Jordan - Efficiency and equity of government revenues and social expenditures (Vol. 1 of 2) : Main report

Iteport No. 5697-JO Jordan Efficiency a E) q-c--i K oicvrnrnment 'evenues aind Social Eencituu^s (!n Twvo VOUliCKs V.'lt1t' !;i june 1986 Divisiorn 2C Courntry Programns D(epartwment H Europe, liddle East anrd Nr(,rtt t ri a ReqiH FOR OFPCIAL 'US E Y ~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~i ' ' , ,'i' Document of the WoridI b13ank ihis report has a rest ric ed clst rlbution and may bi used 11 ci pienAs only ii the perfor,,anie iof thir "'' d uties. It,, .i9. m 'ot ..,herw'S- be discJos,ed without \'\Vorld Bank~ ~ILJ1) I;ho 0 it on.  CURRENCY EQUIVALENTS 1982 1983 1984 1985 1 Jordanian Dinar (J)) = US$2.84 US$2.75 US$2.60 US$2.54 1 US Dollar ($) = JD.352 JD.364 JD.384 JD.394  FOR OFFICUAL USE ONLY JORDAN EFFICIENCY AND EQUITY OF GOVERNMENT REVENUES AND SOCIAL EPENDITURES Table of Contents Page No. Country Data Summary and Conclusions . . . . . . . . . . . . _ . . . . . . i - xiii I - INTRODUCTION . 1. . . . . . . . . . . . . . . . . . . . . . . II - DISTRIBUTIONAL IMPACT OF JORDAN'S PAST ECONOMIC DEVELOPMENT AND PRESENT DEVELOPMENT TRENDS . . . . . . . . . . . . . . . . . 2 A. Distributional Impact of Jordan's Past Economic Development 2 1. Past Development of Growth and Employment. . . . . . 2 2. Regional and Rural Development . . . . . . . . . . . . 5 3. Income Distributional Impact of Jordan's Past Economic Development . . . . . . . . . . . . . , 7 B. Present Trends and Issues - Growth, Employment and Equity . 13 1. Population Growth and Manpower . . . . . . . . . . . . 13 2. Economic Prospects and Labor Market Outlook . . . . . . 14 3. Regional and Rural Development - - 17 4. Wage Development and Future Workers' Remittance Propensity.8 . . . . . . . . . . . . . . . . . . . III - EFFICIENCY AND EQUITY OF GOVERNMENT INCOME POLICIES . . . . . . 20 A. Level, Structure and Buoyancy of Taxation. . . . . . . . 20 B. Efficiency and Equity of Taxation and Resource Mobilization 24 1. Assessment of the Efficiency of the Tax System . . . 24 2. Redistributive Impact of the Tax System . . . . . . . . 31 C. Other Income Policies. . . . . . . . . . . . . . 33 1. Price Support Program for Basic Foodstuffs . . . . . 34 2. Cash Transfer Program . . . . . . . . . . . . . . . . 38 3. Social Security System . . . . . . . . . . . . . . . 39 IV - COSTING, FINANCING AND EQUITY ISSUES IN GOVERNMENT SOCIAL EXPENDITURES . . . . . . . . . . . . . . . . . . . . . . . . . . 42 A. Trend of Social Expenditures . . . . . . . . . . . . . . . . . 42 B. Education . . . . . . . . . . . . . . . . . . . . . . . . . 43 1. Cost Issues in Education . . . . . . . . . . . . . . 43 2. Financing of Education . . . . . . . . . . . . 50 3. Accessibility to Educational Facilities . . . . . . . 56 Thb document has a restricted distribution and may be used by recpients only in the performance of their official dutiesL Its contents may not otherwise be discklsd without World Bank authorizaton.  C. Health . . . . . . . . . . . . . . . . . . . . . . . . . . . 58 1. Cost Issues in Health . . . . . . . . . . . . . . . . . 58 2. Financing of Health . . . . . . . . . . . . . . . . . 62 3. Accessibility to Health Services . . . . . . . . . . . 70 D. Water . . . . . . . . . . . . . . . . . . . . . . . . . . . 71 1. Water Pricing Issues . . . . . . . . . . . . . . . 71 2. Accessibility to Water Supply and Sewerage . . . . . . 72 E. Energy . . . . . . . . . . . . . . . . . . . . . . . . . . . 73 F. Housing . . . . . . . . . . . . . . . . . . . . . . . . . . 74 V -POSSIBLE AREAS FOR POLCY INTERVENTION . . . . . . . . . . . . . 79 A. Future Development Strategy - Economic Growth, Employment and Equity . . . . . . .79 1. National Economic Measures . . . . . . . . . . . . . . 79 2. Regional Development Measures . . . . . . . . . . . . . 82 B. Measures to Improve Efficiency and Equity of Government Income Policies . . . . . . . . . . . . . . . . . . . . . . 84 1. Policy Measures to Improve Efficiency and Equity of Jordan's Tax System . . . . . . . . . . . . . 8 . . . . 84 2. Scope for Revenue Enhancement - A Fiscal Exercise . . . 90 3. Other Income Policies . . . . . . . . . . . . . . . . . 94 C. Efficiency and Equity of Social Expenditures . . . . . . . . 94 1. Education . . . . . . . . . . . . . . . . . . . - 95 2. Health . . . . . . . . . . . . . . . . . . . . . . . . 97 3. Energy . . . . . . . . . . . . . . . . . . . . . . . . 99 4. Water . . . . . . . . . . . . . . . . . . . . . . . . . 100 5. Housing . . . . . . . . . . . . . . . . . . . . . . . . 101 ANNEXES I. Income Distributional Impact of Jordan's Past Economic Development II. Jordan: Summary of Tax System, 1984 III. Guidance for Introduction of a Value Added Tax IV. Local Government Finance in Jordan V. Assumptions Behind Estimates of Income Tax Potential and Sales Tax VI. Encouragemnt Law of Investment VII. Introduction of a Student Loan Scheme - Lessons from International Experience VIII. Costs of Education According to Account IX. Health Care Providers X. List of Questions to be Considered when Policies Involving User Charges in the Health Sector are Examined STATISTICAL APPENDIX  PREFACE A Bank Economic Mission visited Jordan in December 1984. This report is based on the findings of that mission vhich consisted of Messrs. G. Segerlund (Chief of Mission), Bourhan Chatti (Consultant) and Jorge Sanguinetti (Consultant).  ABSTRACT With the lower growth prospects for the economy and the likely sharp increase in unemployment over the coming years, the adverse income distribution impact of declining workers' remittances, grants and real wages coupled with a rapid population growth has brought issues of employment and income to the forefront of the Government's concern in formulating priorities for tne next Plan. For this purpose, Government has recently started a comprehensive survey of basic needs and potential for income generating projects in all cities and villages in Jordan. Considering: (a) Jordan's limited agricultural potential; (b) limited possibilities for continuing past rapid growth of public and private services; (c) limited scope for further labor absorption (within existing capacity) in the large natural resource-based industries; (d) and the reduced scope for out migration, future economic growth and employment will have to rely increasingly on development of export-oriented labor-intensive small and medium scale manufacturing and services based on skills. However, the magnitude of emerging surpluses of labor is such that even with far-reaching policy and institutional changes, the Government would have to face the redistributive implications of increasing unemployment towards the end of the eighties which is expected to continue unless outmigration picks up again. Based on the above considerations, the projected increase in unemployment and the rapid growth of population is expected to increase the demand for public services and Government transfer payments oriented towards satisfying basic needs. This in turn will require special efforts to mobilize domestic resources beyond the requirements to compensate for the shortfalls in grants. As a background, the report evaluates briefly the distributional impact of the rapid pace of past economic development and the likely changes in the present employment situation expected to result from the changed economic conditions in Jordan and in the region. In view of the decline in availability of financial resources, the report examines revenue generating and redistributive features of Jordan's tax system and assesses the cost effectiveness of the Government's social services. Finally, the report contains recommendations on policies to increase the employment content of economic growth; modifying the pattern of growth so as to raise the productivity and incomes of the poorer segments of the population; and reorientation towards basic needs for the poor. It also addresses options to finance social services through more cost-effective programs and increased cost recovery without sacrificir:;, equity, and proposes a mcre efficient tax system to generate adequate additional financial resources to meet the needs of a rapidly growing population. The expenditure side of the budget, apart from that required for social services, is not examined in this report.  