Before the Fund Runs OutDomestic Revenue in Timor-Leste, 2027–2040

Abstract

Timor-Leste pays for its state from a Petroleum Fund of about US$18 billion. Petroleum receipts have ended with the closure of Bayu-Undan, the 2026 Budget Report projects depletion by 2037, and IMF staff in August 2026 again projected depletion in the late 2030s under current policy. A Value Added Tax is planned for January 2027. This paper builds a stochastic model of the Fund, a VAT revenue and compliance-ramp model with an optimal registration threshold, and a solver for the domestic revenue path that keeps the Fund alive. The central illustrative result is sobering: spending restraint to the IMF's proposed US$1.85 billion envelope moves depletion from about 2036 to 2039, and adding a VAT moves it only to about 2041. The financing gap of US$1.3 to 1.6 billion a year is three times the Fund's sustainable income. VAT is necessary, but the depletion date is set mainly by spending.

The paper then sets out the solution in deployable form: the policy measures, the data science and AI models behind each, and the software a new VAT administration needs from its first day, including e-invoicing, Treasury payment matching and a public fiscal-sustainability simulator.

Introduction

Few countries have had so little need to tax. Since 2005 the Petroleum Fund has financed more than 80% of each budget, and the Fund now stands near nine times non-oil GDP. Domestic revenue has been an afterthought, raised through low flat income taxes, a narrow sales tax on imports, a services tax on a few sectors, and excise.

That period has ended. The question for this paper is what domestic revenue path, combined with what spending path, keeps the Fund from running out, and how the January 2027 VAT should be designed so that it contributes as much as a new tax in a low-capacity administration realistically can.

The organising identity splits the revenue gap for tax k into policy and compliance components:

R^{pot}_{k} - R_{k} = \underbrace{\left(R^{pot}_{k} - R^{law}_{k}\right)}_{\text{policy gap: no VAT, low rates}} + \underbrace{\left(R^{law}_{k} - R_{k}\right)}_{\text{compliance gap}}

Timor-Leste adds a third feature that the other Pacific cases lack: the tax base is itself a function of Fund withdrawals, because public spending drives non-oil GDP.

Current tax issues

2.1 Withdrawals far above sustainable income

The Petroleum Fund Law defines Estimated Sustainable Income (ESI) as 3% of petroleum wealth. On a Fund of about US$18 billion and no remaining field receipts, ESI is roughly US$0.54 billion. The 2025 budget was about US$2.6 billion. The IMF's 2025 mission proposed a 2026 central government envelope of about US$1.85 billion. Excess withdrawals are legal with parliamentary justification and have become routine.

2.2 No broad consumption tax

The indirect system taxes imports at low rates and domestic services in a few sectors. Domestic value added in retail, construction and most services is untaxed. The government has committed to a VAT by January 2027, a date both the IMF and World Bank cite. At the date of this paper that is under four months away, with enabling law, taxpayer registration, IT, refund procedures and public education all on the critical path. A slipped or under-prepared launch is the main near-term risk.

2.3 Thin direct tax base that recycles public money

Income tax rates are low and flat (about 10%; confirm against the Taxes and Duties Act). The formal private sector is small, and the largest taxpayers are contractors to government and donors. Domestic revenue is therefore partly Fund money returning through the tax system. When spending is cut, as it must be, tax falls with it. Any projection that holds the base fixed while cutting spending overstates revenue.

2.4 Upstream uncertainty

Bayu-Undan has ceased production. Greater Sunrise remains undeveloped, with first gas not expected before 2032 to 2035. Whatever fiscal terms apply, the state's take will depend on auditing multi-billion-dollar development costs. That capacity takes years to build and must exist before first gas.

2.5 Wage bill and recurrent pressure

The IMF flags a sharply rising public wage bill and recommends containing recurrent expenditure while protecting health, education and capital spending. Revenue that is absorbed by recurrent pay does not move the depletion date.

2.6 Administration

The Tax Authority has limited experience with credit-invoice taxes, refunds or risk-based audit. A large share of commerce is cash-based, and the currency is the US dollar, so there is no inflation tax or exchange-rate adjustment to cushion a fiscal cliff. Adjustment would fall directly on spending.

