 4 percent of GDP in 2007–08.

*Source: _wp1079 - 1. Required Fiscal Adjustment Under Various Debt Relief and Adjustment*

### Appendix IV summarizes the structure of the tax system in Sudan as on January 1, 2009.

### _wp1079 - Appendix IV summarizes the structure of the tax system in Sudan as on January 1, 2009.

### Context and motivation
- Sudan’s fiscal stance in 2008: highly procyclical, oil windfalls largely spent despite an oil revenue stabilization account, and the budget lacked social safety net provisions to cost-effectively guard the poor against rising food prices in 2008.
- Key vulnerabilities motivating the analysis:
  - Dependence on finite oil reserves and vulnerability to commodity price shocks.
  - Miniscule fiscal buffers relative to political and economic risks.
  - Substantial structural fiscal challenges requiring comprehensive fiscal adjustment.

### Quantifying the fiscal adjustment: frameworks and objectives
- Two analytical frameworks used:
  - Permanently sustainable non-oil primary balance (NOPB) “annuity” approach (Section A).
  - Dynamic general equilibrium neoclassical growth model focused on tax-rate changes and their impact on capital accumulation and growth (Section B).
- Objective: quantify size, speed, and composition of the fiscal adjustment needed to satisfy intertemporal solvency and intergenerational equity, given projected oil revenue decline and existing public debt.

### A. Permanently Sustainable Non-Oil Primary Balance (NOPB) approach — key assumptions
- Oil production and prices:
  - Annual oil production projected to peak in 2011–12 and fall progressively thereafter.
  - Oil wealth estimated at 5–6 bn bbl at end-2008; oil wealth exhausted by 2030 under projections.
  - Price discounts assumed: US$5/bl for Nile blend and US$15–20/bl for Dar.
- Growth and interest rate projections:
  - Real non-oil GDP growth: 4 percent a year in 2009–10; about 6 percent a year in 2011–15; converge to 5 percent a year by 2016.
  - Real interest rate: currently 3 percent, rising gradually to 6 percent by 2015.
- Non-oil revenue and grants:
  - Ratio of non-oil revenues and grants to non-oil GDP at end-2008 = 8.5 percent; passively projected forward (no future tax effort imputed).
- Speed of adjustment scenarios simulated: instantaneous (1), 0.50, and 0.25 (i.e., 100 percent, 50 percent, 25 percent of adjustment per year relative to target).
- Initial public debt:
  - Assumed at 83 percent of non-oil GDP at end-2008 (staff estimate).
  - Debt relief scenarios considered: serviceability of 100 percent, 75 percent, 50 percent, and 25 percent of initial debt stock.

### A. NOPB approach — principal quantitative findings
- Required fiscal adjustment (NOPB/NOGDP) ranges from 4–10 percent of NOGDP depending on debt relief and speed of adjustment.
- Table-summary (textual):
  - Average required adjustment in the NOPB/NOGDP ratio: 6.7 percentage points over the medium-term and 9.8 percentage points over the long term.
  - No debt relief: medium-term 6.9 percentage points and long-term 10 percentage points of NOGDP.
  - 75 percent debt write-off: medium-term 6.5 percentage points and long-term 9.5 percentage points of NOGDP.
- Impact of adjustment speed:
  - Under 25 percent adjustment per year (back-loaded), average medium-term adjustment over debt scenarios = 4.6 percentage points.
  - Under instantaneous adjustment, average medium-term adjustment = 8.6 percentage points.
  - Slower near-term adjustment raises long-run required adjustment only modestly (about 0.2 percentage points relative to instantaneous adjustment) because the long-run horizon spreads the burden.
- Effect of public investment (returns to capital spending):
  - Internalizing high-return public investment (e.g., infrastructure) by allowing slower near-term adjustment and higher medium-term growth reduces the required adjustment by 1½ – 2 percent of NOGDP relative to unadjusted growth assumptions.
  - Even under optimistic debt relief and investment scenarios, a substantial medium-term fiscal effort remains: about 3 percentage points of NOGDP; long-term adjustment about 7 percentage points of NOGDP.
- Projected medium-term fiscal need summarized:
  - Overall medium-term adjustment need of about 3 percentage points of NOGDP is feasible via expenditure rationalization and revenue administration, but long-term adjustment of 7–10 percentage points of NOGDP requires major structural change and sharp increases in non-oil tax take.

