RESTRICTED FILE COpy Report \~No. EC - 1 7 1 a Public Disclosure Authorized This report w. as pre. pared for use within the Bank and its affiliated organizat~.on'). They do not accept responsibility for its accuracy or completeness. The report may not be published nor may it be quoted as representing their views. I

INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT

INTERNATIONAL DEVELOpl~ENT ASSOCIATION

" Public Disclosure Authorized

ASPECTS OF THE PROBLEM

OF

INTERNAL RESOURCE MOBILIZATION

IN IRAN Public Disclosure Authorized

August 31, 1970 Public Disclosure Authorized

Economic s Department • ASPECTS OF THE PROBLEM OF INTERNAL RESOURCE MOBILIZATION IN IRAN

Table of Contents

Page No.

SUMMARY AND POLICY ISSUES i-iv

CHAPTER I The Fiscal Problem 1

-, Introductory Co~ments 1 - Overall View 2 - The Level and Growth of Public Ex- penditure 5 - Government Revenues 10

CHAPTER II Direct Taxation 13 - Summary - Taxation of Legal Entities (Companies and Registered Partnerships) 18

CHAPTER III Indirect Taxation 20 - Summary . 26

CHAPTER IV Private Savings Mo~ilization 27

ANNEX Statistical Tables

This report was pr~pared by Messrs. Stanley Please and Emmerich M. Schebeck who 'Here part of the Economic Mission that visited Iran in August­ September 1969. The authors discussed the draft of this report with Iranian officiaJ.s in Teheran during the period April 14-22, 1970 •

• • Summary and Policy Issues

1. Despite the fact that the Iranian economy has continued to grow at a fast pace of about 8 percent per annum, fiscal policy since 1965/66 has been characterized by a level of public savings which has been stagnant in absolute terms and thus declining as a percentage of ChW. This situation has arisen from an annual average increase of current expenditures of over 18 percent which has reflected in particular an increase in expenditures for defense and security of 23 percent par annum. Primarily.due to the buoyancy of oil revenues, current revenue inc reased by 17 percent but could not keep step with the exp endi ture growth. Hence the government's propensity to save fell rapidly. Simul­ taneously, sharply riSing public investment expenditures generated grow­ ing overall deficits which in turn led to an increased reliance on external borrowing. 2. Under these circumstances fiscal policy and the problem of resource mobilization becomes as much a question of expenditure policy as of tax policy. It is difficult to see how public savings can increase at the speed required by the investment program without same considerable slow-down of the grOl~th in current government expenditures. This is particularly true ~n the short-run where the government must choose between higher growth rates involving higher investment outlays, and rapidly increasing government consumption expenditures though even in the long run the government cannot think of the growth in current expenditure or of: the tax effort to be imposed as Simply a matter of political decision-making. Whilst directing more of their attention to the growth of current expenditure the Iranian authorities must, however, ensure that current expenditures on a selective basis for priority develqpment purposes, e.g., tax administration, education, health and communication are not undesirably reduced.

3. The Iranian authorities have in recent years taken steps to raise the base for direct taxation. The Direct Taxation Act of 1967 and its accompanying administrative reforms have represented the major step. in this direction. Direct tax receipts, which increased in previous years by about 18 percent per annum, increased by 28 percent during 1968/69. This rise can be attributed primarily to the deliberate policy decision to strengthen both the formal structure of the system of direct taxation and its administration. Although continued efforts to improve the effectiveness of the assessment and collection machinery were required, it is the willingness and ability to enact and to implement new measures in the area of direct taxation which represent the clearest indication of the government's desire ana ability to develop its non-oil source of tax revenue. - i1 - •

4. Despite these efforts, total direct taxes still contribute less than a quarter of non-oil revenues and represent only 2.6 percent of non­ oil GNP. It is through the development of its system of indirect taxation that the Iranian authorities must look for the major sources of revenue generation in the short and medium run. This development must in par­ ticular resppnd to the ~act which the country's industrialization is having on revenue from customs duties. The structure and level of these import duties must be reviewed in the light, firstly, of their allocative effects, especially on the process of industrialization, and, secondly, on the governmentts ability to generate tax revenue. At present the ta.r~ff structure is rurming counter to the government's attempt to deepen the industrial structure by establishing resource- based industries producing intermediate p,roducts domestically as well as industries producing capi tal goods • A revision of the tariff should help to eliminate distortions in the production structure which resulted from a tariff policy encouraging production of consumer goods rather than intermediary and capital goods. The government might find particular reasons to extend protection to certain industries, ;nut these neecis should be clearly defined and prot4ttction should be administered in a disciplined manner.

S. However, the Report's major recoJ11llendation in the area of tax policy is upon the need to establish a structure of sales or excise taxation upon domestic output, particularly where this has been the outcome of ~ort saving policies. Apart from automobiles, virtually all domestic industrial ouq,ut is outside the scope of indirect taxation" The government should as a mc"tter of priority determine the precise ronn which its indirect tax structure should take. This could range from an extension of excise duties to cover such commodities as refrigerators, air conditioners, etc., to a more conprehensive system of sales taxation based on turnov.. , type of business, etc. Further­ more, it could be a system of taxes which is iJrposed at a single point in the production/distribution structure (e.g., on manufacturors) or at several points (e.g., manufacturers, wholesalers, retailers, etc.). These choices should be based not only on questions ot principle and of revenue need, but alst) on those at administra tive feasibility and cost. In fact" it is to the need to develop the assessment and collection machinery requir~d to implement the extension of the indirect tax system that the' government should give immediate attention.

6~" In addition to domestic industrial output, there is a need fOl:~ the gove~t to consider the indirect taxation of domestic services, particularly in the are~ of public utilities. This should also include the possibility of raising road user charges on congested road networks in urban centers and on congested highways. • 1. Three other important issues to which the Iranian authorities should give immediate attention are: (i) the coordination of budgeting between theyarious agencies, (ii) tax concessions to industry, and (iii) the e;< J'ective mobilization of private savings.

8. The problems which the government of Iran faces in the field of fiscal pol~cy are aggravated by the fact that information regarding the financial ~operations of the various public agencies and enterprises are inadequate. In particular, the present weakness of administrative control over a large number of public enterprises and their reluctance to disclose their accounts prevents a strict enforcement of financial discipline by the Bureau of the Budget.

9. Secondly, the 1967 Tax Act brought also a complete revision of the tax system for legal entities (companies and registered partner­ ships) and introduced lavish tp,x concessions. The Mission questions whether these incentives are required to induce a higher level of investment in private industry in a country in which industrial profit rates are as high as they are reputed to be in Iran. In general~ tax concessions provide budgetary funds to firms for the internal financing of their operations. These budgetary funds are addi tiot.l.al to thes e provided through !MOBI and are, therefore, a means of compensating firms for any inadequacy in the supply of investment funds and particularly for an inadequacy in the supply of equity funds. Knowledge of the f~nancial position of firms in different industries, regions, markets, etc. appears limited. It is therefore difficult to evaluate the need for these concessions and their effectiveness in meeting these needs as compared with other policy instruments. Likewis~ the Mission was not in a position to obtain information regarding the cost of these concessions in terms of forgone government revenues. All of these are important matters for the determination of fiscal policy and should be closely examined by the Iranian authori­ ties in the Plan Organization, IMDBI and the Ministry of Finance.

10. Finally, in addi tion to the need for the government to address itself to the above issues of fiscal policy both on the expendi­ ture and revenue sides of the budget, there is also a need for it to examine policy issues in relation to the mobilization of private savings. Despi te favorable economic conditions, the ratio of savings to GNP shows no marked changes over the past few years. In 1968, private savings reached about 10% of GNP. Yet, the ratio of total bank deposits to GNP increased markedly and reached about 23% in 1968. 'l'his clearly reflects an increase in monetization of the economy and in the willingness of' people to hold savings in the form of financial assets. At the same t:irlTle it is apparent that a considerable proportion of the flow of private savings ,is continUing to now into real assets "U

)J - iv- and into' foreign assets. It is, therefore, important for the Iranian authdrities to· examine the institutional artd policy changes which are required :JD order to ensure the more effective mobilization of private s'avings tor priority development purp·oses. I~ortant in this connection is the problem of the level and structure of interest rates. This raises the related question of interest rates on public sector borrowing, including the borrowing of institutions such as IMDBI which is dependon t entirely upon contributions from the development budget for its domes tic loan funds • Furthermore, i traises the question of the need and possi­ bility in Iran of developing alterna ti va outlets for finanCial savings including the market for mediwn: and longer-tem securities. IRAN • I. THE FIScAL PROBLEM

Introductory Comments

1. Some explanation is required of a report which deals with the domestic resourc e "problem" of an ec onomy in which (i) the level of total domestic savings is currently at 15 percent of gross domestic product and has risen from 13 percent over the past 6 years; (ii) 21 percent of gross domestic resources is received as current revenues by the government and its affiliated agencies and this again has risen from 15 percent over the past 6 years; (iii) over' the same period money and quasi money in the hands of the public has risen from 16 percent of gross domestic product to 23 percent and (iv) the general price level has increased by only 7 percent since 1962/63 and as such Iran represents one of the most price-stable coun­ tries in the 'tv-orld. 2. It is as well to recognize right away that the explanation lies llartly in the fact th.at those interested in development are never to be satisfied and should never be satisfied whilst problems continue to exist in Iran even though as compared with those faced by the authorities in other countries these problems are almost trifling. Secondly, the explanation lies in the fact that the customary criteria of performance, referred to above, might be inadequate for judging performance in relation to the mo­ bilization of resources for development. And finall~ the continuous in­ crease in the net need for foreign goods and services since 1963 which is reflected in the deterioration in the balance of payments position dealt with in the Main Report suggests a priori that the domestic resource mo­ bilization effort has been inadequate to the circumstances and furthermore that this inadequacy has been grot-ring. In particular the. Main Report has 1 noted that the private sector is nO,",1 a deficit sector and thus thel, 'i=> 9Vem­ ment cannot ~ely upon this sector for financing its own needs. 3. Despite the high rate of growth of the economy, fiscal policy since 1965/66 has been characterized by a level of public savings which -has been stagnant in absolute terms and thus declining as a percentage of GNP. This situation has arisen from an annual average increase of current expenditures of about 19 percent which has reflected in particular an increase in expendi­ tures for defense and security of over 23 percent per annum. The tax effort has been inadequat~ to meet these growing current financial requirements of the government with a consequent fall in the government's propensity to save. Simultaneously, sharply rising public investment expenditures generated grow­ ing overall deficits which in turn led to an increased reliance on external borrowing. - 2 -

!J Tt:'.ble 1

Central Government Savings J Investment and Overall Deficit . (IIl'percent of GNP at market prices)

1963/64 196L/65 1965/66 1966/67 1967/68 1968/69

go~ennnent Savings 2.9 2.9 6.1(3.9)L! 4.7 4.3

government Invest- m~t 3.8 5.0 7.3 9.3

Overall Deficit 0 .. 9 2~1 1.6 4.6

l!:_ Figqres in 'brackets are exclusive of the oil bonus receipt of Rls. lo~5 , billion in 1965/66. ~~.Based on revised estimate of GNP for 1968/69 of RIs. 602 billion.

