Could improved tax collection strengthen democracy in Cambodia?

By: David Hutt - Posted on: February 9, 2016 | Cambodia

With Cambodia starting to collect more tax, some argue it could increase political accountability in the Kingdom

Cambodia has long been lambasted for not doing enough to collect taxes. In 2006, for example, it collected a little over $600m. In recent years, attempts to levy taxes on ordinary people have been met with protest but the overall amount of tax collected has been rising. The Department of Taxation recently announced that it collected $1.3 billion in 2015, up 21.6% from the previous year. The Department of Customs and Excise – which collects taxes on imports and exports – has yet to release its figures for last year. In 2014, it collected $1.34 billion.

tax, garment factories, cambiodia
Cambodian workers in a garment factory in Phnom Penh. The Cambodian garment industry is the largest income earner of the national economy and employs about 500,000 mostly female workers. EPA/Mak Remissa

The Cambodian government’s recent enthusiasm for taxation is no mere avocation. It is a reaction to an increasing demand for more funds. In December, it announced that the national budget for 2016 would be $4.3 billion, up 12% from last year.

However, even with the rise, the current level of public spending is low, said Napoleon Navarro, head of policy at the United Nations Development Programme (UNDP) in Cambodia. The budgets of upper-middle income countries in Southeast Asia, such as Thailand and Malaysia, are between 15 to 17% of GDP, whereas Cambodia’s is only 6%, Navarro said. If Cambodia hopes to become an upper-middle income country and achieve its Sustainable Development Goals’ by 2030, he added, it would need to dramatically increase public spending in the future. And this will need to be funded by taxation.

Traditionally, foreign aid and favourable loans have aggrandised Cambodia’s national budgets, while international assistance in areas such as health care, education and poverty relief has diminished the amount the government needs to spend on its citizens’ welfare.

Yet, Cambodia is expected to transition from being a least-developed country to a lower-middle income country within the next 12 months, which will mean that foreign aid and preferable loans may be scaled back.

“Cambodia must be prepared for this as donors would reduce developmental aid and grants, including concessional or soft loans, and give it less-favourable trade deals, et cetera,” Srey Chanthy, an independent economist, told the Phnom Penh Post.

Both of these factors – which will demand more money for the national purse at the same time as Cambodia’s once-abundant sources of cash are drying up – mean that tax reform is an imperative for the government.

Although some progress has been made, this will not be easy. According to Navarro, one of the main problems is that Cambodia’s workforce has been – and remains – largely composed of people in “a dominant informal sector, vulnerable employment, and subsistence agriculture”. Typically, professions that prove difficult to tax.

And then there is Cambodia’s quotidian corruption. To give the most stark example: In December, a report by Washington-based Global Financial Integrity found that between 2004 and 2013 almost $15 billion left Cambodia illegally, mostly through ‘trade misinvoicing’. This is where companies misstate volumes of imports or exports on shipping invoices, and covertly move money into another country. Almost $4 billion exited Cambodia this way in 2013, all of which was untaxed, and which was worth four times as much as that year’s national budget.

Nevertheless, the government does appear to be making some improvements. The taxation department announced that there was a 27% rise in corporate profits tax and 18.6% in income tax collected last year. And the government is revamping the way it taxes smaller companies.

Cambodia traditionally operated a two-tier tax structure, explains Anthony Galliano, CEO of Cambodian Investment Management. On the one hand, there were the ‘real regime’ taxpayers: registered companies, state-owned companies and other businesses with some system of formal accounting. On the other hand, there were the ‘estimated regime’ taxpayers: companies or small ventures with no formal accounting – essentially without a paper-trail of profits – and taxable amounts for these were estimated based on discussions between taxpayers and tax officials.

The Phnom Penh Post reported that in November the government set about scrapping the ‘estimated regime’ to bring all enterprises under the ‘real’ tax regime. The publication also reported that 60% of the country’s state tax collectors worked with ‘estimated regime’ payers, which brought in less than 1% of the total tax revenue. In December, the government issued a prakas – an official edict – to end the ‘estimated regime’, creating a stricter system for small and medium enterprises.

However, it is likely that in the foreseeable future Cambodia’s taxation system will rely heavily on indirect taxes, as opposed to direct taxes such as income tax and import tax. Galliano said that VAT – an indirect tax – “contributes significantly” to the overall tax pool and is “probably the largest tax levied” by the government.

“Over the medium term, chances are Cambodia might have to rely on more regressive indirect taxes to fund its development aspirations, before putting in place a more progressive income tax system,” Navarro said.

If taxation does increase in Cambodia, it could lead to violent scenes like those seen last May, when protests erupted in the Cambodian town of Poipet, on the border with Thailand, following complaints by cross-border porters that customs-taxes were costing them most of their daily wages. “We can barely get enough food, so we set up the strike seeking to reduce the cost of tax,” one protestor told the Phnom Penh Post.

Or, more positively, the laws of unintentional consequences could mean that higher taxation revenues could lead to improvements in democracy.

In the 1980s, a number of Western academics and political economists proposed a theory often called the ‘taxation-produces-representation hypothesis’. A government that relies on taxation to fund its public spending, the hypothesis says, is under greater pressure to be accountable to its taxpayers, is more motivated to promote the prosperity of taxpayers and, as citizens observe how their hard-earned money is being spent by the government, they are more likely to speak up and protest if they think it is being depleted improperly.

Sophal Ear, an associate professor of diplomacy and world affairs at Occidental College, California, and author of Aid Dependence in Cambodia: How Foreign Assistance Undermines Democracy, has been arguing in favour of the ‘taxation-produces-representation hypothesis’ for many years, with a focus on Cambodia’s foreign aid ‘dependency’.

“Large amounts of foreign aid – relative to a country’s GDP, tax revenues and government spending, over long durations – can hurt a country’s development and governance,” Ear said. “In Cambodia’s case, [foreign aid] has hurt democracy because the more the authorities rely on outside resources, the less they are incentivised to collect taxes, which are needed for holding the authorities accountable.”

And, according to Navarro, Cambodia’s increased reliance in taxation “could potentially improve the bargaining position of ordinary citizens and social movements, and strengthen the liberal democracy that Cambodia is”.