### Illustrative public investment case (Merawi Dam)
- Merawi Dam:
  - Capacity: 1,250 MW, completed in March 2009.
  - Project cost: US$ 1.8 bn, of which US$ 520 million corresponds to funding from China.
  - Electricity cost from Merawi Dam: around 4 cents/kwh.
  - Cost of thermal energy (previous main source): 7.9 cents/kwh.

### B. Required tax increase to balance the intertemporal budget: model setup and assumptions
- Model: dynamic general equilibrium neoclassical growth model for a small open economy with capital accumulation and labor productivity links to competitiveness/tax base.
- Households face taxes on consumption, wage income, and capital income; government can adjust these tax rates to satisfy intertemporal budget constraint.
- Key simulation assumptions and calibrations:
  - Oil revenue projections: three-step path (Years 1–5, 6–10, 11–20 averaged from macro framework); after period 21 oil revenue set constant at 2028 level.
  - Structural parameters calibrated to replicate initial steady state (average of 2005–2007).
  - All oil export revenues belong to government; roughly half of revenues directly linked to government expenditure (CPA-consistent federal arrangement).
  - With exogenously given expenditure path, government adjusts tax rates to balance intertemporal budget constraint.
  - Tax timing scenarios: increases implemented in period 1 (immediately), period 6 (five years later), or period 11 (ten years later); rates then constant thereafter.
  - Initial tax rates in steady state set to 5 percent to render non-oil tax revenues of 7 percent of GDP (average 2005–07).
  - Alternate scenarios include initial government liabilities of 20 percent of GDP or full debt relief.
  - Simulated adjustment instruments:
    - (i) raise consumption tax (VAT) only;
    - (ii) raise both wage and capital income tax rates;
    - (iii) raise wage income tax rate only;
    - (iv) raise consumption and wage income tax rates;
    - (v) raise all tax rates.

### B. Tax-rate simulations — principal findings
- General conclusion: best to spread tax burden over as many periods/types as possible; tax rates should be raised immediately.
- Minimum required increase in tax rates (relative to steady state):
  - Between 5–7 percent if implemented immediately and across all tax types.
- Impacts of delay and liabilities:
  - Delaying tax increases increases economic costs non-linearly; changes required from period 6 to period 11 are substantially larger than those from period 1 to period 6.
  - Delays require progressively higher future tax increases, amplifying distortionary effects on labor supply and capital accumulation.
  - Initial liabilities raise required tax increases significantly; starting with liabilities of 20 percent of GDP is equivalent to delaying fiscal consolidation by a couple of years.
- Composition of tax increases:
  - Simultaneously increasing consumption and income tax rates reduces required increases in any single tax rate compared with increasing a single tax in isolation.
  - Raising consumption tax or wage income tax alone would require double-digit increases in that tax rate even when adjustment is front-loaded (period 1).
  - Raising both consumption and income taxes together substantially reduces the required increase in each rate.

### Policy implications and priorities (implicit in analysis)
- Immediate, front-loaded fiscal consolidation is economically preferable to delayed adjustment.
- Fiscal adjustment should combine:
  - Expenditure rationalization and improved revenue administration to capture medium-term gains (~3 percentage points of NOGDP).
  - Structural tax policy reform and increases in non-oil tax take to meet long-term requirements (7–10 percentage points of NOGDP under typical scenarios).
- Consideration of high-return public investment is important; prudent frontloading of such investments can lower fiscal adjustment requirements by 1½ – 2 percent of NOGDP if they raise non-oil growth and tax bases.
- Debt relief materially reduces required adjustment but even optimistic relief scenarios leave substantial fiscal tasks.