~~ Under these circumstances fiscal policy becomes ~~ much, if not MQre, a question of e~epd~ ture policy as of taJ(' policy. The Iranit~Jl authori­ ~!es could and. shoul~ concen.trate vigorousl~" on inlproviIlg tIle tax structure, primarily of indirect taxation, to meet both the fiscal and allocative needs Qf the economy. It is difficult, however, to see how public savings can in­ c~ease at the speed required by the ipvestment program lt~ ~ou t some con­ ~ide[iable slQw'!"down of' the growth in current government e~endi~res. '.!.'his is :p@rticularly true i.., the short~runJ but evep ~n the longef-run gove.rDl'lents can:­ ngt. 'ijlink of tl1.e growth in cu.rrent eJg)en.dlture or. of the tg e!fqr.1i to pe i.m:­ pp~~d on ~ l\~'f;,ion pS s~inpl1 ~ lOCltte~ of polit:ica.'l:- ;.;;1.eQi5;gp~m~:l.1l"~ '.fP.er-e Ar.~ v~r'l r.eal struQwral cmd a.~P4istrat:i.ve constr.a:i-p~ on *~ g"owth of tg: ~e~ venuea. Thus, the government ~st choose petwaep hi~ gr.Qwth n~~e~ with he~vy investment or rapidly increa~~~g current expenditure~J primarily mili~ tAfY expenditure. . .

Overall View ,. From 1963/64 to 1965/66 government saving~ increased nearly t~ree~ fold, reaching aQout Rls."29 "liillion in 1965/66 or 6,1 per.cent of GNP! But the high savings during 1965/66 are \lPward b'itlped d.qe ~P ~eC eipt of an oil bonus of Rls. 10,5,billion~ The fast' growth of cupr-en4 revenue (22 percent compounded annual~y) which was pr~marily tne re~ult of ~ rapidly increas~g 9~ revenue (34 percent), e~cee4ed ~~ far the rise in current expendi~re (10 percent) and GNP <1~.6 perC~"t), This gQQQ ~avings perfovm~ce led to .~ more tnan dov.bl;l.ng pf ~lv~~~~nt ~~~dit\l~e~ w~tllou1!_eperat~;n~ ~trqp.~ pressure~ on domestic an(ie~te~~l. pQ,rl'ol4n~. . - 3 -

Table 2 ~.. . () Expenditures, Revenue and GNP (Annual Compounded Rates of Growth) 1963/64 - 1965/66 1965/66 - 1968/69

~ent Expenditures 10.6 18 •. 7 Defense and Security 20.5 23.5 Social and Economic Services 6.7 14.8

Current Revenue 22 .o( 14. 4>Ll 12.5(17.3)/1 Oil Revenue 34.0(19.4)/1 7.3(16.1),a Non-Oil Revenue 9.9 18.5 Gross National Product 12.6 8.8 /2 /1 Figures in brackets are"exclusive of the oil bonus receipt of Rls. 10.5 -- billion in 1965/66. /2 Based on revised estimate of GNP for 1968/69 of Rls. 602 billion which - is downward adju'stled from the previous est:i.mate of Rls. 612.3 billion. 6. After 1965/66 the fiscal performance changed drastically and by 1968/69 the generation of public savings had become an acute problem. This was due essentially to the rapid increase of current expenditures which in­ creased annually" at about 19 percent, thus exceeding by far both the growth of revenue (12.5 percent) and of GNP (8.8 percent). Over this period public savings stagnated at about Rls. 26 billion while they declined on a relative basis from 6.1 percent of GNP in 1965/66 to 4.3 percent in 1968/69.1/ 7. During the final year of the Third Plan, 1967/60, pressures to rea- lize the Plan targets led to a high level of public investment which increased by about 40 percent over the previous year. With public savings remaining un­ changed compared with 1966/67, the overall deficit in 1967/68 rose to Rls. 25 ,billion -- an increase of 216 percent.

8. In 1968/69 revenues continUed to be buoyant. They increased by almost Rls. 20 billion which represented an elasticity with respect to GNP of 1.9,. However, over 100 percent of the increase in revenue was matched by an increase in current expenditure of which 50 percent was on defense. Government savings remained virtually stagnant in absolute terms while falling sharply to 4.) percent in terms of their ratio to GNP. By 1968/69, it wa& becoming clearer that the deterioration of the public savings

1/ If ex bonus figures for 1965/66 are used, the rates of growth change, but the problem becomes, if anything, more obvious, E".g. in spite of an in­ creased growth rate of current revenue to 17.) percent per annum, revenues could still not keep step with expenditure growth. 'T?blep

:Prelinr~P.relim- inary inary Actuals Actuals 1963/64 1961~/6S 1965/66 1966/67 1967/68 1968/69 1969/10

1. Current Revenue 60;8 68.3 90.0 98.6 108.7 128.3 • 151.3 -1/

Oil -Revenue '(27·.7) (36.4) (SO.: 0)2./ (47.8)Z/ (54.0) '(61.8) (76.4»)/ Non ... Oil Revenue (33.,1) ( 31. 9) (l~0.'D) (50.8) (54.7) (66.5) (74.9) :2. Current Expenc!i tu'res ,50.1 ~~ 61.3 70.5 82.1 ~ 119.:2 I' DefenEF.! and Security!:/ ,(17.6) (20!.2) (25.4) (28.8) (37.8) (L7.6) (57.0) Oth'ed ;(.32.5) ( 35'~\B) (35.9) (41.7) '(44.9) \(54.8) (63.9)

3. Surplus on Current Operation 19.:1 ll:l 28.7 ~ ~ 25.9 )0.4 ·4. Investment Expenditures -i4.o ll:,g ~ 36.2 51.3 ~ 7u.2 'S.NationalGovernrn.ent Def'ic itC .3-4) hl 8.9 1:.2 8.l 25.3 35.1 0:.§ ,6~ financing of Defic it 3,.~ 7.5 6.3 lhQ, 25.3 ill 41 .• 3 t:- {a} Bo'rrovr.in g f,rom:

:Banking System '5.1 8.3 5.3 5.0 12.5 15.3 17.4 Tre.Rsury Bills and Bonds 2.0 2.0 5.4 7.4 8.4 13.0 Foreign Lvans 1.1 0.8 2.3 4.1 10.1 21.2 23,2 Other Resources -1.0 -3.6 0.9 .c·b) 'Repayment of Principle on Fore;Lgn and Domesti.c :Debt.,2/ -3.'0 -3.6 -2.3 -3.5 -4.7 -12.2 -12.3 'ERRORS AND QIlISSIOl'J 0 .• 1 1.4 0·1 0.1 1.5 2.5 1/ 'The currentr-evenue data for 1969/70 ,are ,pre1.irninaryactuaJ.s and do not tally with - the data of Table 4 in the Annex which are lbasadon 'budget estimates. 2/ Includes an oil bonus receipt of Rls. 10.5 ibillion in 1965/66 and Rls. 0.4 billion in 1966/67. J/lncludes an advance payment of Rls.6.0 'billion from the Consortium. '[/ Includes expenditures financed from the Ordinary and Development Budgets. Expenditures financed ,directly by utilization of .external loans .are excluded, but payment of principal and interest on such loans is included (see Table 4) • 51 Includes all non.. defense ands ecuri:t.y ;expenditures of the Ordinary Budget. ,~jIncludes .amortization of principal .onf.oreign .and domestic debt.

:Source: J3udgetof Iran and Bank Markazi

f. .' -5- perfonnance was essentially a public expenditure problem. In particular ex­ penditures for defense and security reached 7.9 percent of GNP as compared with 4.8 percent in 1963/64. Whilst the rate of growth of public investment slackened it still increased by 19 p,ercent in 1968/69. This development led to a further 40 percent increase in the overall deficit to a level of Rls. 35.1 billion. At this level it represented 27 percent of government current revenue and 55 percent of public investment expenditure. 9. Earlier budget estimates for FY 1969/70 provided to the mission during September 1969, suggested a substantial improvement in the fiscal performance. The basis for these estimates was an anticipated rapid growth of government! revenue of 22 percent, which was estimated to surpass the rise of current e~pendi­ ture for the first time since 1965/66. Revised budget estimates which were received from the government in April 1970, indicate that the anticipated improve­ ments in the fiscal performance did not materialize. This was primarily due to a shortfall of oil revepue receipts of Rls. 3.8 billion and due to a sharp increase in military expendi ture$> Government revenue increased by 18 percent, down from the earlier estimate 'of 22 percent, and matched the increase in current expendi­ ture. Public, savings for 1969/70 are estimaued at Rls. 30.4 billion, an increase of about 17 percent' over t~e previous year which corresponds with the average growth of government savings since 1963/64. It must be noted, however, that the growth in revenue is due in part to an advance of oil payments of Rls. 6 billion by the Consortium. If this is treated, as it should be, as a capital item, public savings would'have declined by about 6 percent. By excluding the advance payment the increase of government revenue amounts to 13 percent and is far below the average growth of government revenue sinee 1963/64 as well as tne estimated g:.owth of current expenditures for 1969/70. With the emphasis which is being gi.ven to the development program, investment expenditures were stepped up by 22 percent over the 1968/69 level. As a consequence the overall deficit is estimated to be in the order of RJ.s. 43.8 billion,an increase of about 25 percent over the previous year.

~1e Level and Growth of Public ~xpenditure 10. It is apparent from the above year-by-year account, that the major problem of generating adequate funds for financing the development program is the rapid rate of growth of current expenditure.

(i) Defense Expenditure 11. The increase in expenditures for defense and security has been the main factor for this growth. The relative share of these services in total current e~enditures increased from 35 percent in 1963/64 to 47 percent in 1968/69 and 1969/70. 12. Table 4 presents the figures of expenditure on defense and security as derived from both the government's ordinary budget and from its development budget. Security embraces expenditure upon police, gendarmerie, administration of ,prisons, campaign against smuggling, etc. The figures exclude defense ex­ penditures financed directly out of foreign loans but includes the repayment of princ~pal and interest on such loans. In a period such as that sinne 1963A5~ when foreign borrowing for defense has been rising, this understates expendi­ tures for a given year. This understatement of defense expenditures in the budget depends on the difference b,ffjtween neW loans and debt service. It is Ii /' \, \\ - 6 -

reduced by the short terms of the borrowing, but is increased by the rise in annual defense expenditures. From 1967/68 to 1969/70 expenditure on "hard­ ware, etc." increased by over 60 percent; if the rise in foreign,borrowings :is equally fast, the understatement in the budget may be very considerable even if borrowing is for terms as short as four years.

Table 4

J, Govertuiiellt EXp~~lditures for National Defense and Securit In billions of Rials

Preliminary Budget Actual Estimate 196)/(>,4 1964/65 1965/66 1966/67 1967/68 196B769 1969/70 Ftan Ordinary Budget!/ 17.0 19.1 24.0 27.2 35.7 43.9 51.5 rrom Development Budget,gl 0.6 1.1 ,1.4 1.6 2.1 3.7 17,. 20:2 25.4 2B":'tJ 37.B 477b ~7.0

'~~jj "".~".".~,, '_1':;' y ~cluding eJqlenditures financed directly by utilization of e~terna1 loans, but including payment of principal and interest on sucb loans. 1/ Consists of e.tpend1tures for: construction and housing, CENTO microwave sys­ tem, naval port and part of the c~aign against illiteracy.