Models

3.1 Model A: stochastic Petroleum Fund dynamics

Model A gives the depletion date as a probability distribution, not a single year. With balance F, stochastic return r, petroleum receipts P (zero until Greater Sunrise), spending G and domestic revenue D:

F_{t+1} = F_t\,(1 + r_t) + P_t - \left(G_t - D_t\right), \qquad r_t \sim N\!\left(\bar r,\, \sigma_r^2\right), \qquad T^{*} = \min\{t : F_t \le 0\}

Greater Sunrise enters as a risky option: with probability p-S the project reaches first gas in year t-S, after which the state receives its fiscal take on production q at price p less costs c:

P_t = \mathbb{1}\!\left[\text{Sunrise}\right] \cdot \mathbb{1}\!\left[t \ge t_S\right] \cdot \gamma \left(p_t q_t - c_t\right), \qquad \Pr(\text{Sunrise}) = p_S

The statutory benchmark is ESI, and the economically meaningful condition is that the non-oil primary deficit stays within the real return net of population growth n:

ESI_t = 0.03 \left( F_t + PV(P) \right), \qquad G_t - D_t \;\le\; \left(\bar r - \pi - n\right)\left(F_t + \mathbb{E}[PV(P)]\right)

3.2 Model B: VAT revenue, compliance ramp and threshold

Steady-state VAT revenue is the rate times final consumption times C-efficiency, where C-efficiency is the product of policy efficiency (how much consumption the law reaches) and compliance:

V_t = \tau \cdot C_t \cdot CE_t, \qquad CE_t = \left(1 - g^{pol}\right) \cdot c_t

A new VAT does not reach steady-state compliance at launch. Compliance follows a logistic ramp from launch date t-0 with half-life t-half:

c_t = \frac{c_{\infty}}{1 + e^{-\kappa\,(t - t_0 - t_{1/2})}}

Net revenue must subtract the taxes VAT replaces (import sales tax, services tax) and provide for refunds to exporters and investors:

\Delta R_t = V_t - R^{sales}_t - R^{services}_t - \text{Refunds}_t

The registration threshold is the most consequential design choice for a low-capacity administration. Following Keen and Mintz, the optimal turnover threshold z-star balances revenue from the marginal firm against administration cost A and compliance cost Gamma, with delta the marginal value of public funds and v the ratio of value added to turnover:

z^{*} = \frac{\delta A + \Gamma}{\left(\delta - 1\right) \tau\, v}

High administration cost and a low rate both push the threshold up. With firm-size distribution f(z), the share of potential revenue retained above a threshold is:

\Omega(z^{*}) = \frac{\int_{z^{*}}^{\infty} z\, v\, f(z)\, dz}{\int_{0}^{\infty} z\, v\, f(z)\, dz}

In economies where a few hundred importers, contractors, telecoms, banks and hotels produce most formal value added, omega stays above 85% even at a high threshold. A high threshold costs little revenue and makes the launch manageable.

3.3 Model C: tax base with spending recycling

Domestic revenue across taxes k depends on non-oil GDP, which depends on public spending through a multiplier m:

D_t = \sum_k \tau_{k,t}\, b_{k}\, Y^{N}_t\, c_{k,t}, \qquad Y^{N}_t = Y^{N}_{t-1}\left(1+g\right) + m\left(G_t - G_{t-1}\right)

The implication is a revenue leak from consolidation. Each dollar of spending cut lowers the deficit by less than a dollar:

\frac{\partial \left(G_t - D_t\right)}{\partial G_t} = 1 - m \sum_k \tau_k b_k c_k

With a multiplier of 0.6 and a domestic tax ratio of 12% of non-oil GDP, the leak is about 7 cents per dollar. The leak grows as the tax ratio rises, so it matters more after VAT than before.

3.4 Model D: the required revenue and spending path

Model D works backwards from the goal. Choose paths for the domestic revenue ratio d and spending ratio g that minimise adjustment cost, subject to a survival probability for the Fund and a cap on how fast the tax ratio can rise given administrative capacity:

\min_{\{d_t, g_t\}} \sum_t \beta^{t} \left[ a\,(\Delta d_t)^2 + b\,(\Delta g_t)^2 \right] \quad \text{s.t.} \quad \Pr\!\left(T^{*} > 2060\right) \ge 0.9, \quad 0 \le \Delta d_t \le 0.75\%\; Y^{N}, \quad g_t \ge g^{min}

The floor g-min protects health, education and capital spending. Because survival is a probability from Model A, the problem is solved by simulation: propose a path, run the Monte Carlo, check the constraint, adjust.

3.5 Model E: audit selection for a new VAT and for upstream costs

Timor-Leste has almost no audit history, so selection must be label-free. For VAT, each registrant's declared turnover is tested against customs imports with a sector mark-up, government payment records (the state is the largest customer and knows what it paid each contractor), and bank credits:

A_i = \sum_m \omega_m \max\!\left(0, \frac{\ln \hat{Q}^{(m)}_i - \ln Q^{dec}_i}{\sigma_{m,s}}\right) + \delta H_i

The government payment record is the strongest source available to any tax office in the region: a contractor cannot declare less turnover than the Treasury paid it. For Greater Sunrise, the same logic applies to development costs: benchmark declared capital cost per unit of capacity against independent engineering cost indices and partner-country filings before costs enter the recovery pool.