*Source: _wp1079 - Appendix IV summarizes the structure of the tax system in Sudan as on January 1, 2009.*

### 6.5 percent (although this still represents a doubling of rates).

### _wp1079 - 6.5 percent (although this still represents a doubling of rates).

### Required fiscal adjustment: magnitude and timing
- Both models used indicate the need for medium-term fiscal adjustment in Sudan of between 4–8 percent of non-oil GDP over the medium-term.
- Based on the permanently sustainable NOPB approach and a general equilibrium neoclassical growth framework, the required adjustment over the medium term is at minimum 4 percent of GDP.
- The first (NOPB) approach suggests a fiscal adjustment of 4–10 percent of NOGDP, with the lower bound of 4 percent obtained under assumptions of:
  - an annual adjustment rate of 25 percent, and
  - a de facto serviceable debt stock equivalent to 25 percent of the total.
- Table 1 (scenarios) reports average required medium-term adjustment = 6.7 (as reported in the table) and average required long-term adjustment = 9.8 (as reported in the table).
- The general equilibrium model (tax-rate focused) implies that if consumption and income taxes increased upfront and simultaneously, intertemporal solvency would still require a doubling of tax rates—illustrated by the headline “6.5 percent (although this still represents a doubling of rates).”
- The tax-rate doubling result is described as politically implausible and economically insensible, highlighting the narrow set of tax-side options absent substantial base broadening.

### Implications for sequencing: front‑loading taxes, back‑loading spending cuts
- Contrasting model dynamics:
  - Expenditure-led adjustment (model I; tax take held fixed): suggests required medium-term adjustment would fall in the speed of adjustment, while the long-term adjustment would not be affected much — arguing in favor of back-loaded expenditure adjustments.
  - Tax-led adjustment (expenditures held fixed): suggests back-loaded tax-led adjustments would have adverse growth costs so such adjustments would need to be bigger relative to front-loaded adjustments.
- Read together, the recommended sequencing is:
  - Front-load any tax increases.
  - Back-load expenditure reductions.
- Optimal mix remains dependent on politico-economic considerations, electoral cycle, rigidities in Sudan’s expenditure profile, and potential for voluntary tax collections in a fragile setting.

### Tax policy findings and reform priorities
- Overall tax/GDP ratio is quite low, even compared with other oil producers in the sample (Indonesia, Malaysia and Syria).
- Specific tax structure weaknesses:
  - Low share of income taxes (personal and corporate).
  - High share of taxes on international trade.
  - Personal income tax is relatively less progressive; absence of a material gap between the lowest and highest rate-paying income thresholds.
  - The threshold for paying personal income tax is the highest in the sample: about 3½ times per capita income.
  - Persons over 50 years of age are exempt from PIT.
- VAT issues:
  - VAT revenue productivity is the lowest in the group.
  - VAT registration threshold and VAT rate are close to the sample average, but productivity is low due to weak compliance and wide-ranging VAT exemptions.
  - Share of VAT-exempt imports rose from 40 percent to 60 percent in 2008.
  - Major VAT exemptions include:
    - imports of all goods (intermediate and final) by foreign oil companies and many other public and public-private companies;
    - capital goods;
    - consumption of services such as water, electricity, commercial rentals, and in-city transportation;
    - agricultural products.
  - Many exemptions are difficult to justify (e.g., implied subsidies to the electricity sector appear highly regressive).
  - Exempting capital goods was motivated by refund-administration concerns; the text recommends instituting a VAT refund system rather than perpetuating broad exemptions.
- Table 2 (tax-rate changes) reports specific required increases in tax rates to balance the intertemporal budget constraint (values presented in the source table must be consulted directly for scenario-specific numbers). Note: the table also references an initial steady state tax level of 5.05 percent on consumption, wage and capital income to reproduce tax revenue share of domestic demand (7 percent).

### Revenue administration
- Sudan is significantly behind other countries in the region on revenue administration indicators (see Table 3 in source).
- Key areas for reform include:
  - self assessment,
  - operational integration of VAT-income tax offices,
  - structural improvement in the taxation chamber,
  - improvements in compliance and recovery.
- An improvement in compliance and recovery is expected to generate significant additional revenues and support other reforms.

### Expenditure policy and fuel subsidies
- Fuel subsidy consequences:
  - Sudan incurred large fuel subsidies during the oil price boom; the fiscal burden was 2.3 percent of GDP in 2008 alone (noted earlier in the text).
  - Subsidy is poorly targeted; energy consumption is concentrated among wealthier urban groups.
  - Petroleum dependence rendered fiscal policy procyclical and left Sudan a net refined fuel importer.
- The paper highlights the need to refocus expenditure away from ill-targeted fuel subsidies (which costed 4 percent of GDP a year in 2007–08) towards well-targeted social safety nets.
- Absence of a targeted safety net constrains the authorities’ ability to offset impacts of rising food or fuel prices on the poor; the poor spend more than half of their incomes on food.