13,. Since 1965/66 the growth ofgove:mrnent eXpenditures was increasingly (fetermili-ed oy the sharp rise of defense outlays. 'While in 1966/67 growth in d~fense·and s'ecurity accounted for J 6 percent of the annual increment of cur­ rsnt expendi tures ~t is eXpected to be in the order of S 7 percent for 1969/70 (see Table 7) it '!'he only breakdown for this eXpenditure by object distin.. guishes expenditure in per-sonrtal from expenditure on military hardware and con­ :~truct10tl. '

!!..Etfens~ andSecur~tyExpenditure from Ordinarz Development Bupget .. gn,}>ersonnel andMilft~rY,Hardware, and, Construction tIn billion of Rials)

1965/66 IfJ6~/61 196.7/68 196~/69 1969/70 16.97 18.11 19.32 22.hl 24.81 'txpenditure on Hardware 7.07 ~.10 16.32 21.$b 26.75 'i Expenditure on Construc- tion; (Davelopllent Budget) 1 it 4 1.6 2.1 3.7 6.5

T 1'" 'SOUrce: Ordinary and Development attdgets - 7 -

It can be seen that the major increase in expenditure since 1965/66 has been in military hardware which increased three-fold up to 1968/69 and in construc­ tion which increased morle than two-fold. Estimates for FY 1969/70 show an • increase in construction expenditure by 75 percent and a rise in hardware by 25 percent. However, personnel expenditure itself has increased by over 10 percent per annum over the past four years.

Table 6

Total Military and Security Expenditures1/ in Relation 'to Relevant Economic Magnitudes (In percent) Preliminary Budget Actual Estimate 1963/64 1964/6.5 1965/66 1966/67 1967/68 1968/69 -r9b9~

fotalDefense Expendi- tures as perc ent of ' GNP (at market prices) 4.8 4.8 5.4 .5.9 6.8 7.9 (8.3~ In percent of Current Expendi tures 35.1 36.0 41.4 4.0.9 45.7 46.5 47.1 Proportion of total De- fense Expenditures to total current revenue 29.0 29.6 28.2 29.2 34.8

1/ Financed by Ordinary and Development Budgets. ~/ Based on a growth of GNP of 14.6 percent during 1969/70 3/ Current revenue for 1969/70 include an advance payment of Rls. 6 billion from - the Consortium. 14. The obvious question is whether a rate of increase in defense expenditure which is more than twice the rate of increase in GNP and which now represents around 8 percent of GNP can continue to be consistent with the development intentions of the government. It can be argued that it could certainly be made consistent providing there is a willingness on the part of the country or of the government to make the required sacrifices in other directions. In the past four years l.t is apparent that there has been an inadequate willing- ness or ability to.make the required sacrifices. The deterioration in the balance of payments situation is the most obvious reflection of this inade- quacy. As regards the government sector, expenditure on defense and on de­ velopment (including capital expenditure and current expenditure on social and economic services) ha~, risen by Rls. 95 billion as compared with a revenue increase (oil and non-oilr of Rls. 68 billion. Even i.f the balance of govern­ ment expenditures could have been cut it would have offered small relief since it accounts for less than 10 percent of total government expenditure. A markted increase in taxation over and above that achieved would have been re­ quired in order to reduce the pressure of demand which overflowed into the external s.ector. - 6 ..

~ Growth of Government Car.rent ~nditures bZ Hain Expenditure Catcgor:ie3· . . Annual G!"'OVth Bil1.ion .L"ln:.:a.l G."'C~li Billion Annual Growth Billion Billion Billion Annual Growth in Percent of :tials J.:mual G:'O~h i!' Fe:-~e::t c1 Rials Annual Growth in perceYlt of Rials Annual Growth Rials Rials Annual Growth in percent of Total G:'Ovth in Pe:-ce~t -:'eta.!. G:'-: .....-:~ 1967/68 in Percent Total Growth 1966/69 in Percent lli.U12 1965/66 1966/61 !!!.,Percent Total Grovth 23.6 100 120.9 18.1 100 100 62.7 11.3 100 102.4 Cu;'rent ~tures 61.30 70.50 15.Q Sala.""ies, Ilages and .lllovances 10.9 13.5 ~Gr :Je!'ens8 and Internal Seal- 10 22.41 16.0 16 24.85 18.11 6.7 12.S· 19.32 ': 6.1 :ri.t~ ?er30nne1 !! l.6:97 26.5 26.75 24.2 28.5 ~!l"'!3~~7· S:x:"'"renditU1"8S ~or 22 16.32 79.3 59 21..54 3?0 Ile!e::l=e a!ld Internal. Security ]I 7.01 9.10 28.1

~~n~t~93 for Defense and 16.0 8 6.50 75.7 15 I:;te~al SeC'.lrity incl;. in ~ 14.3 2 2.10 31.3 4 3.70 ~7e1~pcent Budiet 1.40 1.60

S;i:.a.-"I ... arld 'J.lloVllnCes ti~~.'3 fo~· 16 35.80 18.2 JJ ~.i.;li:n!-i93 {'!!hcl. Wens. and 1.6 1S 30.28 '¥ 13.6 J! li.1 21 26.65 r!l-:~::!:.a.l 5ecurity} ¥ 22.30 24.77

1ic;C-~7 7f~ditur~a.b7 8.49 6.1 3 ~s-';riesb(excl. Defense ~ 6.91 ll.6 6 8.00 15.8 5.5 ~t~al: Security} .. ~ 6.24 6.19 -0.8 ·-OS

~st~3&~tie~ and ~~rci&l r-o!'it l'~ of }t.inistri~s and +.53 62.8 J 3.40 12.2 10 237.~ 6 0.94 16.0 + Go~e.~~Dt lienelea 0.24 0.81

I:l:te~~ ?a:I:1~:lts on DoCl,ttStic 21.6 4 4.80 6.7 2 -).4.3 3.70 54.? - 11 4.50 a::d. :~!"9ig:l BorrovinJ 2.80 2.40 -4 10.1.\ -3.3 -2 3S 6.16 -10.1 -6 10.4S S4S 19 D--"E;!' Non-Defens~ Exp~ndit~ 4.28 7.52 7~.1

]I ~llation based onT~ ? in~ Annex. Including C?~ ~~se ~ security ~nditures ot;.t of the Ordinary: Bqet. 2/ Includ.es 0.3 billion t1als ~or the first phase oltha s.tat~ liIplo)'Mnt Lilf 11 Includes 3.0 b~n rials for St;r.te Enp1oy::itlOt Lalor. •

/ - 9-

(ii) Non-Defense Current Expenditure 15. The second determining factor in the growth of total expenditure was wages, salaries and allowances of ministries other than defense and security. As shown in Table 7, these expenditures accounted in 1966/67 for about 27 percent of the annual rise in current expenditures as compared to 18 percent in 1968/69. Estimates indicate that by 1969/70 expenditures for personnel, in­ cluding the proposed salary increase for civil servants will account for about 30 percent of the growth of current expenditures. From ~965/66 to 1968/69 the annual growth rate of personnel expenditures (other than military) was the highest in ministries associated with general services, whereas personnel expenditures in the Ministries of Health, Education, 1rlater 'and Power, Agricul­ ture and Higher Education gre't-T only moderately (see Annex, Table 3). 16. Under the State Employment Law a general increase in civil service salaries was enacted. The first phase of this Act was due to be implemented during 1968/69 but in fact increases totalling only nls. 300 million were in­ troduced as compared with an estimated cost of Rls. 2.3 billion. For the current year, the implementation of the second phase of the Act is budgeted to cost Rls. 3 billion. Aside from this general salary increase, it is esti­ mated that expenditures for non-military personnel will rise by only 9.4 per­ cent as compared with 10.4 percent over the past three yearsa Despite the rudimentary stage of many social and economic services, it is only in the }1inistries of Agriculture and Power that expenditures for personnel are esti­ mated to surpass the average growth since 1965/66.

17. The government's attempt to restrain the growth of expenditure during 1969/70 also finds· its reflection in the overall structure of total expenditures particularly in the growth of general services. Expenditures for de~ense and security are estimated to increase by over 19 percent and total ~nvestment expenditures of the Development Budget by 22 percent. However, the rate of increase of current expenditures on social and economic services is expected to markedly decline. They are estimated to grow by only 9 percent during 1969/70, as compared with about 12 percent from 1962/63 to 1967/68. The most pronounced decline is estimated to occur in the fields of health, education, transport and communication. The only sectors \vhich are estimated to expand beyond past rates of growth are agriculture, wate:P1 and pow'er.

180 Previous World Bank reports have emphasized that the expenditure policy of the Iranian government is in sharp contrast to many developing countries, where increlwes in current expenditures are caused by a great expansion in social and economic services rather than by defense and general services. Recent developments indicate the attempt to curtail expenditures for general services. In doing thiS, the Iranian authorities ehould ensure that incr~~ases on a selective basis for high priority purposes" i. e. tax ad­ ministration, are not undeSirably curtailed. - 10 -

Table 8 Growth of Current Expenditures 1962/63 - 1968/69 1969/70 Annual CQlDPound Annual Growth Rate of Growth over 1968/69

General Services 15.8 6.3 Defense and Security 20.5 19·7 Social and Economic Services 11.7 9.1 Education 9.1 7.7 Hygiene and Medical Care 16.9 5.9 Agriculture, Water and Power 4.5 20.5 Transportation and Communication 10.7 4.3 Others 26.0 11.9

19. The resource mobilization problem is undoubtedly as much, if not more, a problem of government expenditure growth as it is one of revenue gen­ eration. Nevertheless revenue grol-Tth, particularly from the non-oil sector, is very important. However, this is not only a question of the willingness of the government to take action in this regard -- though such l-ril1ingness is extremely important. There are also structural constraints on the govern­ ment's ability to take such action.

Government Revenues 20. Between 1963/64 and 1968/69 government revenues grew at an average rate of 16 perc ent per annum and reached about 25 percent of GNP by 1968/69. it was essentially tne buoyancy of oil revenue which ensured that this growth of revenue exceeded the growth of current expenditure.

21. Oil revenue increased annually by about 17 percent -- as compared with 1, percent for non-oil revenu.e -- thus raising its share in total cttr­ r,ent revenue fran about 46 percent in 1963/64 to 48 percent in 1968/69. F'or the current year" oil revenue is estimated at Rls. 80.2' billion, an i~crease of about, JO percent over previous years. This would r'aise its share in total revenue about 50 percent. 22. The Third Plan Law allocated to the development budget a share ot oil revenues, whi~h was to increase from 65 percent to 80 percent at the end of the Plan period. This latter percentage was retained tor the Fourth Plan, which started in 1968/69. This earmarking a.imed at putting a ceiling on the growth of current expenditures and constituted considerable moral pressure to reduce the deficit of the 'l'.reasury-General's Budget. Despite,tb1s pro­ vision, however, increasing portions ot, Plan Organization' oil revenues were: transferred to the ordinary budget untierthe guise' of financing "recurrent'" development expenditures. i.e. current· e:xpenditur'9S relating to conpleted in­ vestment projects (see .Annex, Table·'J it - 11 -

23. As regards non-oil taxation in 1968/69, it represented over 12 per- cent of non-oil GNP. However, the level of revenue from direct taxation is still relatively low, despite its rapid growth since 1965. In 1968/69 direct taxes accounted for less than 11 percent of total government reyenue .or 2.6 per- ---~_cren't 'or non-oiI"liNl". Table 9

Non-Oil Revenues as Percent of Non-Oil GNP at Market Pric es 1962/63 1963/64 1964/65 1965/66 1966/67 1967/68 1968/69 Non-Oil Revenues 9.4 10.1 9.2 9.7 12.0 11.L 12.5 Direct Taxes 1.5 1.8 1.6 2.0 2.2 2.2 2.6 Indirect Taxes 4.1 4.7 5.2 5.0 6.. 3 602 6.9 Improvements in the tax administ.ration and collection procedures since 1965/66 as well as the Direct Taxation Act of 1967 brought a buoyancy of revenues from direct taxes, primarily as the result of corporation taxes. Tax receipts from corporations more than doubled from 1965/66 to 1968/69 whereas revenues from taxes on salaries increased only moderately (see Annex, Table 4). For- the current year it is estimated that revenue from direct taxes will increase by Rls. 2.5 billion or 18 percent, thus falling short of the growth of 28 per­ cent during 1968/69.