Algorithms and illustrative results

4.1 Algorithm 1: Monte Carlo depletion

INPUT  F0, mean return rbar, volatility sigma, spending path G[t],
       revenue path D[t] from Model C, Sunrise probability pS, start year tS, take P[t]
FOR sim = 1 .. 20000:
  sunrise <- Bernoulli(pS)
  F <- F0
  FOR t = 2026 .. 2070:
    r <- Normal(rbar, sigma)
    P <- take[t] if sunrise and t >= tS else 0
    F <- F * (1 + r) + P - (G[t] - D[t])
    IF F <= 0: record T*[sim] = t; BREAK
RETURN median, 5th and 95th percentile of T*, and Pr(T* > 2060)

4.2 Algorithm 2: required-path solver

INITIALISE d[t] = current tax ratio, g[t] = current spending ratio
REPEAT:
  D[t], Y[t] <- Model C given d, g (recycling included)
  surv <- Pr(T* > 2060) from Algorithm 1
  IF surv >= 0.9: BREAK
  raise d[t] by up to 0.75% of non-oil GDP per year where VAT ramp allows
  lower g[t] toward g_min in proportion to cost weight b / a
UNTIL converged
RETURN paths d*, g*, and the implied annual withdrawal

4.3 Illustrative results

Inputs are mine, not official: opening balance US$18.0 billion, mean nominal return 4.5%, domestic revenue US$0.22 billion growing 5% a year, no Sunrise receipts. The baseline lands within a year of the government's 2037 estimate, which gives some comfort on calibration.

With return volatility of 8% a year, 20,000 simulations of the baseline give a median depletion year of 2036 and a 5th to 95th percentile range of 2033 to 2039. Good investment returns buy three years at most.

Reading. Restraint buys three years; VAT buys two more. A VAT raising about 4% of non-oil GDP net is a good outcome by regional standards and still covers only about 5% of the financing gap. Survival to 2060 without Sunrise requires withdrawals to fall toward US$0.6 to 0.7 billion, which means both a domestic revenue ratio rising toward 20% of non-oil GDP over 10 to 12 years and spending well below the current envelope. Model D exists to find the least painful version of that path.

4.4 VAT design parameters implied by Model B

Rate and targets are illustrative; calibrate on recent VAT launches in comparable economies.

Solutions, software, data science and AI models

Timor-Leste has an advantage the other two lack: it is building a VAT from a blank page, so digital controls can be designed in from launch instead of retrofitted. Each issue maps to a policy measure, a model and a component.

5.1 Issue-to-solution map

5.2 Model catalogue

5.3 Reference architecture

flowchart TD
  A[Sources<br/>tax system, ASYCUDA, FMIS payments, e-invoices, Central Bank Fund data, payroll] --> B[Ingestion and data quality]
  B --> C[Warehouse<br/>bitemporal, single taxpayer view]
  C --> D[Fiscal lab<br/>Fund Monte Carlo, path solver, VAT microsimulation]
  D --> E[Budget documents and public simulator]
  C --> F[Risk engine<br/>Treasury matching, reconstruction, invoice graph]
  F --> G[Refund gate]
  F --> H[Audit allocator and case management]
  H --> I[Audit outcomes]
  I --> F
  C --> J[Upstream audit workbench]
  C --> K[Tax-law assistant<br/>three languages]

The fiscal lab serves the Ministry and Parliament; the risk engine serves the Tax Authority; both read the same governed warehouse.

5.4 Software stack

5.5 Governance of AI use

5.6 Team and indicative effort

Two small units are needed: a fiscal modelling unit of three to four in the Ministry of Finance, and a risk and analytics unit of five to six in the Tax Authority. External support of 18 to 24 months is realistic given the VAT launch. Set against a financing gap above US$1 billion a year, the cost of both units is negligible; the scarce input is trained Timorese staff, so the programme should fund postgraduate data science training from the start. Staffing and duration are my estimates.

Reform sequence

Limitations

References & keywords

• Timor-Leste Ministry of Finance — FY2026 Budget Strategy Statement ↗
  Primary budget context and Petroleum Fund withdrawal path
• IMF — 2026 Article IV mission concluding statement ↗
  August 28, 2026 · late-2030s depletion risk and fiscal recommendations
• IMF — 2025 Article IV consultation ↗
  September 26, 2025 · fiscal tables, petroleum and revenue context
• IMF — 2025 Article IV country report ↗
  VAT plans and tax administration detail
• World Bank — Timor-Leste Economic Report, June 2022 ↗
  Economic diversification and revenue policy context
• Keen — The Anatomy of the VAT ↗
  IMF Working Paper 13/111 · policy and compliance gaps
• Keen and Mintz — The optimal threshold for a value-added tax ↗
  Journal of Public Economics 88 (2004) · threshold model