Cambodia: Selected Issues
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International Monetary Fund
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Publication Date:
07 Nov 2000
eISBN:
9781451821758
Language:
English
Keywords:
ISCR; CR; Cambodia; government; rate; export; tax revenue; revenue enhancement; trade tax; turnover tax; profit tax; Value-added tax; Sales tax
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This paper discusses major macroeconomic issues confronting Cambodia. The report also discusses recent growth performance of the economy and presents recently updated national accounts estimates. Revenue mobilization remains a key objective since, despite recent significant improvements, revenue performance is still low by international standards. The costs and benefits of a high degree of dollarization are briefly discussed. Export performance and trade policy are also reviewed. Maintaining export growth will depend on maintaining Cambodia's commitment to an open trade and exchange system.

Abstract

This paper discusses major macroeconomic issues confronting Cambodia. The report also discusses recent growth performance of the economy and presents recently updated national accounts estimates. Revenue mobilization remains a key objective since, despite recent significant improvements, revenue performance is still low by international standards. The costs and benefits of a high degree of dollarization are briefly discussed. Export performance and trade policy are also reviewed. Maintaining export growth will depend on maintaining Cambodia's commitment to an open trade and exchange system.

III. Fiscal Reform and Revenue Mobilization

A. Overview

1. The current level of fiscal revenue in Cambodia, measured as a ratio to GDP, is one of the lowest in the world. Cambodia has not had sufficient resources to allocate funds to recurrent expenditure to improve government service or to finance mounting development needs in the social sector such as education, health, and public infrastructure. This chapter provides a background on recent fiscal developments in Cambodia, with a particular focus on revenue issues. In section B, fiscal developments since 1992 are examined. In section C, Cambodia’s revenue structure is compared with other countries’ structure, and in section D, its weaknesses and reform agenda are summarized.

2. Cambodia’s efforts to establish a fiscal revenue system were initiated from extremely low levels of revenue collection. Under the socialist regime in the 1980s, a modern taxation system did not exist. In the early 1990s, fiscal revenue stood at only 4–6 percent of GDP, while expenditure exceeded revenue by 4–5 percent of GDP (Chart III.1). With limited flows of external financing, the government’s recourse to central bank financing averaged 3–4 percent of GDP annually, leading to hyperinflation of over 100 percent.

Chart III.1
Chart III.1

Cambodia: Fiscal Development, 1990–2000

(in percent of GDP)

Citation: IMF Staff Country Reports 2000, 135; 10.5089/9781451821758.002.A003

Source: Data provided by Cambodia authorities, and Fund staff estimates and projection.

3. The first credible steps toward revenue reform were made during 1992–94, which succeeded in eliminating central bank financing, and led to improved macroeconomic stability. In 1992, a major fiscal reform was initiated with assistance from foreign experts (including the IMF), followed by a significant effort in revenue mobilization by the new government formed after the UN-sponsored free election in 1993. The introduction of comprehensive revenue enhancing measures sharply increased revenue to 9 percent of GDP by 1994. Together with substantial external concessional financing, there was no need for recourse to central bank financing (until 1998), and fiscal policy played a central role in maintaining macroeconomic stability.

4. During the mid-1990s, little further progress was made in revenue reform, amid increasing political uncertainty. Several attempts were made between 1995 and 1998, including introduction of new tax measures and reform in tax administration, but all of these efforts were essentially undermined by political intervention and an overall deterioration in governance.

5. Efforts at fiscal reform have resumed since late 1998. The new government formed after the July 1998 election has initiated important revenue measures including the introduction of the VAT. Consequently, total revenue increased beyond 11 percent of GDP in 1999. Progress has also been made in re-directing spending from defense and security to the social sectors.

6. Despite these efforts, fiscal revenue ratios—especially for tax revenue—remain among the lowest in the world (Table III.1). A major problem lies in the weak revenue structure. Cambodia relies heavily on international taxes with customs duties, export duties, VAT on imports, and excises on imports, generating more than 80 percent of tax revenue (Chart III.2). After joining ASEAN in early 1999, Cambodia started reforming customs tariffs in line with the AFTA agreement. This will require Cambodia to make further efforts in seeking revenue enhancing measures to offset expected reductions in customs duties in the near future.