24. The most important source of revenue other than oil is indirect taxes which have increased at an annual rate of about 19 percent since 1962/63. In 1968/69 this revenue amounted to about 7 percent of non-oil GNP. Import duties (including the commercial benefit tax and the registration fee on im­ ports) are the major source of indirect taxation and accounted for about 39 percent of non-oil revenue in 1968/69. With no substantial changes in the import tariff up to 1968/69, the annual increase of revenue from customs duties of about 17 percent is the result of a much faster growth of imports (21 percent annually). This disproportionate growth of in~orts and revenue Was due to the rising level of capital good and raw material imports with relatively low tariff rates. For the current year, the govel"nment estimates an increase of revenue from import duties by about 27 percent to a level of Rls. 32.7 billion. The only other indirect tax which shol-TS dynamism is th.e tax on petroleum and fuel, but despite its rapid growth its level is still smnIl. Other indirect t~tes in the form of sales taxes on cars, records and alcohol are of relatively minor importance.

25. Another important source of non-oil taxation is derived from reVenues from monopolies and other government agencies. In recent years these revenues had been very sluggish and their share in non-oil revenue declined from 2$ percent in 1962/63 to about 15 percent in 1968/69. This slotV' growth of revenue - 12 - in recent years is explained. by the fact that since 1965/66 only net profits are recorded as a reVEnue in the budget, Whereas previously gross receipts were entered into goverrunent revenue accounts. At the same time monopolies and govermnent agencies financed larger parts of their capital expenditures out ·of their own'resources, but also improved their cash position with the ibanking system. 26.. Undoubtedly the rates of direct taxation of people and companies can be increased and the basis for such an increase has been laid in the 1967 Act and in subsequent tightening of tax administration. However, experience suggests that it is at both lower and higher levels of development, than that reached by Iran, that direct taxation can provide the major contribution to the buoyancy of' tax revenues (revenues fran oil aside) • Thus it is indirect taxation which must be st~ed up to meet the combined resource needs of defeIl5e and d(evelopment. II. ]lIRECT TAXATION 27. Direct taxation in Iran consists predominantly of taxation assessed on income from work and from real and financial assets. Though there are in addition taxes assessed on the value of assets themselves, but these are no't, quantitatively important. Total direct taxes contrj.bute less than a quarter of non-oil revenues and represent only 2.6 percent on non-oil GNP. They have increased at around 18 percent per annum in recent years and during the past year they increased by 28 percent. It is this latter increase which is of special significanc~ because it can be attributed primarily to deliberate policy decisions to strengthen both the formal structure of the system of direct taxation and its administration. It is the willingness and ability to enact and to implement these new measures which ~epresent the clearest indi­ cation of the government's desire to develop its non-oil sources of tax re­ venue and to act accordingly. 28. The changes in the formal structure of direct taxation were embodied in the Direct Taxation Act 1967, which replaced the Iranian Income Tax Law of 1965 and its amendments. The new Act became effective in FY 1967-68 (FY 1968/69 for corporate taxation). The detailed provisions of the Act are not described here. Only its more significant elements are taken up for discus­ sion. Basically the Act changed the tax system from a system of schedular taxes to one lvhich compris es a glohCill progressi.ve tax on personal incomes and on independent structure of corporate and other business taxation.

29. As a result of these changes, it i~ hot possible to make a compre- hensive comparison between the previous and the new tax structures. In effect the Act changed the exemption limit, and the level of tax rates. Firstly, the exemption limit for wage and salary earners and for independent professional and businessmen has been raised from Rls. 48,000 to Rls. 60,000. Secondly, the average tax rates on personal income from wages and salaries are for every level of income lower than under the 1956 Act, with the largest reduction occurrring for very low income groups. And finally, the structure of personal income taxation for wage and salary earners has been changed in such a way that its progressiveness varies from ane range of incomes to another as compared with the 1956 tax structure. It should be noted that at higher levels of income, wages and salaries become relatively less important in total income, thus complicating a comparison of the progressiveness of the tax struc­ ture under a global tax system with that under a schedular system. 30. The coverage of the income tax has been extended so that for the first time it now includes government employees. At the same time private employees are subject to deduction of tax at source. This latter change is just one of several improvements which have been introduced into the adminis­ tration of the tax laws. - 14 -

3~,. The system by which legal entities (companies and registered part­ nerships) are taxed has been completely changed by the 1961 Act. A Corpora­ tion Tax of 10 percent is payable on total taxable profits. Distributed pro­ fits are then subject to a withholding tax of 15 percent ,and undistributed profits to income tax at the rate of 25 percent on undistributed profits up to Rls. 100 million (50 percent on those in excess of Rls. 100 million). Divi­ dends accruing to bearer shares are treated as undistributed proft ts for tax purposes.

32. These formal rates, however, ar~J effectively reduced by liberal de- preciation provisions and by a series of exemptions of which the most impor­ tant is the tax holiday. This varies in extent and duration according to the indus try and its location. The range is from 20 - 100 perc ent exemption and can be effective for five or ten years, but so fa~ the degree of selectivity introduced has been quite limited. Geographically the distinc tion has been made between the income derived by a finn from factories established in a radius of 120 kilometers from Teheran (no exemption), those established in Isfahan (50 percent exemption) ~md those established elsewhere (100 percent exemption). For factories in frontier areas the exemption is extended from S to 10 years. The industrial requira.ent is applied as a secondary criterion to the geographical requirement and is simply administered negatively in that all firms are given 100 percent exemption if they are beyond 120 kilometers of Teheran providing they are not producing the following consumer goods and services -- alcoholic and non-alcoholic beverages, ice, chewing gum, tea, cos­ metics, furniture, matches, covers and furnishings, venetian blinds, stone­ cutting, ceramics, painting, playing cards, rackets, carpet-cleaning, dry cleaning, car .service, electric appliance repair, film making and decoration. Finns are also given a five-year exemption in respect of those profj.ts attri­ buted to non-traditional exports (i. e. excluding oil, sulphur, cavtar, chemical fertilizer, carpet, wood, marble, ore and clay). 33. Q,ne other major concession exempts from taxation those profits re- served for expanding or developing a firm's existing capacity or for estab­ lishing completely new capacity (providing it is not in the non-priority sec­ tors referred to in 'the previous paragraph). After 1972, however, this con­ cession will "only be granted on tWQ conditions. Firstly, that the firm's shares are accepted by the Acceptance Board for transactions in the Stock Exchange and secondly, on condition that its entire share capital is in registered shares, that there are at least 100 shareholders and that no single shareholder owns more than 10 percent of the total equity. Satisfying the listing require­ ments of the stock exchange is further encouraged by a 15 percent deduction from taxable prof~ts in computing tax liability and by completely exempting capital gains derived from stock exchange transactions fr~ taxation. Also PQJment of the 10 percent corporation tax is excused where the requirements relating tQ share ownership (second condition above) are met. 34. The concessions granted to companies and to other legal entities raise the same problem in Iran as in many other developing countries. On the one hand,there seans to be little or no knowledge regarding the cost of the - 1, - concessions either individually or in total, in terms of foregone government. revenues. On the other hand, there is a lack of knowledge regarding the need for the concessions and their effectiveness in meeting these needs as compared with other policy instruments. The concessions certainly are 1avish,but it must be remembered that a tax holid~ firstly benefits a firm in its early years when its profitability is likely to be low and that the existence of the holiday in effect makes all the other concessions otiose. Furthermore, in the case of depreciation provisions, any concessionar,y elements which they might include are made less effective firstly by the tax holiday itself which in effect reduces their value for firms benefitting from the lloliday not merely to zero,but to a negative figure in view of the smaller depreciation reduction in subsequent years when profits become taxable. Secondly, however, a three­ year limit on the carry-forward of losses might also reduce tileir effectiveness. 35. The justification for the concessions must derive either from con- side:rations of private incentives or ot availability of private funds. It can certainly be questione~whether additional incentives are required to induce a higher level of investment in private industry in a country in which indus­ trial profit rates are as high as they are reputed to be in Iran. Of course the major concession -- the tax holiday -- is limited to firms established outside of Teheran. It"7 be the ease that there is a marked in- crease in private costs as a consequence of this location policy which might be thought to justify this selective treatment·. Certainly the government has deemed it necessary to introduce an administrative control which prohibits further industrial development in Teheran. In so doing the need for the tax concession as an incentive device is made irrelevant unless the't'e is evidence that in the absence of the concession investment would be so unprofitable out­ side of Teheran that it would not be undertaken at all. 36. Perhaps of more crucial importance is the five year tax exemption on profits attributed to non-traditional exports. This exemption is of course inoperative if the firm is recently established and therefore benefitting from the overall tax holiday. When it does become operative,it is calculated on the basis of the profits attributed to exports by assigning variable costs to the exported output and a proportionate share of overhead costs. If, therefore, export possibilities are taken up by firms on the basis of their profitability lUlder some, however crude, system of' marginal cost pricing, the export concession would not be calculated on the actual profits generate~ but on a lower figure which might very plausibly be zero. To the extent that the exemption does become operative, of course, it does alter the relative effective profitability of foreign as aga~r8t domestic markets. The consession, hOvlever, is of very limited importance, if Set-egainst the preferences given under the present system of customs duties and quantitative import controls for import-saving industrial development. These preferences not only increase the cos ts of exports, but also fail to reflect the implied value of foreign exchange in their gross revenues. 1hus a much more effective system of sub­ sidies would be required in order to deal with the present discrimination against exports. - 16 -

37. In addition, however, to providing incentives, tax concessions also provide additional funds to firms for the internal financing of their opera­ tions. If the supply of funds external to the finn is inadequate, then tax concessions are a means of compensating fin~ls for this inadequacy and particu­ larly for any inadequacy of equity funds. The legal provision,which exempts from taxation funds earmarked for financing investmen~is obviously the most relevant tax concession in this connection, though all the concessions achieve in. effect the same obj ective. It would seem difficult on the basis of super­ ficial observation to justify the concessions on these grounds. The IMDBI is the source of virtually all the long-term funds for the private industrial sector and claims that availability of funds is no constraint on its lending operations. This matter is taken up more fully in a later section, but it is relevant to note here that to the present all the domestic borrowing of IMDBI has been out of government funds and thus "availability" raises the whole fiscal problem ill Iran and the role of IMDBI in mobilizing its own private domestic loan resources. Short ten. funds are available from the commercial banks which have been building up their resources very rapidly in recent years. As regards the availability of equity funds in particular as opposed to capi­ tal funds in general, this would seem to be a problem of demand rather than of supply. There is no difficulty in selling ordinary shares,if they come on to the market; the difficulty on the contrary is to induce firms to make such opportunities available when a high gearing gives such high returns to ordi­ nary shares. By encouraging self-financing through tax concessions, firms are discouraged still further from widening their shareholding base. However, after 1972 the re-investment tax concession is made dependent on a company quoting its shares on the stock exchange and widening its ownership.

