2008 BUDGET'S DIFFICULT PASSAGE UNDERSCORES

C O N F I D E N T I A L SECTION 01 OF 03 RABAT 001810

SIPDIS

C O R R E C T E D C O P Y (ADDED "CLASSIFED BY" LINE)

SIPDIS

E.O. 12958: DECL: 12/04/2017
TAGS: EFIN ECON PGOV MO
SUBJECT: 2008 BUDGET'S DIFFICULT PASSAGE UNDERSCORES
GOVERNMENT TENSIONS


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Classified by ECONOFF Stuart M. Smith for reasons 1.4 (b) and (d).


1. (SBU) Summary: Morocco's lower house approved the
government's 2008 budget on Saturday, December 1, after a
raucous debate that saw opposition deputies accuse the
government of misusing its constitutional power to rule
opposition amendments out of order. The budget's torturous
passage through the lower house also underscored tensions in
the government, as the socialist USFP abandoned its coalition
partners and pressed for a cut in both the country's income
tax and for maintenance of a higher profit tax rate on
Morocco's banks. In the end, Finance Minister Salaheddine
Mezouar was forced to compromise, agreeing to limit the
reduced bank rate to 37 percent and to agree to consider
lowering income tax rates starting in 2009. If the
government's decision to wield its constitutional power to
close of debate underscored the limits of parliament's power
in Morocco's budgetary process, the USFP's defection had the
opposite effect, forcing a government retreat on at least
some USFP proposals, after it realized that in the face of a
united opposition, without the USFP the budget might have
gone down to defeat. End Summary.


2. (SBU) The broad spending plans of the government were not
contested in parliament, although they are based on an
optimistic economic forecast (6.8 percent growth, 2 percent
inflation, and oil at 75 dollars a barrel) and forsee an
increase in the budget deficit from 1.9 percent of GDP to 3
percent. The government's tax plans sparked a firestorm of
controversy, however. Both the opposition Justice and
Development Party (PJD) and socialist USFP Party slammed the
government's decision to grant general relief by reducing the
rate on companies from 35 to 30 percent, and by reducing the
rate on banks and financial institutions over two years to 35
percent from 39.6 percent. PJD Deputy Secretary General and
chief economist Lahcen Daoudi described the measure to us as
an unwarranted "gift" to a sector that is already doing very
well, and insisted that any change should instead be targeted
on small and medium sized enterprises, who are most in need
of tax relief. USFP deputies echoed this critique, and were
not moved by Minister of Economy and Finance Mezouar's
arguments that SMEs would be the principle beneficiaries and
that the change was needed to compete with the lower
corporate tax rates in such competitors as Tunisia and
Turkey. USFP Deputy Khalid Hariri (the party's chief
economist and Vice Chair of parliament's Finance Committee)
told us 90 percent of the corporate tax benefit would have
gone to the largest 100 corporations in Morocco. He added
that his party remains convinced that income tax relief would
do more for the competitiveness of Moroccan companies than
would reduction of the corporate tax.


3. (SBU) The government ultimately invoked article 51 of the
constitution to rule most opposition amendments out of order
in the finance committee, but in the face of continued USFP
recalcitrance it was forced to extend an olive branch to its
coalition partner, as it faced the prospect that it would not
secure the votes necessary to pass the overall budget. After
emergency consultations last week before the November 30
plenary debate, the government ultimately agreed to limit the
corporate tax reduction on banks to 37 percent (abandoning
next year's second cut) and to "engage" formally to review
income tax rates in the 2009 budget. With these concessions,
the USFP ultimately joined its coalition partners in
approving the draft. In a sign of how the USFP's stand
animated the debate, however, more than 250 deputies attended
the start of the plenary budget session on Friday November
30, more than three times the number that attended the
session the year before.


4. (U) Reduction in the corporate tax is not the only
significant fiscal measure introduced in the budget, however,
and there is a strong possibility that the government will be
forced to make further concessions in the upper house when
that chamber takes up the budget this week. Particularly
controversial in the north is a proposal to eliminate the tax
advantages that the Tangier region has enjoyed since 1963.
Since that time, companies in Tangier have benefited from a
50 percent reduction in corporate tax, which can be
compounded by other tax advantages. Hence exporters in the
north face an 8.25 percent tax rate (half of half of the
corporate tax rate). Critics argue that the region needs no
such special benefits, given the extensive investment in
infrastructure and other projects that has occurred there in
recent years. Arguments in favor of equal treatment
prevailed in the lower chamber, but regional representatives
are likely to puruse their interests in the upper house,
arguing that the north's economic take-off is still fragile,
and the change would seriously damage the area's
attractiveness to investors.