COUNTRY DATA - 30hDAN I/ MU ~~~POPULATrtS OENSIY I/ 91.000 sq. km 2595.1 thousand (mid-1984) 28.5 per square km Rate of growth: 4.GX PfPtIATrNITrCs 2 HEALTH Crude birth rate (per 1.000) 45.0 Population per physician 900 Crude death rate (per 1.000) 8.0 Population per hospital bed 520 ACCESS To rim hATR / ACCESS TO ELECTRICITY Occupied dmellings without Z of population - urban piped water (2) 80.0 - rural - total NUTRmON ED UCTION Calorie intake as S of requirenxents 131.0 Adult literacy rate : Per capita protein intake (grams/day) 81.0 Primary school enrollment 2 103 Index of food projection per capita (1969-71=100) 71.0 GNP PER CAPITA (1984) US$1570 GROSS NATIONL PROOSJCT rK 19M ANNUAL RATE OF GROWTH tfercent constant orices) USST millions Percent 1979-81 ilA81-- GNP at market prices 3.894.9 100.0 9-4 4.9 Gross domestic investe#7t 1.433.0 36.8 29.6 -10.9 Gross national savings 1.034.1 26.6 38.9 -26.3 Current account balance 5 -268.0 -6.9 63.8 214.4 ExPorts of goods. NFS 1.919.9 49.3 13.3 Sj 5.1 2/ Loports of goods. NFS 3.898.4 160.1 8.2 0.8 UTPUT.. EMPLOYMENT AND PRODUCT!VITY IN 1984 Value Added Labor Force (1985) V.A. Per Worker U~SS1imain f~Percelnt Thousands Percent 5 Percent Agriculture 289 8.4 85.2 14.1 Industry 1031 30.0 161.8 26.7 --- Services 2114 61.6 358.2 WLz Total/Average 3434 100.0 605.2 100.0 ... .-. PUBLrC FINANCE J30millions Percent of GNP lq8 I85 1983-RS Current receipts 434 28.0 28.2 Current exccnditures 542 34.9 33.5 Surplus/Deficit (-) -107 -6.9 -5.3 Investment 277 17.8 17.5 Y/ Most recent estimates (1981-84) for East Bank. unless otherwise noted. Z/ Entire country 3/ Capacity to import 5J/ including grants  CStMTY DATA - Jomna. 1NEY. CEDIT mn UCES Millions of Jordaian Dinars ostanding at Ld erM id . Wr ISLE QxWO f19341 ma ma m1a num ma lmanESR Money Suply 594.8 701.7 787.5 869.4 878.4 84.2 Oil 0 0.0 Bank credit to public sector 223.2 287.6 397_5 483.3 532.4 593.2 Re exports 77 10.2 Bank credit to private sector 541.6 691.1 843.0 993.3 1153.9 121S.6 Total 757 100.0 t a af Sndex umbers EX L -ILC BE DEc. 311 T984 My as percent of COP 60.7 60.2 59.5 60.7 S7.7 S1.9 Mtl ft1U1ua GOP deflator (1981=180) 86.1 105.0 111.6 117.5 121.0 124.5 Otsbursed only Z.336 Annual percentage change in: lncluding undisbursed 3.12X GOP deftlator ... 16.1 11.6 5.2 3.0 2.9 Bank credit to public sector 35.6 25.9 38.2 21.6 10.2 11.4 Bank credit to private sector 21.7 27.6 22.0 17.8 16.2 5.5 BALMCE OF PanTs M"ilions of US Dollars DEBT SERvicE RATMO FOR 19R4 ii z i QR Ql 19s Percent Exports of goods. WFS 1123 1576 1896 1753 1850 PubliC Debt 8.8 Irmports of goods. NFS AZM 3i GZ 2211 am9 Resource Cap (deficit=-) -S97 -1650 -2398 -2160 -1906 Met factor tncoem -552 687 1000 9S5 917 Met transfers z1 2z zZ U 4 Current account balance -1056 -937 -1372 -1190 -944 nIUPOIDa LENOINEG DEC. 31 1984 (def cit=-) USS Itillion 1930 IDA Grants to govermsent 1049 1311 1032 798 670 Mamonetary capital 226 116 199 267 Z34 Outstanding and 105.7 83.2 met errors and omissions 13 -119 -151 -31 -125 disbursed Overall balance (deftcit=-) -232 -371 292 136 16S Und1sbursed 271.8 0.0 Gross reserves (end year) 1z2S 1516 1211 1075 1240 Outstanding incl. 377.5 83.2 Petroleum imports 244 410 659 571 534 und1sbursed  SUMNKARY AND CONCLUSIONS Introduction - Background and Issues i. Overview and Scope of the Report. With the lower growth prospects for the economy and the likely sharp increase in unemployment over the coming years, the adverse income distribution impact of declining workers' remittances, grants and real wages coupled with a rapid population growth has brought issues of employment and income to the forefront of the Government's concern in formulating priorities for the next Plan. For this purpose, Government has recently started a comprehensive survey of basic needs and potential for income generating projects in all cities and villages in Jordan. Considering: (a) Jordan's limited agricultural potential; (b) limited possibilities for continuing past rapid growth of public and private services; Cc) limited scope for further labor absorption (within existing capacity) in the large natural resource-based industries; (d) and the reduced scope for out migration, future economic growth and employment will have to rely increasingly on development of export-oriented labor-intensive small and medium scale manufacturing and services based on skills. However, the magnitude of emerging surpluses of labor is such that even with far-reaching policy and institutional changes, the Government would have to face the redistributive implications of increasing unemployment towards the end of the eighties which is expected to continue unless outmigration picks rp again. ii. Based on the above considerations, the projected increase in unemployment and the rapid growth of population is expected to increase the demand for public services and Government transfer payments oriented towards satisfying basic needs. This in turn will require special efforts to mobilize domestic resources beyond the requirements to compensate for the shortfalls in grants. As a background, the report evaluates briefly the distributional impact of the rapid pace of past economic development and the likely changes in the present employment situation expected to result from the changed economic conditions in Jordan and in the region. In view of the decline in availability of financial resources, the report examnes revenue generating and redistributive features of Jordan's tax system and assesses the cost effectiveness of the Government's social services. Finally, the report contains recommendations on policies to increase the employment content of economic growth; modifying the pattern of growth so as to raise the productivity and incomes of the poorer segments of the population; and reorientation towards basic needs for the poor. It also addresses options to finance social services through more cost-effective programs and increased cost recovery without sacrificing equity, and proposes a more efficient tax system to generate adequate additional financial resources to meet the needs of a rapidly growing population. The expenditure side of the budget, apart from that required for social services, is not examined in this report. iii. Distributional Impact of Jordan's Past Economic Development. Undoubtedly, the Jordanian economy has benefitted greatly throughout the last decade from massive income transfers (grants and workers' remittances averaging almost JD 0.4 billion per year from 1975 to 1980) from the neighboring oil producing countries which enabled .Tordan to grow rapidly (over 10 percent p.a.) and to develop public services fairly evenly throughout the country. High growth and investment offered the private  - ii - sector large opportunities, primarily in construction and services. On the other hand, these massive income transfers created also a number of redistributive distortions primarily in pricing of labor and land. They caused demand-pull inflation through rapid increase in prices of land and real estate. The demand-pull inflation was aggravated by a cost-push inflation caused by the massive outmigration of about 300,000 Jordanian workers (equal to about 40 percent of the total labor force) to the high-wage neighboring oil producing countries. The modern sector, to which much of the development effort was directed, was poached of its most expensive and scarce skills. Socially