38. One much wider aspect of this problem of the level and pattern of corporate taxation is the question of the incremental use of funds by the government. The marginal rate of savings by companies and dividends' receivers is "quite high" though we have no ,,(lay of knowing "how high". It is of course unlikely to be 100 percent and thus if it could be assumed that by increasing the effective level of taxation of profits, government savings would be in­ creased by the full amount of the additional revenue it receives, then total national sa.ving~ would be increased. Leaving aside the problen~ of the dis­ tribution of national savings between private and public sectors this increase could be judged to be desirable. The magnitude of any possible increase should not, of cours.e, be exaggerated. Revenue from private companies is running at about Rls. 3 billion per annum and thus a rise in the effective tax rate upon them by one-third would only generate Rls. I billion of additional revenue. This is equivalent to about 3 percent of public savings,but if it is offset by the effect of, say, a ,0 percent marginal private saving rate, then the net increase in national savings would only be Rls. 0.5 billion. Moreover, even this figure would have to be reduced to the extent that the government's mar·· ginal savings rate is less than 100 per.cent. 39. What these illustrative figures indicate is that there are costs involved in pushing up the effective rate of taxation on companies -- and on - 17 - the economy in general -- which must be considered (and ,frequently are not) when deciding on the desirability of such increases. These costs will, quite obviously, be mor~ worth incurring the greater is the assurance that the government's use of incremental revenues will be highly beneficial to the economy. 40. The above comments on the level and structure of tax concessions in Iran, on the cost of raising the effective rate of tax on companies, etc., must of necessity be highly tentative. Our knowledge. of the financial posi­ tion of firms in different industries, different regions, different markets (e.g., e~orts v.s. domestic), etc., is restricted to limited observations and a priori reasonu1g. Likewis~little or nothing is known of the impact of the concessions on the level and growth of government revenue in general and their impact on particular groups of firms in particular. All these are matters to which the Iranian authorities in the Plan Organization, IMDBI, the Ministry of Finance should be alerted: - 18 -

Summary

T'axation of Legal Entities (Companies and Registered Partners;~~ps) 1'., Taxes on Profi.ts'

A. Corporation Tax on Total Taxable Profits -- 10 peJrcent B. Withholding Tax on Distributed Profi ~ -- 15 percf~nt c. Income Tax on Undistributed Profits I. 25 percent on undistributed profits up to Rls. 100 million 2. 50 percent on those in excess of Rls. 1100 million. Dividends accruing to bearer shares are' treated as undistributed profits.

II... Exemptions

A. Tax Holiday, extent and duration vary with:

1. Geographical location -- factories est;ablished: a. In a radius of 120 lan. of Teher1an -- no exemption b. In Isfahan -- 50 perc ent exernp1Gion c. Elsewhere -- 100 percent exemp't,ion

2. Type of Industry

a. It nQt producing' listed conmmler goods and services: and located beyond 1.~10 km. of Teheran -- 100 percent exernpt~~on. (e.g." alcoholic and non""!alcoholic b~~verages, t~ e, chewing gum, tea", cosmei;ica, ~ru,rniture, matches, covers and furnishin~~s, venetiaJ'l blinds, stone-cutting, ceralPij~s, painting, playing cards, r~ckets, came;~cle.an:i.lJg, dry cleaning" C::ir se"ice, ell~ct~ic ap~ pliance J;"epair, film mak:~ng a~tKl de.cora.,t~()n)~, b. Profita on non-tr~(ij. t.iOI1A~ eXfl~ort,~ ~.~ five"'! year exemption (i. e." e~~lqding oil., sulphul', caviar, chem~cal fertil:i.~~er, ci).rpets, l'lood, marble, ore and clay).

B. Exanptions dependent upon Stock Exchange""!l~tsting and Share Ownership Re~irements

1. If a. fin,.'s falu1r~ are aceEPt~! by the A~QeptapQQ :fJQ.~r4 for traneactions in the ~tock :EJJchAllge theJ;'e :i~; - 19 -

a. 15 percent deduction from taxable income in computing tax liability b. Complete exemption from taxation of capital gains derived from stock exchange transactions 2. If there are at least 100 shareholders, and no single shareholder owns more than 10 percent of total equity (providing its entire share capital is in registered shares), the firm is excused from 10 percent corpora­ tion tax. c. Profits for Expanding or Developing Existing Capacity or Establishing Completely New Capacity (if not in non-priority sectors listed in A.2(a) -- exempted from taxation; after 1972, this concession granted only if conditions 1 and 2 above are met. III. INDIRECT TAXATION

41. The previous section has commented upon some of the issues raised by the 1961 Act in relation to direct taxation. The emphasis given in that section to some of the problems created by the 1967 measures should not hide the fact that the Act and its accompanying administrative reforms represent a major policy decision, ~,Jhich brio. the system into line with the develop- ment of the eco~omy and particularly its industrial development. '!his requires emphasis, because it is in marked contrast to the lack of action in relation to the structure of indirect taxation. To anticipate the conclusion of this section: if revenue growth is to be maintained or increased, vlhilst at the same time it is to' be consistent with the allocative needs of a rapidly de­ veloping economy, then the Iranian authorities must next turn their attention to the structure and level of indirect taxation.

42'. It has to be clearly recognized that the resource allocation prob­ lens. which must be d:onsidered when studying indirect tax policy, are at least as important as its revenue-raising aspects. TIlis is, of course, to some ex­ tent true of direct tay..ation policy as well. Income tax concessions to those investing in certain~ industries, to those exporting part of their output etc., also affect, and are" intended to affect, the allocation of resources in the economy between alte'rnative uses. However, in the case of direct taxation tfi'ere is typically d,ne structure of rates for all income receipts. Special rates are then de'sig~ed to encourage: or to discourage particular uses of resources which are explicitly selected by the government for this exceptional treatment.

4.3". The situat, ion regarding indirec t taxatiort, is typically the exact reverse: of this. Irtcome when it is' spent is subject to an array of tax rates based on the nature of the commodity or service purchased. There is to be­ gin with the distinction between expenditure on imported goods and services and that on domestic goods and services. Then within each of these two cate­ gories each commodit,y and frequently varieties of each commodity "tiil1 be assigned a special fiate of tax. Thus the effect of indirect taxation upon tIl-e allocation of refsoUrces is likely to be much more significant than in. the case of direct taxatlion. FUrthermore, these allocative effects 'trill be the greater, the greater' is the range of indirect tax rates which exists.

44. These two general sets of considerations, i .• e., the revenue and the al1oc~tive aspects, are particularly relevant in the case of Iran. Indirect ~axes are now reSpor.lSible for about 55 percent of total gov~~''l1ment non-oil reVenue and this prc!portion has continuously increased since the early 1960' s, when it represented leSS than 45 percent of non-oil revenue. This growing relative importance of indirect taxation is not apparent if revenues from gOvermnent mOi'lopoliE~s and other government agencies are included in indirect taxation. If this is done then indirect taxation has remained ata fairly constant 10 percent' of total non-oil revenues due to the small absolute in­ crease in thes e agellCY revenuefJ" In particular revenue from the tobacco - 21 -

monopoly (which accounts for around half the total) fell between 1964165 and 1967/68, and by 1968 had simply increased to its 1962/63 level., The com­ parison of revenues derived from government monopolies and agencies is vi­ tiated by the change in budgetary accounting of these revenues referred to in para. 25 above .. 45. Indirect taxation in Iran means predominantly customs duties (in- cluding the commercial benefit tax and the registration duty on imports). In 1968/69 customs duties generated PJ.s. 25.8 billion which represented about 20 pe:rcent of total government revenue, 39 percent of non-oil revenue and 70 per­ cent of indirect tax revenue. Leaving aside the registration duty which only accountt3 for Rls. 3c.6 billion of revenue, customs duty revenue is generated from a comolex set of custom duty rates to which is added on equally complex structure ~f commercial benefit tax rates.l/ The rates are predominantly speci­ fic duties and consequently it is difficult to establish the ad valorem equi­ valent in many cases. It is apparent, however, that the range of rates is very wide. A list of the ad valorem rates given in Table' 7 of the Annex illus­ trates this fact.

46. Customs diivi~~ are .re~arded predominantly as a revenue device. Equipment for factories and for farms are subject to low rates of tax. The high rates of tax are imposed on luxuries (wooden furniture, eyelash curlers, automobiles, gramaphones, baby-carriages, etc.), though there appears no relation­ ship between the rate of tax and the degree of "luxury" (e.g. watches are taxed at only between 30 and 50 percent and photographic apparatus at 40 percent).~/

Y Commercial benefit taxes are similar to tariffs except that they may be imposed or changed without legislative action. ~/ As an aSide, it can be noted that along with customs schedules the w6rld over, there are some "'oddities" in the Iran schedule which superficially defy explana­ tion by these generalizations and raise one's curiosity. Why, for instance, a 50 percent duty tax on string and wind musical instruments but a 100 percent duty on percussion instruments? Why should equipment for tennis be completely exempt from duty whilst other sports equipment is subject to a 100 percent duty and children's games to 200 percent and their import at the moment is in fact banned? It is very difficult ir.~~ed to see what social, economic or even political purpose is served by this selective treatment particularly when the degree of selectivity is so stark. - 22 -

47. Revenue generation as the basic aim of the customs schedule can be readily accepted as making good sense in a pre-industrial stage of develop­ ment. In effect under these conditions customs duties are a virtually iden­ tical alternative to sales and exci.se taxation and certainly much easier and, therefore,cheaper to administer. Once a country starts to develop indus­ trially, duties which were designed entirely for revenue purposes take on a px'otective role. Whilst this role might initially be unintended, interest groups rapidly spring to the defense of the previous structure irrespectjve of whether or not it is consistent with the objectives of industrial policy as opposed to revenue policy. 4e. That this consistency is not evident in Iran is the conclusion of a r~p~nt Bank study of industrialization of Iran. The study finds tha.t the level and structure of the present customs duties are running counter to th e govern­ ment's attempt to deepen the industrial structure by establishing resource­ based industries producing intermediate products domestically as well as in­ dustries producing capital goods. In addition it concludes that the protec­ tive structure runs counter to the development of non-traditional export in­ dustries. In tenDs of' policy conclusions, whilst the study indicates that there is a range of options which are open to the government, it argues that the government should aim at a simpler and more uniform structure of duties With clearly deflned objectives. '.lhese duties should be complemented by a structure of e:xport subsidies.

49. The government would need to recognize the broad implications of the above for its fiscal activities. In effect the government has been obtaining it$ domestic tax revenue firstly from oil and secondly from syphoning off through custans duties some of the premium attached to imported goods over and above their C.I.F ~ value at the existing exchange rate. Those who earn for­ eign exchange from non~oil exports have not been permitted to reap the bene­ fit from this premium. This is, of course, a general phenomenon in develop­ ing countries with traditional exports which provided adequate foreign ex­ change earnings until the process of economic development generated rapidly increasing inport demands. In the short.... run it is possible for governments to use the premium' on imports for financing its own activ1ties,but in the longer run it ~ be detrimental to the exploitation of those non-traditional exports for which both the supply' and demand elasticities are reasonably hign. If the more favorable, short run revenue position has led the government into non-development expenditure obligations which .it camot sustain at the stage at Which it recognizes that non-traditional export earnings must be stimulated by. price-cum-profit measures, then one of the implications of the new situa­ tion is that its eXpenditure obligations must be. revis ed., o ,0. In addition the government must recognize\'; the implications of the above prOblem for policy in relation, to indirect taxation. Leaving aside tor tJie manent questions of tax. administration, what is required in principle is a structure of sales taxation and of eXCise duties which falls equally upon a commodity, whether it be imported at produced danest1cally, supplement..ed if need - 23-

be.by a uniform rate of customs duty on all imported goods. However, there might be particular reasons for giving pZtotection to certain industries, but these should be clearly defined and also administered in a disciplined manner. In this way the tevenue needs' of the country would be met with no undesirable allocative effects. Discrimination between commodities would, of course, still be justified on grounds of equity considerations -- presumably luxury goods should be taxed more he~vi11 than necessities -- but the pattern of discrimination at present against-particular imported good~which means that domestic suppliers ~re encouraged in practice to produce consumer goods rather than intermediate and capital goods, would disappea~. 51. In fact in Iran at the moment the taxation of domestic output is virtually limited to the taxation of petroleum and fuel (Rls. 6.8 billion of revenue in 1968/69), the tobacco monopoly (Rls. 4.6 billion), communications radio and T.V. (Rls. 1.4 billion), industrial alcohol and alcoholic compounds (Rls. 1.2 billion), a tax on the domestic output of cars (Rls. 0,1.5 billion) and on domestically produced music records (Rls. 0.02 billion). Almost the whole of domestic industrial output is exempt frcm indirect taxation quite apart from the growing output of consumer services. 52. There is, therefore, a stark gap between the "optimum" structure of indirect taxation (optimum being thought of one which ensures a more effi­ cient allocation) which is relevant to a developing industrial country such as Iran and the structure as it exists at present. However, it must be pointed out that bridging this, gap may not bring in large additional net tax revenues, because the predominance of small scale enterprises in the area of industry and trade would necessarily imply a very high cost of collection of such revenues. Thus, in moving towards a structure of indirect taxation which is more in keeping with the development of the economy, the government must continually be weighing up its impact on resource allocation as opposed to its impact on tax revenues. Two sets of general considerations are of immediate relevance in this regard.