Table III.1

Cambodia: Comparison of Tax Revalue Structure with Other Selected Countries

article image
Sources: IMF, Tax Policy Handbook, Government Finance Statistics, International Financial Statistics, Recent Economic Development, Statistical Annex, and World Bank, World Development Indicator.

Data refer to average of 1995–98 or 1995–97, unless otherwise indicated.

Data refer to 1998.

Other revenue includes non-tax revenue and capital revenue.

Unweighted average of sub-group countries.

The sample includes Benin, Burkina Faso, Burundi, Cameroon, Central African Republic, Chad, Comoros, Congo Dem. Rep. Of, Congo Rep. Of, Cote d’lvoire, Djibouti, Ethiopia, Gambia, Ghana, Guinea, Guinea Bissau, Kenya, Lesotho, Madagascar, Malawi, Mali, Mauritania, Mozambique, Niger, Rwanda, Sao Tome and Principe, Senegal, Sierra Leone, Sudan, Tanzania, Togo, Uganda, Zambia, and Zimbabwe.

Based on agriculture share as a percentage of GDP larger than 40 percent, excluding those classified under selected post conflict countries.

Data refer to 1998.

Chart III.2
Chart III.2

Cambodia: Current Revenue and Domestically Financed Expenditure, 1994-2000

(in percent of GDP)

Citation: IMF Staff Country Reports 2000, 135; 10.5089/9781451821758.002.A003

Sources: Data provided by the Cambodian authorities, and Fund staff estimates and projections.

7. The government faces severe constraints in implementing its expenditure policy because of low revenue. For most of the period 1994–99, domestically financed expenditure remained at 9–10 percent of GDP. With defense and security spending accounting for 40–50 percent of domestically financed expenditure, social sector spending and locally financed capital expenditure have been limited. To fulfill development needs, Cambodia relies almost entirely on external grants and concessional loans to finance its public investment programs; 80 percent of capital expenditure was financed by external resources during 1994–991.

B. Fiscal Development Since 1992

Fiscal developments between 1992 and 1994

8. The government made comprehensive reforms in mobilizing revenue during 1992–94. Revenue mobilization was one of the main objectives of the overall fiscal reform agenda, and a major effort was initiated in 1992 with assistance from the IMF and UNDP. The reform program covered all aspects of Cambodia’s revenue system in tax policy and tax and customs administration. These efforts were rewarded by a significant revenue increase in 1994; total revenue increased to 9.5 percent of GDP compared to 4.4 percent in 1991, well beyond the initial reform targets2. Under the Organic Budget Law, introduced in December 1993, domestically financed expenditure was contained within budget estimates, and central bank financing was eliminated for the first time since the late 1980s when Cambodia started moving from a centrally planned economy to a market oriented economy.

9. Among the various reform measures taken during this period, the most effective were in improving international taxes, customs administration, and forest revenue, whereas domestic tax collections did not improve as much as had been expected mainly because of delays in implementing measures related to wage and profit taxes. Revenues from international taxes and the forestry royalty were almost nil in 1991, but both of them increased by about 5 percent and 1 percent of GDP, respectively, by 1994. These successfulmeasures included:

  • Introduction of a new tax. The business tax on imports was replaced by a consumption tax on imports in September 1993. The consumption tax had a much simpler structure with an ad-valorem tax rate of 4 percent levied on the duty-inclusive value of all dutiable imports. The new tax generated revenue of about 1 percent of GDP in 1994.

  • Increases in tax rates. The duty rate on petroleum products was increased gradually from 3–5 percent in 1992 to 50 percent in 1994 along with an increase in the administratively set dutiable values. As a result, import duties from petroleum products increased from virtually zero in 1991 to about 1 percent of GDP in 1994.