### Petroleum pricing reform (Box 1)
- Current regime: extensive government control; diesel and gasoline sold to distributors at regulated prices via Sudan Petroleum Corporation (SPC); retail prices also controlled.
- Problems with ad-hoc price setting:
  - increases fiscal procyclicality and instability;
  - prevents price pass-through and optimal private demand/supply response;
  - distorts public spending decisions by hiding implicit subsidy costs;
  - subsidy accrues predominantly to richer quintiles;
  - creates incentives for smuggling (Sudan pump prices below some neighbors);
  - under-taxes a consumption good with negative environmental externality;
  - subsidy costs borne mostly by the federal government, creating a mismatch between costs and benefits.
- Reform options:
  - Move to an automatic (semi-automatic) pricing mechanism: pre-commit to updating ex-refinery sale prices at known intervals via a known formula.
  - Automatic pricing systems can use:
    - moving average rules (based on past spot prices), or
    - trigger rules (update if spot prices change by more than a predetermined trigger).
  - Choice of market-based benchmark price: import-parity (CIF adjusted for taxes and pipeline fees) or export-parity (export price adjusted for pipeline, refining costs, and taxes).
- Advantages of an automatic pricing regime: reduce procyclicality, depoliticize pricing, and protect budget while smoothing short-term volatility. Any transition should limit impact on the poor via mitigating measures.

### Social protection and mitigation
- Short-term mitigating measures and longer-term options discussed in the source include targeted cash transfer schemes to shield the poor against commodity price shocks effectively and efficiently (i.e., at the lowest possible fiscal and macroeconomic cost).

### Conclusions and policy recommendations (summary)
- No feasible adjustment strategy exists without significant broadening of the non-oil tax base.
- Policy priorities:
  - Enlarge non-oil tax base by tightening generous VAT and personal income tax exemptions and strengthening tax administration.
  - Front-load tax effort and back-load expenditure rationalization, subject to politico-economic constraints.
  - Structural reforms in petroleum pricing to reduce procyclicality and fiscal instability (move toward semi-automatic pricing with appropriate benchmarks and smoothing rules).
  - Reorient expenditures away from ill-targeted fuel subsidies (costed 4 percent of GDP a year in 2007–08) toward well-targeted social safety nets capable of protecting the poor from rising fuel and food prices.
  - Anchor fiscal policy in non-oil indicators (use of oil revenue stabilization mechanisms such as the ORSA is noted against the absence of strong anchors).
- The combination of model results, cross-country comparisons, and administrative diagnostics point to substantial room for improvement in tax/GDP ratio, personal income tax threshold design, VAT revenue productivity, and revenue administration.

*Source: _wp1079 - 6.5 percent (although this still represents a doubling of rates).*

### Box 2. Protecting the Poor in the Face of Rising Food Prices

### Box 2. Protecting the Poor in the Face of Rising Food Prices

### Trade-offs Policymakers Face
- Allowing full pass-through of higher import prices to domestic prices:
  - Risks entrenching inflationary expectations.
  - Reduces real incomes of poor households (both through food price inflation, and its indirect impact on the prices of other commodities consumed by the poor).
  - Can engender potential protests, especially by urban groups.
- Resisting increases in domestic prices via import tariff/tax reductions or price subsidies:
  - Prevents demand-supply adjustment by the private sector.
  - Raises fiscal and trade deficits and potentially undermines external and fiscal sustainability.
  - Generates the possibility of food shortages, black markets, and smuggling.
  - Blanket measures are very poorly targeted and accrue disproportionately to the rich.