it led to unrealistic raising of job and niay expectations among those who did not migrate. iv. The above mentioned massive income transfers made it possible to maintain a high level of investment and to promote regional and rural development by improving public services in outlying Governorates and by developing irrigated agriculture. While most secondary urban centers seem by now as well equipped with water, electricity, etc. as Amman, substantial differences remain between urban and rural areas, and this within all five Governorates. Development of irrigated agriculture within its limited means in the Jordan Valley during the 1970s was by far the most important single factor contributing to a more balanced regional development during the last decade. In contrast, the capital intensive, resource-based projects (phosphate mining, cement and potash) had a more limited enclave impact on regional development. According to the Bank's Regional Development Study, the major contribution to regional growth in manufacturing was attained by small workshops which were basically construction related. V. In addition to a more even distribution of income on a regional basis, the previous Plans and the current Five-Year Plan recognized the importance of reducing disparities in income levels among various segments of the population and of achieving a more equitable distribution of GNP and economic development gains. Given the incomplete income distribution data for Jordan, the results of the data analysis cannot be made with a strong degree of confidence. Nonetheless, it appears that during the 1970s, most income groups have benefitted fairly evenly from economic growth, mainly as a result of the scarcity of labor which produced real wage increases in all sectors. Also, the rapid expansion of Government services absorbed a great number of unskilled and lower-skilled Jordanian labor, while large segments of the poorer population also benefitted from receiving remittances from emigrant members of their families. vi. In contrast, future development of income distribution is expected to become much less favorable as a result of the economic slowdown and -ae rapid population growth. As mentioned in para. (i) the magnitude of subsequent surpluses of labor is such that even with far-reaching policy and institutional changes, the Government would have to face the redistributive implications of increasing unemployment towards the end of the eighties. With this background the report makes a reassessment of the Government's income policies and social expenditures. vii. Efficiency and Equity Issues in Government Income Policies. The issue addressed here is the scope for Government mobilization of resources and transfer payments to cushion the expected decline in personal incomes of lower income groups and meet additional demand from a rapidly growing  - 111 - population. Simply to maintain the same level of public consumption in per capita terms would require substantial additional mobilization of resources. viii. Nothwithstanding commendable tax administrative efforts to increase revenues from income tax and customs duties, Jordan's tax effort remains low by international standards, particularly when taking into account that GDP underestimates the tax base by excluding transfers from workers abroad. It is also low in relation to the Government's revenue requirements. Jordan's tax structure is characterized by a limited income tax base and is eroded by extremely generous exemptions and excessive dependence on indirect taxation consisting mainly of a number of exempted import duti9s and narrow based consumption taxes. Customs duties, at the current -:ates, are likely to play a diminishing role given the balance of payments prospects and the fact that the import po'icy will have to give priority to capital and intermediate goods which carry low tariffs or are exempted. At the same time, higher tariff rates on finished products are not appropriate as this would increase protection of domestic I-oducts beyond what is desirable in terms of the recognized need to improve the economic efficiency of the domestic productive base. ix. An analysis of Jordan's tax system indicates low efficiency as an economic policy instrument when it is compared with tax systems of other middle income countries. Normative indicators show that the efficiency of Jordan's tax system is hampered by low concentration of tax revenue sources, great dispersion of low-yielding nuisance taxes, and in particular by a seriously eroded statutory tax base. The efficiency of the tax system has recently been somewhat improved through various tax administration efforts seeking to bring the statutory tax base closer to the effective one through improved eLiorcement. The reliance on ad valorem taxes (except specific rates on excise taxes) secures the effectiveness of the tax system with respect to inflation. x. While previous and current Plans have emphasized the redistributive role of Government expenditures, Government revenues have generally been viewed as financing instruments only. Over the years, the tax system has basically remained regressive with a heavy reliance on indirect taxes coupled with a seriously eroded income and property tax base. Various measures have been taken to soften the regressiveness by i-easing custom duties on luxury goods, by exempting basic food stuffs from customs duties and by gradual enforcement of income and property tax laws. The inequitable impact of the regressive tax system is only marginally reduced through a limited cash support program and even somewhat augmented through a general food subsidy. The cash transfer program provides limited assistance to 6,000 families representing only about 20 percent of the families eligible for assistance. The untargetted food subsidy scheme covers only subsidies of wheat flour. Since the scheme provides for subsidies to higher income households as well, its cost-effectiveness is low with respect to lower income groups. xi. Costing, Financing and Equity Issues in Government Social Expenditures. As mentioned in para- (ii), the projected increase in unemployment and rapid population growth has brought issues of costing and financing of social expenditures without sacrificing quality and equity to the forefront of the Government's concern. As analyzed in this report, there is a considerable potential to reallocate resources more effectively  - iv - within the social sectors through increased emphasis on basic needs. The analysis also shows that unless some system of generating finance on a continuous basis is an intrinsic part of programs to meet basic needs they are liable to be limited in coverage and in duration as Jordan may become overburdened with fiscal liability. Given a continued rapid population growth and claims from more immediately productive sectors the Government wonld have to address a number of crucial inter- and intra-sectoral allocation issues during the Next Yive-Year Plan. These issues will be taken up below with a focus on intra-sectoral allocation issues. xii. The first cost issue discussed is related to the trend in the total cost of social services. In spite of a freeze of general salaries from 1981 to 1985 social expenditures increased by an annual average rate of 12.2 percent at current prices or about 6.4 percent in real terms during 1980-84. Is total cost rising so fast that it will become increasingly more difficult for the Jordanian Government to "foot the bill"? If it is, what are the most effective cost-saving measures? From the observations and the analysis of the data in this section, it clearly emerges that the Government would have to face a simultaneous increase in demand for resources for primary education, a substantial increase in demand for secondary and higher education and an overall demand for improvement of quality of