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5. (C) Also controversial are plans to re-establish a 20
percent tax on capital gains (the rate is currently 10
percent). The brokerage industry is mobilizing to fight the
change and one brokerage has even taken out full page ads
suggesting that the government maintain the current lower
rate for short term speculators, while imposing the higher
tax on those who hold their assets over the long term. It
argues that the first group could be discouraged by the
higher rate in its efforts to turn a "quick profit." Given
that such short term positions make up 40 percent of the
volume of market transactions, it argues any such
"discouragement" could have a serious impact on the market as
a whole. Hariri told us wryly that the lower chamber
dismissed the brokerage proposal, given that short term
speculators do little to promote savings and investment, and
that maintaining stock market volume is not a "national
interest."


6. (U) A final point of controversy surrounded the budget's
elimination of the fiscal exoneration that developers of
"social housing" have enjoyed. Instead, they will be subject
to a 15 percent corporate tax on their profits in 2008 and
the full 30 percent tax in 2009. Though the measure has been
criticized, most market analysts forsee only limited impact,
given thriving market demand. The government has also
maintained the tax exemption for a new low-cost housing
product (priced at 140,000 MAD or 18,000 USD),provided
developers construct sufficent properties in both rural and
urban areas.


7. (U) More generally, opposition critics have also focused
on the optimistic assumptions that underpin the budget,
including particularly the 6.8 percent growth forecast.
Finance Minister Mezouar resolutely defended the prediction,
pointing out that Morocco has averaged 5 percent growth over
the last five years, even when confronted with two years of
drought. With an "average" harvest, he insists, growth
cannot be below 6 percent. Relatively little attention has
been paid to the budget's expenditure side, which underlines
the government's social focus by increasing spending on
social programs 17.5 percent to 79.5 billion MAD (10.3
billion USD),nearly half of the government's planned
non-debt expenditures. Spending for security increases even
more dramatically, up nearly 30 percent to 45.6 billion MAD
(5.9 billion USD). Together the two areas account for nearly
80 percent of non-debt expenditure. Overall spending
increases at a 13.5 percent rate, while receipts are
projected to rise 17.5 percent.


8. (U) Much of this spending, however, is for regular
government operations. The wage bill remains a heavy burden,
restrained but not resolved by the voluntary departure
program that the government carried out in cooperation with
the World Bank. With plans to recruit 16,000 new civil
servants (up from the 6,000 added in 2007),spending on
personnel will increase 6.7 percent to 67 billion MAD in 2008
and together with related retirement and medical insurance
costs (which total 12.5 billion MAD) will continue to absorb
nearly half of non-debt government spending. Also slated to
increase dramatically in 2008 are expenditures for subsidies
on the price of basic goods including bread, wheat, sugar,
and fuel (up more than 50 percent to 21 billion MAD) and
spending on investment, which will rise 39 percent to 36
billion MAD. The latter figure is only a third of the
government's overall investment budget, with the remainder
coming from investments by state enterprises and support from
the Hassan II investment fund. Critics note, however, that
often these investment plans are only partially realized.


9. (C) Comment: Passage of the 2008 budget has been a trial
by fire for the new government and particularly Minister of
Finance Mezouar. As much as substance, the maneuverings seem
to have been used by all parties to position themselves in
the face of what is widely perceived to be a weak and
inchoate government. The USFP in particular sought to
demarcate itself from its partners, in the face of continued
discontent in its rank and file over its poor showing on
September 7 and over its subsequent decision to participate
in the government.


10. (C) Comment continued: Finance Minister Mezouar has
remained determined in the face of the storm, however, and
his concessions to date to the USFP appear as much to track
with his own long-term plans for tax reform as to represent a
climbdown by the government. While the current budget is
largely the work of his predecessor, and was only modified on
the margins, Mezouar has large ambitions, as reflected in the

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number of tax reforms the draft contains. He plans to go
further: during a November courtesy call by the Ambassador,
he conceded that income tax is very sensitive and cannot be
changed immediately, but he insisted it will ultimately
require a "change in structure." Similarly, he outlined
plans to further reduce the corporate tax and value added
tax. These are laudable ambitions which would help reduce
Morocco's informal economy, but they remain challenging when
the underlying budget deficit remains in the range of 3
percent of GDP and privatization revenues are no longer
available to help cover the gap. End Comment.


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Riley