### Features of a Balanced and Comprehensive Response
- (i) Reasonably high pass-through of world prices to domestic prices:
  - Induces desired consumption response (reduction in excess consumption, and switching to cheaper substitutes).
  - Induces production response, mitigating fiscal and balance of payments impact of the shock.
  - Reduces risk of food shortages.
- (ii) Subsidy reform to free up fiscal resources for pro-poor spending:
  - Examples of blanket subsidy schemes to consider removing: tax exemptions, controls on fuel prices, VAT exemptions on utilities.
  - Removal can generate substantial fiscal savings for more targeted spending.
  - Public information campaigns may be necessary to overcome opposition from organized groups that capture blanket subsidies (usually urban middle and upper classes) and to obtain support from the more diverse potential beneficiaries (poor consumers spread over the country).
- (iii) Synchronized short-term measures to protect the real incomes of the poor:
  - Options include:
    - Drawdown of strategic grain reserve to address shortages in affected areas.
    - Reduction of distortionary taxes/tariffs on commodities important in poor households' budgets (like wheat or kerosene)—fiscal neutrality may require raising offsetting taxes/tariffs on luxury items.
    - Maintenance (delayed elimination) of price subsidies on key staples (such as sorghum, rice).
    - Food-for-work, feeding mothers, food stamps/ration cards, and school lunch programs to help target the most vulnerable groups.
    - Enhanced access to/lowered costs of public services important to the most vulnerable groups, such as schooling, health, mass urban transportation; water and electricity (below a certain threshold).
    - Targeted subsidies to farmers to enable them to boost production—including input (seed and fertilizer) subsidies, smallholder credit facilities, extension services, and improved infrastructure.
  - Important trade-offs:
    - No perfect set of mitigating measures—each comes with costs and benefits.
    - Measures that are easy to implement (politically and administratively) and can achieve wide coverage are often less targeted, more distortionary, and costlier in fiscal terms.
- (iv) Direct cash transfers (medium-term):
  - A targeted social safety net that can identify, track and reach vulnerable groups is the most effective and cost-efficient way of achieving social protection.
  - The amount of cash transfer can be index-linked to a measure of inflation most relevant to the poor, so that a formal approval is not needed each time there is a surge in inflation.
  - As capacity improves, safety nets can promote social development by linking transfers to school attendance and primary healthcare for children of poor households.
  - Although Sudan does not have a targeted social safety net program, evidence from other countries, such as Senegal and Indonesia, suggests such nets can be successfully instituted if:
    - good poverty statistics are available,2
    - rollout is gradual,
    - reliable distribution channels exist,
    - technical and financial support from abroad can be tapped, and
    - strong ex-post monitoring and oversight is maintained.3

### Targeting and Vulnerable Groups
- Effective mitigation depends critically on the ability to identify groups most vulnerable to the price increase.
- In an agro-based economy like Sudan’s:
  - Many rural poor are food producers and are likely to be less adversely affected than urban or semi-urban poor (rural households not engaged in agricultural activities).
  - Within these categories, children and pregnant women, and the elderly and unemployed, generally warrant special attention because nutritional loss among these groups can be fatal or produce lasting physical and mental disabilities.

### Higher Food Prices as an Opportunity for Agricultural Development
- Higher food prices can stimulate food grain production and enhance agriculture’s contribution to medium-term growth.
- The recently launched commercialization initiative to tap Sudan’s vast agricultural resources is appropriate and can—like countries such as Brazil, Malaysia and Thailand—boost agricultural productivity and increase food security.
- To maximize the medium-term supply response, avoid unhelpful intervention such as:
  - mandated grain prices,
  - export restrictions,
  - forcible procurement,
  - marketing boards.
- Focus efforts on reducing information gaps, connecting markets, and lowering distribution and marketing costs:
  - Benefits of publicly accessible grain market information systems are documented (as in India and Mali).
  - Improvements in inland transport infrastructure have proven beneficial (Congo Republic and Nepal).
  - Efficient grain storage and customs facilitation are important.

*Source: Box 2. Protecting the Poor in the Face of Rising Food Prices (excerpt).*