education and training. If nothing is done to reduce unit costs and to improve the cost-efficiency ratio of education services, it would become extremely difficult to maintain present standards of education without large increases in education expenditures. xiii. Faced with increasingly severe financial constraints, the Government of Jordan would have to look for not only measures to lower unit costs but also for strategies aiming at increasing other groups' contributions to the rapidly-growing needs for additional financing of education. A central issue is to determine the optimal amount of "user charge" which should be imposed on education, taking into account a reconciliation of two partly conflicting objectives: efficiency and equity (see paras. xxliii - xliv). xiv. In the health sector, the Government faces a similar problem as it does in education of how to expand hospitals and other facilities, maintain and operate the public health centers and hospitals, and improve the quality of services at all levels. Total public recurrent expenditures in health in 1983 was about 2.7 percent of GNP (4.8 percent including the private sector). While the present share may seem low (although about the average of other middle income countries), the potential for rapid expansion in the next two deLades is substantial. xv. In contrast to the education sector, the review of cost effectiveness in the health sector shows that the Government has already taken a number of comprehensive cost saving measures. However, not only cost-effective measures but also the means by which a country finances the costs of health services can have an important impact on the quantity and quality of care provided, and on the efficiency and equity with which scarce resources are utilized. Under current policies in Jordan and in many other developing countries, health services are financed to a significant degree from public revenue sources (almost 90 percent) which implies that users pay relatively little for these services. Obviously, a key question which needs to be addressed is whether the households in  Jordan would be able and willing to pay higher fees. The report concludes that higher fees, closer to the marginal cost, would still be affordable to most households in Jordan. xvi. Even with vigorous efforts to improve pricing policies in the health sector, Jordan may still be faced with financing problems in the remainder of the 1980s and beyond. Another set of options is concerned with the publiclprivate roles. Reducing the public role as health care provider would obviously reduce the requirements for scarce public funds. In 1982, the private share of total health sector expenditures reached about 41 percent which is somewhat below the average for a number of developing coumtries. xvii. Since water is one of Jordan's scarcest resources and energy comprises a large share of Jordan's total import bill, pricing and allocation are the principal equity and efficiency issues in the water and energy sector. In contrast to education and health services, which are distributed evenly throughout Jordan, access to piped water, sewerage and electricity in rural areas is still inadequate. xviii. While tariffs for municipal water have generally been in line with the cost of these services, water for industrial use and irrigation has frequently been provided well below costs of production and resulted in serious depletion of ground water in populated areas. Consequently, water for municipal use has had to be transported from distant locations at high costs which implies that the households are subsidizing the water use of industry and agriculture. xix. While pricing and allocation remain key issues in the water sector, the Government has taken a number of measures to increase prices and reduce subsidies of petroleum products and electricity for higher level and higher income consumers. In 1985, the fuel subsides were cut by two-thirds and an increasing block rate system for electricity taxes also introduced in 1985. xx. Although there has been large-scale investments in housing in Jordan, urban lower income groups have not been well served and about 40 percent of them live in units with four or more persons per room. The overcrowded conditions are a result of the high costs of housing. Housing has over the years become less affordable to lower income groups through a much faster increase in housing costs compared with the average increase in incomes of lower income groups. The rapid increase in housing costs was due to rapid increase in price of land and real estate triggered mainly by the massive inflow of workers' remittances. Access to rent-controlled housing has, therefore, become the only affordable option for a large segment of the lower income groups unless they benefitted from workers' remittances. xxi. The Government's basic response in the past to the high housing construction cost problem has been to establish heavily subsidized housing funds and to encourage low interest construction and sale of housing by the Jordan Housing Corporation. However, these programs did not cater to demand for low income shelter. The Government has therefore implemented an urban develop-ment program providing for low income shelter financed through cross subsidized full cost recovery. The scheme provides for the full  - vi - range of social and infrastructural facilities required for sound urban development. Possible Areas for Policy Intervention xxii. To formulate a strategy aiming at growth with redistribution in Jordan, it would seem necessary to combine three elements: maintaining high rates of growth in incomes; modifying the pattern of growth so as to raise the productivity and incomes of the poorer segments of the poDulation; and providing basic needs to the poor. The first element of the strategy outlines an approach to increase employment opportunities and incomes of broad segments of the population through export-oriented labor-intensive smali and medium scale manufacturing and services based on skills. Having in mind that the direct impact of employment and income generating measures may be limited in the short and medium term the last two elements of the strategy outline the scope for cost-effective measures to finance an orientation of public services more towards basic needs. Some of these services can be financed through more cost-effective programs and increased cost recovery without sacrificing equity, but additional fiscal revenues generated by a more efficient tax system will be required to meet the needs of a rapidly growing population after having satisfied the financial requirements of economic services and other goverment functions (security, general public services, etc.). Future Development Strategy - Economic Growth, Employment and Equity xxiii. National Economic Measures. Schematically, three ways can be considered to improve the employment situation in the short and medium terms: 1/ (i) Increase the overall demand for labor in the country through higher economic growth and/or more labor intensive production; (ii) substitute nationals for expatriate labor; and (iii) stimulate emigration. However, a sustainable improvement of the labor market situation would require that the Government introduce policies to slow down overall population growth, keeping in mind that they will only have an impact in the very long term. xxiv. While all three possible policies can contribute to ease the projected labor surplus problem, their relative importance is very different. Given the probable economic developments in neighboring oil producing countries, future emigration is unlikely to remain as important an outlet for Jordanian labor as in the past. While the potential to substitute nationals for foreign workers is substantial in theory, actual possibilities are limited because most foreigners occupy unskilled positions, which are often considered undesirable by Jordanians. On the other hand changes in attitudes amr,ng Jordanians may develop and thus somewhat improve the substitution possibility of expatriate unskilled workers. In consequence, the only measures that can bring about a sizeable reduction in surplus labor are those influencing labor demand, i.e. measures stimulating overall economic growth and particularly growth in labor intensive activities. 