53. Firstl~ is the question of the administrative capacity to introduce a system of sales and excise taxation on both imported and domestic output. Customs duties may have many shortcomings for an economically developing coun­ try, but they are at least likely to be consistent with its stage of administra·· tive development. Only a detailed study could determine to what extent a system of sales ~nd excise taxes would be constraint in practice. At one ex­ treme there are industries with only one or a few producers and wholesale distributors or, as in the case of automobiles, where purchasers must register their purchases. In these cases the administrative difficulties are, it would seem, little more onerous than in the case of customs duties. This would, for instance, certainly appear to be true for most durable goods manufacture ... - e.g., refrigerators, washing machines,. etc. At the other extreme there are industries with numerous producers and distribution outlets and in which no effective licensing of productive capacity exist. In these cases it would obviously be foolish to permit tax policy to run ahead of tax administrative - 24 - capacity. The dividing line between these extremes would be a matter of judg­ ment. Furthermore, it is a dividing line that would move progressively over time as administrative changes being enforced under the Di.rect Taxation Act 1967, and the needs for developing the administrative capacity to introduce and extend the structure of indirect taxation, should be examined in order to ensure that the possibilities for their acting in a mutually reinforcing man­ ner can be fully eXploited. 54. The second general consideration that should determine the extent to which the government could move to a more comprehensive structure of indirect taxatio~which covers domestic output as well as imports, is a quantitative one. This is the extent to which misallocations of resources occur as a re­ sult of the present system. Essentially the misallocation is said to result from the fact that the domestic production of consumer goods, subject to high rates of customs dutie~will attract an excessive volume of resources to pro­ duce import substitutes under highly profitable conditions. At the same time, other domestic production would be starved of resources due to the more pro­ fitable opportunities elsewhere. The extent of the first of these misalloca­ tions might, in some cases, be quite small. This will be the case where a par­ ticular consumer good is subject to both highly inelastic demand and domestic supply conditions. TIle danger here is that these conditions might hold in the short run and be the basis of tax policy decisions, but they become distinctly unrealistic after a few years. Substitute commodities become far more accep­ table to consumers in the longer run and certainly the ability of a country to produce both a particular commodity, but more particularly, its substitutes increases over time. 55. As regards the problem of the unduly low allocation of resources to those sectors wi·th low protection and where, therefore, profitability is low (i.e., intennediate and capital ,goodS industries), it has to be recognized that adequate investment and production might nevertheless be undertaken par­ ticularly by the government itself. This is undoubtedly what is occuring in Iran where government itself is undertaking the development of the steel indus­ try, machine tool industry, petro-chemical, and other basic industries. Whether this is desirable raises wide issues of industrial policy. Certainly any ten­ dency on the part of public sector investors to ignore the structure of inter­ national prie'eis in making their decisioDS would itself lead to misallocations of resources. There is the additional danger that this might be obscured behind administrative controls over imports rather than behind tariff protection. fur­ thermore, the private sector might be investing in sectors where protection is at present non-existent or low, but where there is a clear understanding that protection will be granted in the future. 56. There is concern among Iranian authorities about a possible rise in prices as a result of the imposition of a system of indirect taxes and the impact these taxes would have in the short-run on act:i.vity in the rnanufact~ring sector. Following a four-year period of substantial price stability, the price level as measured by both the wholesale and cost,.;. of-living indio es, started to rise during 1969 and was, in March 1970, 3.4 percent and 3.6 percent, respectively, higher than one year earlier. Since the basket and weights of the cost-of-living index i8 out of date, the price movement may even be underestimated. The inorease in wholesale prices during 1969170, was to a large extent due to a rise in prices of construe tion materials and importijd goods reflecting higher international prices and the increase in import dUties at the beginning of the year. The rise of the cost-or-liVing index was nearly errtlrelygenerated by a ri,se in food prices which - 25 - determine nearly 75 percent of this index. The government is well aware that the direct impact on the cost-of-living index of the imposition of in­ direct taxes on some manufactured consumer goods would not be perceptible, because the weighting accorded these goods is extremely small. There is, however, concern that a price rise due to an extension of indirect taxa­ tion could be used as the occasion for mo»e widespread price increases. However, there is no common agreement on this issue and in the opinion of some officials such a price rise must not be passed on to the consumer, but could be absorbed by manufacturers in lower profit rates. 57. So far in this section the emphasis has been on the need to develop the structure of indirect taxation to deal not only with the government's need for revenu~but also with the needs of a rapidly developing industrial sector. There are, however, issues of indirect ta~ policy which do not give rise to problems in relation to import-export policy and industrial policy. In par­ ticular, as in many other countries, there are in Iran instanc es in which a deficiency of supply in relation to demand at an administratively controlled price comes to be reflected in a market premium over and above the controlled price. The receipt of such premium rarely serves any apparent economic or social purpose and if it is considered that for some reason the controlled price should not be increased, there are strong! priori reasons for the govern­ ment to syphon off these scarcity rents in the form of a tax. 58. There is'one obvious instance of this in Iran. This is in the sup- ply of telephone service. Demanders not at present receiving telephone ser­ vice are widely known to be paying high premia unofficially to those fortunate enough to have received the priviledge of service. The situation has existed for a long time and shows no signs of ending given the intended level of in­ vestment. There are, of course, reasons for questioning the actual pricing and investment policy when this situation exists. It would seem desirable either to formally raise the official price or to impose a much higher excise duty than at present on telephone service. ,9. A similar, but not identical, situation arises in the case of road user charges. The Iranian authorities are, in fact, a;lready considering rais­ ing additional revenues through increased road user charges. Such an increase is certainly called for in the case of the congested road network. This is relevant to Teheran and perhaps to other urban areas in the country. Not only are decisions urgent in relation to the nature and level of investment in the urban transport netN()rk (e. g., roads as aga.inst public transport), but in addi­ tion the charges made to the public must reflect the costs of supplying them with transport services including the congestion costs. In the case of the inter-urban road network, the case for raising additional revenues from road users would appear to be less obvious. Having invested in improved roads, it makes little sense to restrict their use unless there is widespread congestion on the roads. Of course, the variable maintenance costs of road use should be levied. In addition, if the demand for road use is highly inelastic then it will, on the basis of general considerations, represent a good tax base. The general point remains, however, that the authorities should clearly distinguish between increased charges for the use of congested highways and for the use of non-congested roads. - 26 ....

Summary

60. To summarize this section, we can say that indirect taxation in Iran has to the present reflected the pre-industrialization stage of the country's history. As such the emphasis has been upon customs duties for revenue purposes. Attention must now be devoted to the problEift of making the pattern and level of duties consistent with the industrial development policy of the country. This must be undertaken in a manner which provides for a growing level of revenue needs. To achieve these allocative and revenue objectives, not only must sales and excise taxes be developed in respect of domestically produced industrial goods, but in addition the whole structure of indirect taxation on domestic services must be examined including the related problem of utiiity pricing. IV. PRIVATE SAVINGS MOBILIZATION 61. In Iran, more so than in most developing countries, several of the factors which are generally considered to have a favorable effect upon private savings have simultaneously been at work over the past years. (i) Real national income has been rising rapidly at an annual average rate of growth of 8.1 percent over the period 1962 to 1967 with real per capita income rising at 5.2 percent over the same time. (1i) The distribution of incremental income has been reflected in particular in very high rates of profit in industry. (iii) The level of taxation has been low and has even been reduced in respect of certain income groups since the passage of the 1967 Direct Tax Act. This Act also gave concessions to companies in respect of ploughed­ back profits.

(iv) Finally, Iran has experienced almost complete price stability for many years. This has meant that nominal returns on savings have also been reflected in near-identical returns in real tems as canpared with many other developing countries where positive nominal rates obscure the fact that real rates are negative.

(:Q.. Despite these favorable conditions, the ratio of private savings to GNP showed no marked change over time.11 Yet, the ratio of total deposits to GNP increased sharply from 15.9 percent in 1963 to 22.8 percent in 1968. Table 10

!i,?neY2 Dqposits and Private Savinss - in percent - 196) 1964 1965 1966 1967 1968 M/GNP 1).2 13.2 12.8 13.7 13.9 14.0 D'/GNP 15.9 16.7 17.1 19.1 20.5 22.8 Private Savings/GNP !I 9.2 13.4 12.7 10.5 11.3 10.S

"rt DIM 66.) 71.2 75.0 80.7 87.2 101.2 ..6D/private Saving 10.7 11.4 16.9 21.3 )1.2

M = Money supply comprises coins, currency and sight deposits D = Savings and time deposits D' = Total deposits include sight, savings and time deposits !l Although estimates of private savings are deficient (see Main Report, toot­ no·te on p. 15), it is unlikely that more reliable estimates would change the trend. " - 28 -

At the same time, .the ratio of money to GNP remained nearly unchanged, thus indicating no significant change in the velocity of money.

63. At first glance the developm:p..nt of private savings seems to con- tradict the development of bank deposits. The ratio of deposits to money and the ratio of the change in deposits to private savings increased from 1963 to 1968. Thus an increased monetization of the Iranian economy Was furthered by a growing strength of the banking sector. Although the ratio of private savings to GNP stagnated over time, the ratio of the change in deposi ts to private savings indicates a shift from non-financial assets into financial assets.

64. It is the growth of the ratio of total deposits to GNP which is the clearest reflection of the monetization of the economy and of the willingness of people to hold thei:- savings in the form of financial assets.