### APPENDIX III. RECENT FISCAL PERFORMANCE IN SUDAN

### APPENDIX III. RECENT FISCAL PERFORMANCE IN SUDAN

### Fiscal Stance
- Most of Sudan’s fiscal stance indicators over the last decade (and over various sub-periods) have lagged those of other oil producing countries.
- Sudan’s non-oil domestic revenue was around 10 percent of non-oil GDP, well below the group average/median (around 18 percent).
- Sudan’s non-oil primary balance (NOPB) lay well above its comparators’ for most of the period, but the gap began narrowing since 2005 and was eliminated by 2008.
- Oil accounts for a much smaller share of GDP in Sudan (one-sixth) than on average in the comparator group (one-third); an identical NOPB ratio for Sudan implies a weaker fiscal stance relative to comparators.
- Sudan’s overall deficit to GDP ratio showed a large excess over that for other countries, especially after 2004.
- The oil boom that started in 2005 and peaked in mid-2008 led to a deterioration in Sudan’s fiscal position greater than the median comparator country, particularly in the last two years where Sudan fared worse than most comparators on non-oil revenue and overall balance, and worse than the median on both the NOPB and the non-oil primary operating balance.
- Treatment of transfers to subnational governments as current spending could overstate non-oil deficits in fiscally federal countries like Sudan; preliminary data suggest most transfers were targeted to current uses, making the comparison reasonable.

*Countries used for comparison: Algeria, Angola, Azerbaijan, Cameroon, Chad, Congo, Ecuador, Equatorial Guinea, Gabon, Indonesia, Iran, Kazakhstan, Nigeria, Sudan, Syria, Venezuela, Vietnam and Yemen.*

### Evolution of Key Fiscal Aggregates and Financing (2000–08)
- Over 2000–08:
  - Government current expenditure tripled, to over 20 percent of GDP.
  - Capital expenditures rose to a 4 percent of GDP level.
- Increases in expenditures were financed mainly by oil revenues and domestic borrowing (banking system and nonbank sector).
- Gross bank financing was offset by net oil revenue stabilization account (ORSA) savings over 2000–08; foreign financing averaged less than ½ percent of GDP.
- Resort to unconventional promissory notes (letters of guarantees, standing orders, sanadats) and outright domestic arrears was common.
- Accumulation of arrears increasingly exceeded their clearance in recent years; the commitment deficit became larger than the cash deficit.
- Large arrears in 2007 on bank-held government debt and suppliers payments induced serious problems in the banking system, pushing the overall non-performing loan ratio above 50 percent.
- Non-oil tax revenues:
  - Grew from a very low base of about 5 percent of GDP.
  - Except for the 2004 spike associated with VAT and excise reforms, collection has not exceeded 6 percent of GDP.
  - Declining tax/GDP trend over the last five years, partly attributable to the fall in import tariff rates to Arab Free Trade Area and COMESA member countries.
  - Loss in tariff revenue was not compensated by other revenue sources.
- Factors contributing to weak non-oil revenues:
  - Weaknesses in tax administration.
  - Government complacency about other non-oil revenue collection (parastatal/joint venture profits and departmental fees).
  - Weak aid response by donors due to concerns over Darfur.
  - Difficulty of enforcing direct taxes in a fragile politico-economic setting.