1/ See a detailed discussion of the skill structure in Manpower Development in Jordan, No. 5117-JO, June 1984.  - vii - xxCv. As mentioned in para. (i), future economic growth will have to rely increasingly on development of small and medium scale manufacturing and services based on skills. Given the small size of the domestic market, most of this will have to be export oriented. The emerging overall surpluses of skilled labor in Jordan and its expected dampening effect on wage increases and labor turnover will improve the competitiveness of Jordan's industrial exports, giving the country a unique opportunity to develop an export oriented industrial growth strategy. Engineering industries for instance require a relatively large number of skilled labor which makes them particularly suitable to lead the technological change in a new industrial development.strategy. In contrast to the expected slow growth performance of traditional private services, the prospects are favorable to exploit Jordan's skill potential and meet the demand for specialized services in areas such as consulting, contracting and maintenance. With most of infrastructure in place in Jordan and in the Gulf countries, a large market for maintenance contracting has been created. Since Jordan has a good potential to develop engineering industries, it is expected that Jordan's developing consulting capability in engineering has excellent growth prospects. Employment opportunities are likely to be favored under pro-trade policies by socially desirable labor-capital substitutions, based on realistic price relationships encouraging the use of suitable combinations of labor and capital. Thus, the speed with which Jordan will be able to develop export oriented manufacturing industries and services will decide to a large extent the rate of overall economic growth and of future labor demand. xxvi. It has to be recognized, however, that political uncertainty in the region combined with economic uncertainty of future development of oil incomes raise the risks to private investors of future long-term investments. To offset this perceived risk it is important that the Government introduce quickly incentives and institutional support for export oriented industrial development. The ideal protection and incentive system is one which allows the exchange rate to carry the main burden of the adjustment between the domestic and the international price level while import protection/export subsidies are reduced to a minimum which is justified on infant industry grounds. Nonetheless, it has to be recognized that the Bank's Manpower Study shows that with even a rapid growth of the formal manufacturing sector, it would absorb only about 10 percent of the large number of entrants to the labor force. On the other hand, a rapid growth of the manufacturing sector would have important linkages and multiplier effects by directly increasing employment in the informal manufacturing sector and indirectly through higher incomes which in turn would increase demand for goods and services. xxvii. Options for Regional Development. Government has a number of social and political reasons to strive for more rapid economic growth outside the Amman area. There is, however, according to the Bank's Regional Development Study, no compelling economic justification to pursue the option to slow down growth of population and economic activities in the capital area, which is still well below the threshold size at which further growth of an urban agglomeration is considered to result in diseconomies. A second, more specific option, as recommended by the Bank's Regional Development Study, is to favor the rising of new economic activities in the larger urban centers of the other regions and this could ans-wer the concern for the Southern Region by developing activities in the Aqaba area. A  - viii - third option, which forms the basis for the Government's national survey of basic needs and income generating potential is, in addition, to prevent the "depopulation" of large number of villages, especially in the South, by identifying the activities that could be expanded at the village or "village clusters" level. To forego the economic benefits associated with the externalities of the existing urban centers in the various regions, in favor of creating new externalities at the village or "village clusters" level, cannot be considered an acceptable proposition. All actions at the village level should be an important "addition" and, moreover, should only include viable income generating activities. The viability of such activities should reflect the additional costs for the Government, in terms of basic infrastructure, required to bring them about. The main implication of this approach is that the population level of villages or village clusters will have to be ultimately dictated by the potential for sound economic activities at that territorial level. xxviii. At a time when the growth prospects for the economy are becoming less favorable than in recent years and the Government budget is becoming increasingly tight, a very careful assessment of the cost for the country of an ambitious regional development effort in terms of its dispersion on the country's territory is required. Clearly the burden will be a function of the timing of such effort, but in any case, given the complexity of these types of programs, a "pilot project" approach is recommended in order to test the functioning of the combined private and public activities. Measures to Improve Efficiency and Equity of Government Income Policies xxix. Measures to Improve Jordan's Tax System. Having reached the economic development level of a middle income country the most important mean for Jordan to improve the effectiveness of its tax system would be to introduce a general sales tax. The recommendation to the Government that it should introduce a general sales tax is here limited to general guidance based on the experience of other countries (see a detailed proposal for introduction of a value added tax in Jordan in Annex III). To be efficient, such a tax should be levied at a uniform rate on as broad a base as possible. In practice, however, general sales taxes are often levied with multiple rates although this creates considerable administrative complications, and although the available evidence indicates that little is gained in terms of equity by having multiple rates. The basic rate that the Government would choose for this tax would depend on revenue needs and on how broad the tax base is. Even though the base for the general sales tax should be broad, some well-defined products could be exempted for administrative of social reasons (basic foods, school books, medicines). To the extent possible, the base should include services, and specially those sold by public enterprises. Furthermore the tax should avoid, or at least limit, cascading. For these reasons a value-added tax is preferable to other forms of general sales taxes. However, a precondition for introduction of a value-added tax in Jordan is that bookkeeping and accounting practices be upgraded to meet the assessment and auditing requirements of such a tax. xxx. Since Jordan has reached not only a higher level of per capita income but also improved its tax administration, it is also timely for the Government to review the whole exemption system for the personal income .ax. The Government