Table 11

Currency HOldings and D~osits of the Private Sector with Commercial and Specialized Banks Uns. billion}

Coins & Sight Saving & Time Total Deposit· to Currencl D~osits D~osits D~osits GNP GNP Ratio~%2

1963 22.6 26.4 32.S S8.9 )70.) 15.9 1964 24.1 29.8 38.4 68.2 LoS. 8 16.7 1965' 25.4 3b.9 h5.2 80.1 469.5 17.1 1966 ;~7 .4 39.4 5).9 9).) .489.1 19.1 1961 )0.8 46.3 67.2 l13.S 553.9 20.5 1968 )2.6 53.8 87.4 141.2 618.4" 22.8

Not only does th~, growth ot bank deposits refiect the willingness of the private sector to hold a growing proportion ot its savings in financial form, it refiects in addition the tact that the institutional means for mobilizing these savings have been devel~ed very rapidly. As the following table shows" the number· of bank branches has increased. very rapidly (SO perc ent from 1966 to 1967). In tact the rate of g~ particularly of branches of private banks is quite alanning in tema of its probable implications for bank costs (68 percent from 1966 tQ 1967). Such a rise of costs might be nee essary at this stage ot banking development in Iran particularly as banking pushes out into the rural areas. It could, however, reflect an undesirable proliferation bt branches resultiDs fro- the tact that 'be.. are unable to c~ete for deposita through interest rat. pol.1c)' and do 80 ~tead through cost-raising 8erv~ces. These are matters whiCh require further tnv8stisation. - 29 -

Table 12 Growth of Bank Branches and Their Distribution

Grand Total Private B09.nks State Banks Foreign Banks WO:-of NO. of No. of No. of B:t:'anches L Branches L Branches ~--- Branches L 196) J.,354 824 529 1 196L 1,518 +12.1 886 +7.5 631 +19.3 1 1965 1,847 +21.7 1,111 +25.4 735 +16.5 1 1966 2,275 +23.2 1,443 +29.9 831 +13.1 1 1967 .3,407 +49.8 2,429 +68.3 977 +17.6 1 1963-67 +151.6 +194.8 +84.7 1 65. There is considerable controversy in Iran regarding the role played by in+;Drest. l'ate policy and by "gimmicks" such as lottery benefits ~in stimu- 1atiEg deposit gro~lth. Many bankers argue that the lottery together with branch expansion have been the crucial attractions to depositor~ but others argue that lotteries have simply led to a redistribution of deposits between bank~ with little or no impact on total savings. Likewis~the rate of interest is regarded by some as central to the question of overall d~osit mobilization and by otber§ as y~rtual1y irrelevant. Interest rates on.d~osi~s have been raised twice since 1968 (see Annex, Table 6). The first of these changes (in September 1968) could be claimed to be associated ~ith the marked increase in time and savings deposits which took place in the first quater of 1969 -- i.e., with a lag of about three months or so. In September 1969, the Central Bank took a s~cond step to adjust the interest rate structure to a more realistic level by raising the rediscount rate from 7 percent to 8 percent andincreasing the interest rate on saving deposits from ~ to ~ percent and on time deposits up to a maximum of B percent. This upward revision of the structure of interest rates was primarily designed to increase the mobilization of savings in the form of bank deposits whether those higher interest rates brought a genuine increase in bank savings or resulted in a shift of funds from cash and demand deposits to saiings and time deposits will need further examination. This is a policy issue of great importance for Iran and, therefore, such as examination should be given priority.

66. The growth of bank deposits in the Iranian economy is particularly important in view of the fact that there are virtually no other means of small savings mobilization. There are no post office savings schemes and very little life insurance. The latter can be explained-in part by What appears to be a very sound and expanding govermnent systEJIJ of social insurance administered by the Workers Social Insurance Organization. This has the very unusual feature of deriving its revenue completely from employer and employee contributions (13 percent and 5 percent of salary, respectively) with no gover.nment contribu­ tion whatsoever. - )0 -

67. The Iranian authorities a~e taking active measures to develop al­ ternative outlets for financial savings through the establishment of a stock exchange, the granting of tax exemptions to companies which spread their ownership more widely, etc. They are at the moment actively considering with the assistance of I.F.e. the establishment of an investment trust. All these measures must be seen as influencing the development of the pattern and level of financial asset holding in the longer run.

68. The major gap j~h both the development of the financial institutions and instruments in Iran is in regard to the development of a market for medium and longer term fixed interest securities. There are very few financial assets competitive in terms of yield, liquidity and security which savers can hold and which lie between money and near money at the one extreme and equities (if they are made.available on the markets), land and overseas asset holding at the other extreme. The absence of such primary securities in this range, furthennore, makes it difficult for financial intermediaries such as life insuranc e companies to develop. Their need is for a balanced portfolio which matches their liabilities.

69. Central to the development of a market for fixed interest securities is government policy in relation to internal publi.c debt. To the present this has been based on considerations of minimizing the budgetary cost of the debt with the result that funds have been derived predominantly from the banking system. Time and savings deposits have carried both a higher interest rate and a higher liquidity so that non-captive investors have had no incentive to lend directly to the government.. Recognizing this deficiency, the Central Bank started to issue for the first time government bonds in November 1969. The terms offered on these bonds are very attractive since they are tax-exempt and yield 61 percent interest for one year bonds and 9 percent interest for two year bpnds. The two reasons which led to the issuance of government bonds Was, firstly, to rollover funds previously held in treasury bills and secondly, to mobilize funds from the private sector .for public sector dev~lop­ ment expenditures and in so doing to foster the development of a capital market in Iran.

70. If the development of financial intermediation and of the financial system generally is to keep pace with the development of the "real" economy, public debt policy should be examined. This applies not only to government debt as suc~but 3lsoto the role to be played in this r~gard by other public or semc)"public institutions in Iran. Included in such an examination should be the role of IMDBI which at the manent receives all its danestic loan f-unds from the development budget. Obviously there would be important financial implications to any changes in policy in regard to the source of domestic funds for IMDBI. These would have to be weighed against any desirable wider impact which such changes ~~'.have.

~conomic~ Department 4u.gust 31, 1970 ANNEX

STATISTICAL TABLES

1. Central Government Current Expenditures 2. Total Current Expenditures and Expenditures for Salaries, Wages and Allowances by Ministries and Affiliated Organizations

3. Growth of Expenditures for Salary, Wages and Allowances by Ministries 4. Summary of Government Revenue

5. Distribution of Oil Revenue Between Plan Organization and Ordinary Budget 6. Interest Rates on Savings Accounts (1959-68) 7. Ad Valorem Tariff Rates of S elected Items Table 1

Ordinar~ Budiet '. Central Government -urrent E!Eenditur~/ (in billion of Rials)

Preliminary Budget Actual!! Estimate 1962/63 1963/64 1964/65 1965/66 1966/61 1961/68 !~bR7b9 !~b977o 8.9 11.8 General Services h.6 5.6 g 8.0 1.:.2 1b1 2.7 2.5 Supreme Leadership 0.5 0.6 1.1 1.3 1.S 1.9 0.6 0.8 0.8 0.8 0.1 1.0 0.8 0.9 Internal Affairs 1.1 1.3 Foreign Affairs 0.4 0.6 0.6 0.6 0.1 1.0 .1.3 1.5 1.6 2.0 2.1 2.8 3.1 Judiciary Affairs 1.1 2.5 Finance Administration 1.1 1.5 2.4 2.5 1.8 2.1 2.3 0.8 1.4 1.5 Others 0.9 0.8 0.'8 1.2 0.8 51.5 Defense and Securitl 15.9 !.l:.2 ];hl ~ ~ l2d hl:2. 12.1 12.6 13.8 18.1 20.0 27.8 3h.4 41.3 Defensell 10.2 Security 3.8 4.4 5.3 5.9 7.2 7.9 9.5 Social and Economic 31.2 37.2 40.6 !3ervices2/ ~ ll& 24.3 24.6 ~ 18.2 Education 10.0 11.0 12.0 13.0 13.8 15.0 16.9 Hygiene and Medical Care 2.0 ).0 4.6 4.3 4.5 4.8 5.1 5.4 Agricu1 ture, \va ter ,and POW'3r 3.0 3.3 3.9 2.11 3.0 3.1 3.9 h.7 Transportation and Communication 2.5 2.1 2.5 2.1 3.2 3.4 4.6 4.8 Others 1.7 1.6 1.3 1.5 3.8 4.9 6.7 7.5 2.8 2.4 4.5 4.8 Interest Pa~~ents -1.1 1:.2 ~ hl 1.1 2.oSI g; Others~/ 3.1 3.4 1.6 0.5 3.5 ~ 114.4 Total 1:h2 49.5 54.9 59.9 613.9 80.6 98.7

1/ Includes current and recurrent development expenditure of the Ordinary Budget and t.he Plan - Organization. 2/ For th~ years 1962 to 1964, it includes recurrent development expenditure estimated by - the Bank mssion. 3/ Expenditures forrefense financed directly by drawings on external loans are excluded from - current expenditures;, however, payment of interest and principal on these loans are in- cluded in current expenditures. 4/ Miscellaneous expenditures of the ordinary budget a,nd current expenditures of t.he Plan - Organization. . 5/ Includes 0.3 billion rials actual expenditure!!!, for the first phase of State Employment - Law, '.

~t Ordinary Budget and Plan Organization. ~ rotal Current Elplllditur..!! ~tuN8 tor Salari.. , W.. _ and movaJIC_ bi t.!.fh~JfiOOF oi'Ul1iitiona •• -:.~~---=-:!..:;. Actual.s ActuaJ.s lctu81e Budget Estimates Budget Esti.'IIates 1965166 1966/67 ,J 1967/68 1268£:62 1262Llo Expenditures 1'01' Elcpenditures for iSPlllldi tures for Ixpllllditures for ~endl tures for Total CUrrent Salaries, Wages & Total. Current Salaries, Wages & Total Cllrrent Sal.ri•• , Wai" &: rotel Current Salaries, Wages &: rotal Current Salaries, Wages &. Expenditures Allowances Elcpendituras illlowances Ezpendltures All OWUlC P ~turp lllOVlP5j,' Immditprc:§ Al10yansea

Prime :-tinister I sOfi'ice & Af'flliated Organ. 587 (76) 795 (194) 1,078 (230) 1,.3h4 (347) 1,497 (378) :Unistry of Im;erior 7n (632) 718 (541) 896 (640) 836 (136) 890 (159) :iinistry of Foreign Mfairs 562 (281) 681 (446) 916 (575) 1,064 (680) 1,247 (till) • ~inistry of Infomation 251 (191) 269 (204) (598) 644 (436) 735 (512) ,'!inistry of Justice 640 l,5h7 (1,381) 1.,604 (1,h39) 1,715 (1,520) 1,979 (1,743) 2,205 (1,930) Ministry of PiniUlc. 1,851 (l,552) 1.,839 (1,499) 2,120 (l,6Sl) 2,276 (1,801) 2,497 {2,066) Ministry of Education 11,726 (10,290) 11,970 (10,957) 12,736 (11,777) 13,581 (12,667) 14,Sl8 (13,531) :Unistry of Sciences & Universities l,831 (1,500) 2,045 (1,609) 2,367 (1,878) 3,296 (2,432) 3,679 (2,764) :iinistry of OJl.ture and Arts 305 (191) 325 (202) 440 (251) 520 (300) 582 (322) 1inistry of Heal.tb 3,811 (2;421) 4,172 (2,837) 4,280 (2,835) '4,465 (2,977) 4,686 (3,090) '!inistry of Labor 236 (192) 256 (197) 274 (218) 367 (283) 391 (307) 'iinistry of Housing iUId DlnelopMnt 41 (38) 391 (317) 214 (185) 461 (393) 484 (408) 'Unistry of Agriculture, Natural. Re30urces, Agricultural. Products, Land Hefom 2,047 (1,321) 2,597 (1,911) 2,243 (1,659 2,757 (2,075) 3,285 (2,613) Ministry of Wate~ and Powr 193 (164) 203 (177) 240 (177) 280 (231) 306 (274) Ministry of EconOlQ" 424 (276) 398 (271) 412 (282) 168 (446) 795 (468) ~nistry of Roads l,246 (826) 1,458 (980) 1,663 (1,108) 1,851 (1,237) 1,976 (1,335) ;{inistl'y of Post, TIIlefon and :relegraph 1.,l03 (965) l,239 (991) 1,312 (1,069) 1,490 (1,191) l,Sl8 (1,216) Sub-Total. Non-'Ulitvy!!penditures 28,532 (22,297) 30,966 (24,772) 33,566 (26,653) 37,979 (29,975) 41,291 32,804 Ministry of Defence l8,118 (11,847) '20,031 (12,191) 27,751 (12,725) 34,388 (14,656) 41,257 (16,446) Police Department 2,975 (2,565) 3,399 (2,748) 3,688 (3,178) 4,686 (3,903) 5,oao (4,163) GendlllJlerte Departllent 2,941 (2,559) 3,181 (3,168) 4,204 (3,419) 4,875 (3,153) 5,258 (4,240) ;?Ub-Total. ~U1ihrl Expenditures 24,040 (16,9n) 27,211 (18,113) 35,643 (19,322) 43,949 (22,412) 51,595 (24,849) (Total Expenditures for OOaries, Wages, and Allowances) (39,268) (42,885) (45,975) (52,387) ($7,653) CustO!llS Dutir.s 241 812 936 1,525 3,403 I'ilterest P~ents 2,800 2,400 3,700 4,500 4,800 'Other Payments 4,281 4,511 6,755 10,747 13,311 Total. Central. Govt. Current Expenditures 59.900 65.900 80,600 98,700 114,4~