### Structural Fiscal Reforms
- Tax policy reforms:
  - Corporate income tax regime reformed in 2008:
    - Unification of business profit tax rate at 15 percent across sectors.
    - Withdrawal of authority to grant new income tax holidays under the Investment Encouragement Act.
    - A 3 percent net profit tax on otherwise grandfathered exempt businesses was imposed.
  - VAT reforms:
    - Finance minister’s power to grant exemptions was withdrawn (now vested in the council of ministers and not used so far).
    - VAT rate consolidated at 15 percent.
    - Telecoms rate raised to 20 percent in January 2009, creating a two-tier structure.
    - Large existing stock of VAT exemptions on capital goods, final good imports by many business and non-business entities, and major domestic sectors (electricity, agriculture, water, in-city transportation and commercial rentals) remains.
- Revenue administration reforms:
  - Establishment of a large taxpayer office (LTO) for the top 300 companies (accounting for about 70 percent of domestic tax collection) and a medium taxpayers office (MTO) for the next 1,300 businesses.
  - Adoption of a new function-based headquarters structure for the taxation chamber and introduction of self-assessment for large corporate and individual taxpayers.
  - LTO and MTO appear to be working well, but reorganization of the taxation chamber is incomplete due to lack of a comprehensive modernization strategy.
  - Use of unique taxpayer identification numbers across customs and tax agencies is still pending.
  - Jurisdictional issues (federal vs. state) over taxation of large individual taxpayers remain unresolved.
- Expenditure policy and subsidy issues:
  - Privatization process slow due to disputes over non-uniform retrenchment packages across parastatals.
  - One-time fuel subsidy adjustment in mid-2006 raised ex-refinery price to US$49/barrel; price remained at this level during 2007–08 even when oil prices reached the US$147/bbl level.
  - Resulted in a fuel subsidy cost of over 4 percent of GDP in two years, one third of which is the direct cost of subsidizing imported refined products.
  - Sudan became a net refined fuel importer in 2008 as demand for imported refined products soared in 2007–08.
  - Sudan lacks a targeted social safety net program, inhibiting cost-effective support for vulnerable populations.
- Public financial management (PFM) reforms:
  - Adoption of the GFSM 2001 classification for the federal budget to increase transparency and facilitate consolidated fiscal reporting.
  - Need to modify chart of accounts, clarify treatment of financing and cash-vs.-commitment expenditure concepts, and extend classification to extra-budgetary units and subnational governments.
  - Centralized domestic debt unit established in 2008, but capacity is low and good quality regular domestic debt reporting remains elusive.
  - Volatile oil revenues and political pressures rendered some budgets underfunded ex-post; revenue or financial shortfalls typically translated into arrears.
  - Cash-informed expenditure ceilings have been only partly effective in controlling commitments; recent developments more encouraging.
  - Cash management remained weak with arrears accumulating while spare balances were held in line ministries’ accounts.
  - Progress towards establishing a Treasury Single Account began in 2007 but was thwarted by software procurement problems related to US sanctions on Sudan.
- Enduring shortcomings and policy design needs:
  - Absence of a multi-year budget planning framework and reliance on conventional, rather than non-oil fiscal indicators.
  - Public spending moves in sync with rising oil revenues, rendering fiscal policy—measured by non-oil fiscal indicators—extremely procyclical and complicating macroeconomic management.
  - Multi-year budgets and/or oil revenue stabilization accounts that tie spending to a sustainable trajectory for the NOPB (and non-oil revenue) can help cushion against oil revenue shocks.
  - Most higher-than-budgeted oil revenues accumulated in the ORSA during a year have been spent in the same year; less than one-tenth of the cumulative 2007–08 oil revenue windfall (approaching 10 percent of GDP) remained at the end of 2008.
  - Latent concerns about erosion of declining non-oil revenues and rising fuel subsidy costs were not matched, until recently, by actions to transparently set/track non-oil fiscal targets.

### Tax Rates and Exemptions in Sudan (Appendix IV)
- Personal income tax (salaries and wages)
  - Annual income (SDG): 9,050 — Exempt
  - next 120 — 5 percent
  - next 240 — 10 percent
  - exceeding 240 — 15 percent
- Business profits tax - individuals
  - Annual income (SDG): 3,000 — Exempt
  - next 3,000 — 5 percent
  - next 4,000 — 10 percent
  - Above 4,000 — 15 percent
- Business profits tax - corporations (Rate (%)):
  - Industrial — 10
  - Commercial — 15
  - Agricultural — 0
  - Banks and insurance — 15
  - Petroleum production — 35
  - Petroleum distribution — 15
  - Tobacco and cigarettes — 35
- Tax rate amendment dates:
  - Business profits tax – individuals: January 2006 – 35%; January 2007 – 30%; January 2008 – 15%
  - Business profits tax – corporations:
    - Agriculture: from 5% to 0% in March 2001
    - Industry: from 35% to 10% in July 2003
    - Banks and insurance: January 2006 – 35%; January 2007 – 30%; January 2008 – 15%
    - Commercial companies: January 2006 – 35%; January 2007 – 30%; January 2008 – 15%
    - Development tax: January 2008 – 3% of net profits of exempted person (companies and individuals)
  - VAT:
    - standard rate: from 10% to 12% in June 2007 and to 15% in January 2008
    - telecommunications: from 15% to 20% in January 2009
- Summary of key exemption areas:
  - Business profits tax:
    - Agricultural sector and animal products
    - Valid investment exemptions
    - Companies exempted under agreements
    - Exemption agreements such as for the sugar sector
    - Capital goods
    - Telecommunications sector
    - Financial services, rents and insurance
    - Water and electricity
    - Fertilizers
  - VAT:
    - Agricultural products
    - Telecommunications sector
    - Insurance sector
    - Private education

*Source: IMF staff estimates; Taxation Chamber.*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/wp/2010/_wp1079.pdf_