should in its review of the exemption system consider  - ix - the following recommendations: (a) A uniform exemption allowance for personal income should be reinstated. Moreover, to provide for a more equal treatment of income from employment and income from other sources, the allowance should be lowered to the previous allowance of 15 percent subject to a specified maximum amount or even more ideally from an equity point of view it should be replaced by a fixed absolute allowance; (b) deduction of rents for residential purposes should be eliminated; and (c) deduction for higher education studies should be abolished as soon as the proposed student loan program is in place. xxxi. Since Jordan's tax system effectively exempts most people from personal income tax, the Government should consider an increase of the first rate from 5 to 10 percent at least as an interim measure until the exemption system has been reformed. The Government could also for the same reason consider introduction of a minimum tax of say 5 percent of total income in excess of the maximum personal exemption -without permitting any other allowance if the resulting tax liability exceeds that computed on chargeable income under the regular income tax schedule after all permissible allowances. uxxii. Although the objectives of the Encouragement of Investment Law is desirable, the subsidy's effectiveness is open to questions given investors' surveys carried out in other developing countries indicating that investment decisions are usually marginally responsive to tax incentives. It is, therefore, strongly recoummended that a cost-benefit analysis should be carried out so as to evaluate the effectiveness of the investment incentives. E.g., the Government may instead have used the foregone revenues more effectively to promote regional development through infrastructure projects in the regions. As proposed in the Bank's Regional Development Study various employment subsidy schemes for new jobs may also be considered to encourage more labor-intensive production techniques. xxxiii. Once a general tax on imports is in place, accompanied by a general sales tax and by differentiated excise taxes, it is recommended that Jordan as a long-term strategy should start considering dismantling revenue generating tariffs (if combined with an appropriate exchange rate policy) and retain those for the purpose of protection only. The entire list of customs duties exemptions and their implementation should also be carefully reviewed. E.g., on equity and revenue grounds the duty exemptions for Government employees purchases of consumer goods in special Government stores should be reconsidered. xxxiv. Finally, it is recommended that simplification of tax rates of import and excise taxes are carried out. To make the import tax simpler to administer, it is recommended that the Government should consider to unify the surcharges into one flat ad valorem rate. Also all the extra excise tax surcharges should be consolidated with the basic rates on an ad valorem basis. oxxxv. Scope for Revenue Enhancement. The most immediate challenge is how the fiscal revenue system of Jordan can become more efficient and what other appropriate fiscal revenue sources may be introduced to meet the shortfall in grants and the expected reduced growth in customs duties. The fiscal exercise below would provide the scope for revenue enhancement so as to be able to generate financial resources to meet present and future needs for social development expenditures.  xxxvi. The combined tax efforts as shown in the report's fiscal exercise indicate the range of possible revenue enhancement in Jordan amounting to about JD 145 to JD 210 million. This is to be compared with both the present level of tax revenues reaching about JD 315 million and the total domestic revenues of JD 437 million. If the budget support grants of JD 124 million would be phased out completely, the fiscal exercise clearly shows that the introduction of a broad based sales tax combined with a reform of the exemptions for income tax would be necessary to not only maintain the present level of revenues, but also to meet future requirements. xxxvii. Other Income Policies. Reforms of food subsidy schemes are politically sensitive in most countries that have instituted them. A special study is needed to assess the most suitable targeted food subsidy scheme for Jordan. Experience from other countries has shown that a gradual adjustment in prices of basic foods using an indexation formula accompanied by introduction of a highly visible compensatory measure aimed at the target groups are critical to ensure a successful implementation of a food subsidy reform. xxxviii. If the costs for the food subsidy scheme could be lowered by targeting it to the lowest income groups it would also enable the Government to expand the Government's cash support program (this could constitute a highly visible compensatory measure). What clearly emerges is that the Government's cash support program of JD 600,000 is far from adequate. As a minimum measure, the Government should consider to increase the allocation from JD 600,000 to JD 3 million to meet the estimated minimum need of 30,000 families. xxxix. Measures to Improve Efficiency and Equity of Social Expenditures. Orientation of public expenditures and programs more towards basic needs can be designed to improve both efficiency and equity without a conflict between these two goals. This section shows that required resources are reduced in a more basic needs oriented approach by economizing on the resources required and by increasing the available resources. The required resources are reduced because the basic needs approach economizes on resources devoted to non-basic needs. Thus, this section recommends that a comprehensive reform of education and health policies is required, involving a movement away from subsidized higher education to primary education and from modern curative health care to preventive care. The available resources are increased because a sustained basic needs approach makes for a healthier, better skilled, better educated labor force and can, therefore, be considered a form of long-term investment in human capital. xl. Because the cost of teachers is by far the largest item of total education cost, the report examined possible ways of reducing it. The overall conclusion is that there is hardly any scope to cut costs by lowering individual teachers' salaries since they cannot be considered to be well paid, neither by international nor Jordanian standards. xli. One obvious avenue would be to increase the average class size (within a reasonable range), since most studies show no significant influence of class size on internal effectiveness. Since average class size for each educational level in Jordan is not characterized by overccowding, it is realistic to consider an increase in the average class  -xi - size of preparatory, general secondary level and community college level by say 15 percent which would provide for substantial budgetary savings. Studies also show that a moderate increase in class size would provide enough savings to finance important quality improvement. xlii. Although Jordan is facing an increasingly severe financial constraint and is looking for cost-reducing policies in education, the Government is aware of the need to further upgrade the quality of their schools and that some cost-saving measures may push this quality still further down. Based on existing research findings, some measures are both inexpensive to implement and very effective. First, text books is the measure which comes out consistently with the strongest positive effect. Second, level of education of teachers does not seem to have a powerful effect on student achievement as long as teachers have a minimum of education and of training. Furthermore, those