Source: Budget Law of the Imperial ~v"rlllllent of Iran for 1345, 1346, 1.341, 1348 Y Including recurrent deve10plllent ~enditures

• .. ,. Tablo 3 Gro\-ith of F.,'xpenditures for Salary, liages and AllOto[ances b, Ministries 196,/66 - 1968/69 Annual Compoundod 1968/69 - 1969/70 -Rates 0 f Grollth Annual Growth Rate Prime Ministor's Office &. AIt. Org. 6$ 8.9 Minintl'l' o.r Interior ,.2 3.1 n "Fbrei.f,n Affairs 34 22.2 n II Infonn2.tioll 32 17.4 " n Justico B.l 10.7 " II Financo ,.1 14.7 " II Education 7.2 6.B " :r Sci onecs &~ Uni.vcrsi tlt~s 17.5 13.7 " " Culturo &. Arts 16.2 7.3 " If lIo~th 7.1 3.8 rr J.. abor 13.8 8.5 It" \. fI Housifl'; & Dov. 100 3.8 " Agl'ic., Nfl, AP, LR 16.2 "II 25.9 " Wat~r t-t. Pouor 12.1 18.6 II "Econon,y l.7.3 4.9 " "no~.d::; 14.4 7.9 " "}lOt'lt~ TOl. &. 'l'eloBraph 7.3 2.1 Sub-Tot~ Non-iii] itfU'Y Personnel E>~pcndi t Ul' C:.l 10.4 9.4 Hj n 'i. n t. ry o.r l'h:~ f'cnr: t.:"! 7.4 12.2 Pol:i.c() nf.1p:'l.rt.mcnt 15.0 6.7 Gcndcu'l!!crin Dcp.'lrtrnc.:nt 14.6 10.0 Sub-Tot:l.l Hi.Ii 1;,u'y Personnel F.xpcndituros 9.7 10.9 TotCll l'o:~s()nnnl Itl'\.p0\1l1i tUl'CS 10.1 10.1 --- '----~------,-.------.------.--~-----......

Sr)urcel Table 2

,

• IlIf~ .. M:"

S~w'l~i1ii;;:lr.~=.!t~.. )

Budpt

1'166/61 1961/68 1968/62 ~~~!:,:,,!~~,,!!!. Marc~,20 1962/6-)· 1763/64 1964/65 1~6S(~6 I~r

10.7 ·1~·1 lb.2 _~.,T~. ~ 2.:2- 2.:J.. bl ~ ~ ).0 ).1 4.1 T~ \l~ aalari.. 2.S l.a • 011 Goft,. ()n';cr.;\i.o~ n.a. 1.1 1.6 1.9 ).1 ).0 } 1~2 0.9 ).2 on Pr1,~te CorpoJ'at10~. n~a. 1.0 1.1 1.S 2.? .0.2 011 111". ~ 0.2 0.2 0.2 0.2 0.2 0.1 )~7 ~:----'T ~. ~.9 ).) 4.1 12.1 18.1 20.8 26.8 29.6 ~ ~ W+~~ l.,tlli~,.~" ~ ~ ~ *~~ 6.0 6.8 7.4 ~"·~4~. 2.) 3.S 4.4 4.5 6.5 8!7 10.1 11.1 :13.0 16.2 lB. 21/ 22.2 ~J.8

~ l.9 ~1""9Il,~.--.~ 2.r ).6 0.• 7 0.8 1.0 l·) 1.) t:i:"" ~t,~.~ l~Q 1'!1 1.6 2'!0 2.8 ).2 4:2Y 4:7'Y ' .... ,~ "" \ -..;_ ~;,.4

10.0 ~ l.:l ~ ~ ~ W ~ 4.6· - ~;C.;'~g 4.6 4.6 4.9 ).0 3~1' 3.6 4.7 CW'~q~.;~o. _ T1: 0.1 0.7 0.8 0.9 1.1 1.) :1.4 1.6 ~.

~!~'BL~.~~, ~~~.~,~ Q.&. 2.:! !.:l ~ ~ ~ J.:! W. !:! It':~, 14;.2 ~ ~ ~.. 1 J:l ~ J.:l 2 1M~l!·1tl 2.2. , ~ )~.9 4?O Z?·8 ~ ~.~S ~ 61.~ 2 ''I~'.~ U:l 21~J ~ ~ llJi 2!l.& 80. Q1]. .~. a.c.~pt ~.,? ~ 'lO!AL 52.9 68.~ ~O.O 328.) ..,J_., .. ~ ~ l2W. ~

.Jt ","exoh~n:te d1ff~\ttJ. ~ pr.:-t re~is"ratiQn fee . .;! I,nd,ll!les 1 . .i 'pillion Rls. for stamp dut..r in 1968/69 and 1;6'1i7'J • ..ipur~:; O~din.~ Buc!«,t ~~P1~ 0:rg~i::.~t.ion

& *' • • . ,. • Table 5

:istrib~ticn sf Sil ~evenue Between Plan Organization and Ordinary BUdgetl/ (i~ till~:~ :f ri~ls\

1962/63 1963/6L 196h/65 1965/66 1966/67 1967/68 1968/69 1969/70 Plan Organiz&t:'')n 7 t:.. I • ..., 12.3 17.9 ,....- ~ 22.1 ,J c., . 31.9 36.7 52.0 Crdinary Budget 16.1 15.u 1B.5 17.h 22.1 22.1 25.1 2e.2 Direc~ Allc~aticn (1].B) I, (ll.h) ~ J.. h ...-,) (12.G) (12 ~ 9) (13.') (I") r.) \ J.iJ (16.~) SDntribu~i0n frcm Plan Organization to finance recurrent develvoment; expenditur~/ . (2.3) (L.o) (L.L) (5.L) (9.2) (9.1) (10.1) (11.l.t) Transfer from Plan Organi­ zation ~c finance new state emplo:nnent law r­ (2.0) ~ T:;~al 7 ..-- 23. 27.7 36.L 39.5 - L7.L 5L.o 61.~ BC.2 Percentage Distribution

Plan Organizatio:! - 32.0 L4.0 L9.0 56.0 53.0 60.0 60.0 65 Ordinary Budget 68.0 56.0 51.0 L4.0 47.0 40.0 ho.o 35 1/ This distribution is purely institutional and does not reflect the allocation of oil revenue between current and capital expenditure because the distribution of Plan Organization and Ordinary Budget~oes not coincide :with an ec'onomic claSSification of public expenditure. The above table shows that tp.e direct allocation to the Ordinary Budget was reduced t9 24 percent of total oil revenue in 1967 in accordance with the 1962 Plan Law. In 1968, with the enforcement of the Fourth Plan La", the direct allocation to the Ordinary Budget was further reduced to 20 percent of total oil revenue.

2/ :In-:;il 196L there was in fact no transfer tc the Ordinary Budget since the amounts were paid directly by tr. ~ Plan Organization without this being considered as revenue and expenditure of the Ordinary Budget. Source: Ordinary Budget and Plan Organization " TablE',~- Inter.lt Rat.son !5aVings Accounts (19,9-68) SeEt. 23 196j O.S¢riptiOll 1959/60 .1960/61 1961/6~ 1.9<62/63 1963164 .1'961.&/65 fJ.965/66 J.966/67 1967/68 1968L69 19697'0 Regulation ~Ott:}, ~to.20,OOO RialS .U% 5% 5%5% ~ "'5% 5% $~ Changed ~~{O.OOb"tb 50.000 (first 20.000 same as above) 2 3 '3 ; '3 ~ 3 '3 (See below) "'tt ~Q.~ ".t:o lOO.CXX> .( '.. 5'0.000 same as above) 1 2 2 "2 2 '2 2 2

'NONE NONE NONE NOME Notm NONE NONE MOO ~~oo.,ooo Since Since Aug. 67 Alii. 68

NONE NCIfB -"l.-}J..~~ 5t ;~ppliC8 ble totb"e ~ 'n.i~ ~ "~joeo ~R&'la i(.lawestoa1anc'e of 1i~ 4~ 5t ~We month NOO NONE ~~~it)OO 'f

¥,~f1A1Ml n:'347 ((1f~ a968.\)" ~h" appTies to the 'lo-"eS'tba1.anee .:ttl ·10 da~J '·i!ist'ead or +lie lch'est la"11l'1'iD8 an "6De .'mrea...

:Sou:rCe.tIBaJik :Of :Me111,. DiVi'sicm of EconOlr.ic-5 ~nd Stat:istics-.

• • • • Table 7 .. Ad Valorem Ts~iff Rates of Selected Items Mineral and chemical products with a quoted ad valorem rate 30% Drugs zero to 30% Perfumes 70% Wooden furniture 300% lrJooden packing cases, casks, tubs, etc. 35% Door mats 200% Ornamental and decorative articles of ceramic materials 300% Chandeliers 200% Opaque glass 120% Cut, engraved, etc., glass 300% Optical, spectacle, etc., glass 30% CuI tured pearls 55% Locks 60% Tools with diamonds 10% Eyelash curlers 100% Cutlery articles 100% Domestic electric lamps 100% Powder and lipstick cases 150% Cigarette lighters 100% Steam boilers, locomotives, engines 5% Aircraft and marine engines zero Bicycle motors and other motors 10% Hydraulic motors 10% Motors driven by compressed air, gas jet 10% Road Rollers 10% Fire extinguishers 10% Mechanical pumps for deepwe1ls zero to 2($ Air pumps, blowing pumps, etc. 35% Centrifugal machines, hydraulic presses, etc. 15% Well-drilling apparatus 5% Agricultural machinery (fertilizer spreaders rooters, rolle~, threshers, drying machines, sorters, creamers, ploughs, etc.) 5% Household washing machines 30% Welding machines 30% Re£!I'tgerators 60% Crushing machines 10% Machines for preparing hides and skins, paper-making, printing, spinning and • weaving, etc • 30% Typewr'i ters, calculators, etc. . )0% Coffee mills, mincing machines, dishwasher and dr'yer, clothes ringer, toasters, e~c. 55% to 75% Table Z ...... ,1 Ad Valoran Tariff Rates ot Selected Itans ( contInUed)

'I .

Electric generators, transtormers, welders, etc. 15% Fans, shavers, vacuum cleaners, irons, etc. 45% Electric light bulbs .30% Railway rolling stock 15% Tractors zero to S% Automobiles 2~ to a rate which at the margin reaches Soo,C or cars costing over Rle. )00,000 (C.I.F~) Sweep ers, fire engines, etc. 15% Baby carriages ~ Invalid wheelChairs IS. Vessels tor personal use and recreation 30% Photographic ~~tua 4QC C1nematogr~ ~ar.tus 70% Speedometers, bar

•

•