characteristics which seem to be the most effective (home environment, attitude towards students, attitude towards work, etc.) are not those which can be affected by policy. Third, management of the school is an important variable. Improvement of management through better training and higher salaries of principals appears to be relatively cheap and cost effective. xliii. As mentioned in para. (xiii), the Government of Jordan would have to look for not only measures to lower unit costs but also for strategies aiming at increasing other groups' contributions. Overall the equity arguments reinforce rather than diminish the efficiency arguments in favor of reducing subsidies to secondary and higher education in Jordan and transferring the funds to primary education, where they would be used more efficiently and be distributed more widely, to the benefit of less privileged social groups. If total recurrent cost recovery is achieved for e.g., university education in Jordan, about JD 20 million could be transferred to primary education. xliv. Introduction of a national student loan program in Jordan combined with selective scholarship for needy students would make it possible to increase tuition fees and improve cost recovery. This, in turn, would make it possible to expand the domestic capacity of higher education which would make it possible to reduce the substantial outflow of scarce foreign exchange to finance education of Jordanian students abroad. By reducing the level of subsidy and so bringing the private and social rate of return closer together, loans can lead to a more efficient use of resources, since a massive education subsidy may lead to over-investment by individuals in higher education. xlv. Another, although indirect, way for the Government to reduce its financial burden is to encourage the development of private schools. Before endorsing such a policy, the Government may take into account that increased privatization of the school system as a means to reduce the budget squeeze is not always necessarily financially advantageous. Nor may it always be advisable for equity reasons. xlvi. As mentioned in para. (xv), the Government has already taken a number of comprehensive cost effectiveness measures in the health sector. An essential theme of new Government initiatives should be to have users bear a larger share of health care costs. This does not necessarily mean that all fees for services should be raised substantially. Across-the- board increases, without discriminating among types of services, should be  - xii- avoided. For curative services, efficiency pricing should be the standard benchmark, and proposals for departures from it should have to be rigorously justified; and changes in fee structures at Government facilities may often need to be only one component - perhaps even a minor one - of broader reforms. There is, however, one category of curative services - referral activities (all inpatient and some outpatient care) - where a different approach is needed. Significant increases in fees for referral services generally should not be undertaken until the broader complex of incentive issues surrounding public/private roles, risk-sharing, and the structure of subsidies have been effectively resolved. Preventive services require smaller adjustments. Jordan should concentrate on correcting their policies on the curative side first, not only because - as noted earlier - curative care accounts for a large proportion of total expenditure but also because the underlying issues on the preventive side are more difficult and any adjustments may need to be more gradual. xlvii. The theme of increased cost recovery from users should be pursued not only through fees for services but also through fees for coverage - i.e., by encouraging increased application of risk-sharing arrangements. Schemes that combine both kinds of fees should be fostered. In such schemes, fees for coverage can generate most of the revenue needed to cover costs, while fees for services, in this case called co-payment or cost-sharing, serve efficiency objectives. Equity goals are not undermined because the coverage fees can be spread fairly across the entire covered population; and thus make it possible to keep the service fees relatively modest. xlviii. At the same time, tendencies to expand the public role in providing care should be dealt with, and public subsidies should be restructured to improve incentives. Unquestionably for certain types of services, there are compelling reasons for having Government remain a primary provider. Included in this category should be most preventive services. Yet for most curative services, the arguments for public provision do not, on close inspection, stand up well. In general, Jordan, like most - though not all - developed countries before them, should begin to think about having Government do less direct providing of care and more indirect financing and regulating of providers. xlix. The overall recommendation in the housing sector is that the public sector should focus its efforts on providing essential services and infrastructure to urban land and rather stimulate the private sector to improve the housing supply. This does not only reflect that investment in housing structures are rarely an efficient use of public resources but also that low income households, in particular, value improvements in essential services very highly - more highly in fact than improvements in the quality of the buildings in which they live. 1. Once the initial Government urban development schemes are in operation, the possibility of encouraging the private sector to develop and market plots affordable to low income groups should be explored. The essential government contributions to such an effort would be to give planning permission for small plot sizes and low-cost infrastructures, and to provide social services. It might a'Lso assist by making appropriate land available. The previous analysis on measures to reduce costs  - xiii - concluded that allowing higher residential densities and collecting higher annual taxes on land (preferably based on market price rather than rental value so long as rent controls remain in effect) are the two most attractive single measures from the point of view of density and affordability criteria. li. In the areas of energy and water the recommended measures focus on improved cost recovery so as to improve equitable allocation of resources and stimulate conservation of energy and water. Substantial progress has been made to reduce fuel subsidies and thus reduce distortions in both level and structure of energy demand. The justification behind the remaining fuel subsidies (except for kerosene) is not convincing. With the decline of oil prices in US dollar term-e (although the increase has been substantial, in dinar terms as a result of the dollar appreciation) subsidies are no longer justified to dampen the large price increase in the 1970s. Also, the misallocation of resources and waste that follow energy subsidies to the coumodity producing sectors and services are well known. In particular, the subsidies for the energy intensive transportation sector does not seem justified since lowering of transportation costs has an insignificant price dampening impact on the final goods. Kerosene is the only petroleum product which justifies a subsidy on equitable grounds. Even so, it is recommended that the subsidy would be gradually phased out to be replaced as recommended in paras. (xxxvii-xxxviii) by a more targetted food and cash transfer program. lii. Substantial progress has also been made to introduce a more efficient electricity pricing. The recent introduction of increasing block rates will ensure improved resource allocation and energy conservation. However, the new increasing block rate seems to be designed to check high consumption rather than provide more equitable treatment of low income consumers. For this purpose, an additional block rate would probably have to be introduced. liii. Pricing and allocation of industrial and agricultural water affect pricing of mnicipal water. Instead of pumping e.g., expensive water f,-om surplus areas to replace ground water for irrigation in North Jordan's Uplands, alternative solutions would be to relocate irrigated agriculture to areas where water resources can be obtained at lower costs, such as the Jordan Valley, or to convert irrigated agriculture to rainfed agriculture. A somewhat similar situation exists regarding water use by industries with their own wells. Indications are that if these industries were to be charged appropriately for water used, their water consumption would be substantially reduced. These measures would ultimately ensure that a more fair share of the cost recovery burden would fall on municipal consumers.  I. ENWRODUCTION 1.1 With the lower growth prospects for the economy and the likely sharp increase in unemployment over the coming years, the adverse income impact of declining workers" remittances, grants and real wages coupled wfth a rapid population growth has brought issues of employment and redistribution to the forefront of the Government's concern in formulating priorities for the next Plan. For this purpose, Government has recently started a comprehensive survey of basic needs and potential for income generating projects in all cities and villages in Jordan. Considering: (a) Jordan's limited agricultural potential; (b) limited possibilities for continuing past rapid growth of public and private services; (c) limited scope for further labor absorption (within existing capacity) in the large natural resource-based industries; (d) and the reduced scope for out migration, future economic growth and employment will have to rely increasingly on development of export-oriented skill labor-intensive small and medium scale manufacturing and services based on skills. However, -he magnitude of emerging surpluses of labor is such that even with far-reaching policy and institutional changes, the Government would have to face the redistributive implications of increasing unemployment towards the end of the eighties which is expected to continue unless outmigration picks up again. 1.2 Based on the above main considerations, che projected increase in unemployment is expected to increase the demand for public services including transfer payments oriented towards satisfying basic needs. This in turn will require special efforts to mobilize domestic resources beyond the requirements to compensate for the shortfalls in grants. As a background, the report evaluates the distributional impact of the rapid pace of past economic development and the likely changes in the present employment situation expected to result from the changed economic conditions in Jordan and in the region (Chapter II). In view of the decline in availability of financial resources, Chapter III examines revenue generating and redistributive features of Jordan's tax system and assesses the cost effectiveness of the Government's transfer programs. Chapter IV reviews education, health, water, energy and housing to xamine the present status and scope to make efficient use of existing resources through cost effective programs with an increased emphasis on provision of basic needs. Finally, Chapter V contains recommendations on policies to increase the employment content of present economic growth; modifying the pattern of growth so as to raise the productivity and incomes of the poorer segments of the population; and reorientation towards basic needs for the poor. It also addresses options to finance social services through more cost-effective programs and increased cost recovery without sacrificing equity, and proposes a more efficient tax system to generate adequate additional financial resources to meet the needs of a rapidly growing population. The expenditure side of the budget, apart from that rc luired for social services, is not examined in this report.  - 2 - II. DISTRIBUTIONAL IMPACT OF JORDAN' S PAST ECONOMIC DEVELOPMENT AND PRESENT DEVELOPMENT TRENDS 2.1 As analyzed in this chapter, the Jordanian economy has undoubtedly benefitted greatly throughout the last decade from massive income transfers (grants and workers' remittances averaging almost 3D 0.4 billion from 1975 to 1980) from the neighboring oil producing countries which enabled Jordan to grow rapidly (over 10 percent p.a.) and to develop public services fairly evenly throughout the country and offered the private sector large opportunities, primarily in construction and services. On the other hand, these massive income transfers created also a number of redistributive distortions primarily in pricing of labor and land. They caused demand-pull inflation through rapid increase in prices of land and real estate. The demand-pull inflation was aggravated by a cost-push inflation caused by massive outmigration of about 300,000 Jordanian workers (equal to about 40 percent of the total labor force) to the high wage neighboring oil producing countries. The final section shows that the lower income groups of the population most likely did not become worse off neither as a result of these distortions nor as the level of national income rose. A possible explanation is that the biased distribution of capital gains towards higher income groups was largely offset by an increase in the wage share of value added and large inflow of workers' remittances benefitting low and middle income wage earners. While there are several indicators pointing to that Jordan's income distribution at present ranks favorably by international standards, it is expected tht the regional and domestic economic slowdown and the subsequent rising uaemployment coupled with a rapid population growth could rapidly worsen distribution of income. A. Distributional Impact of Jordan's Past Economic Development 1. Past Development of Growth and Employment 2.2 Conscious of the country's limited natural resources, its relatively narrow productive base and the sensitiveness of the economy to changes in its oil-rich regional environment, the Government has wisely pursued liberal, outward looking policies in trade, labor migration and foreign exchange. This enabled Jordan to alleviate the effects of one of the highest natural population growth rates in the world (3.5 percent) through massive emigration stimulated by high salaries in the neighboring countries and through rapid expansion of domestic production. At present, about 40 percent of Jordan's total workforce is employed abroad. In addition to sizeable workers' remittance inflow. Jordan benefitted from large inflow of grant aid from neighboring countries as well as rapid increase in regional demand for its exports. During the period 1976-82 the yearly inflow of workers' remittances and grants reached on average close to two-thirds of Jordan's GDP. The abundant supply of foreign resources and favorable entrepreneurial climate enabled Jordan to maintain a very high consumption rate and a high investment rate. As a result, the Jordanian economy with public and private services as the primary sources of growth expanded rapidly in recent years reaching an annual average growth rate of over 10 percent (Table 2.1); in GDP per capita terms, the economy grew from about $400 in 1973 to about $1700 in 1983. Almost fulL employment was reached and the number of foreigners working in Jordan increased considerably.  -3- 2.3 The economic slowdown in the neighboring countries since 1982 has in many ways affected the Jordenian economy; it led to a slowdown of domestic economic activity and a reduction of inflow of external resources. One immediate impact of the recent slowdown has been a substantial weakening in domestic and exter