  • Improved customs administration. A reform of customs administration was a core of the fiscal reform, resulting in significant increase in customs duties, up from 1½ percent of GDP in 1991 to 4½ percent in 1994. The steps taken included: (i) the adoption of a general tariff based on the harmonized system of classification, together with the rationalization of the tariff structure (including the elimination of discounted tariff rates for selected countries), (ii) the adoption of an invoiced-based system for valuation of customs duties, and (iii) the adoption of an anti-smuggling task force.

  • Increased revenue from the forestry sector. A log export ban, which had been imposed since September 1992, was temporarily repealed in October 1993, resulting in an unsustainable increase in logging activity. However, the export ban was re-imposed in May 1995, and together with a deterioration of governance, revenue performance in the forestry sector deteriorated considerably after 1994.

Fiscal developments between 1995 and 1998

10. Following this initial progress, revenue mobilization during 1995–98 stagnated with total revenue not exceeding 9–10 percent of GDP. In particular, between mid-1997 and late 1998, the government faced serious difficulties in managing fiscal policy. Shortfalls in revenue collection, and difficulty in restraining military and security expenditure led the government to use central bank financing of the budget in 1998 for the first time since 1994.

11. During this period, several attempts were made to further enhance fiscal revenue, and a total revenue target of 11 percent of GDP for 1998 was set by the government3. To achieve this objective, the government’s efforts focused on enhancing tax revenue by introducing a new tax, increasing tax rates, and broadening the tax base, especially in the area of domestic taxes. In addition, attempts in improving tax and customs administration were continuously made.

  • In 1995–96, the government introduced several new taxes and increased tax rates on existing taxes4. New tax measures included (i) the introduction of a tax on wages, (ii) the introduction of a 20 percent excise tax on gasoline, and (iii) the introduction of an advalorem export tax on rubber.

  • Efforts to improve tax and customs administration included: a establishment of a Large Enterprises Administration Bureau in the Tax Department of the Ministry of Economy and Finance (MEF)5, a computerized database of large taxpayers, and launching preshipment inspection (PSI) for imports in 1995.

  • In 1997, to further improve tax policy and strengthen tax administration, the National Assembly adopted a new Law on Taxation. The law included: (i) extension of the coverage of wage and profit taxes, (ii) inclusion of the first sale of import goods into the turnover tax, (iii) replacement of turnover and consumption taxes for incorporated business with a VAT, (iv) reinforcement of the authority’s power on taxpayer investigation and tax collection, (v) introduction of “Charter of Taxpayers Rights and Obligations,” and (vi) reinforcement of a penalty clause.

12. However, almost all of these reform attempts were undermined by a lack of political will or deterioration in governance. The authority of the MEF was contravened by line ministries, undermining the effectiveness of revenue collection. The implementation of most of the critical tax policy measures included in the 1997 Law on Taxation was postponed or neglected; for example, the implementation of the VAT was postponed until January 1999. More seriously, fiscal policy was affected by conflict over power sharing between the two main coalition parties, and military interference. These resulted in widespread ad-hoc exemptions of tax and customs duties, extensive smuggling, a significant loss in forest revenue, and increased arrears problems in both tax and non-tax revenue.

Fiscal developments in 1999

13. Fiscal performance improved considerably in 1999, Total revenue increased by 2.5 percentage points to 11.5 percent of GDP. With well-restrained expenditure, the government’s net debt with the central bank was reduced by 0.6 percent of GDP in 1999.

14. A significant increase in revenue was primarily accounted for by implementing measures that had already been included under the 1997 Law on Taxation, such as the VAT. Discipline in fiscal policy management was also improved by strictly avoiding ad-hoc tax and customs duties exemptions. In addition, an effort was made in strengthening the MEF’s authority to collect non-tax revenues from line ministries, as evidenced by the timely transfer of funds associated with the garment quota auction revenue. More specifically:

  • Strong performance of the VAT introduced in January 1999 led to an increase in tax revenues by 1.8 percent to 8.3 percent of GDP, even higher than the initial budget projections by 0.9 percent of GDP. The VAT, which replaced the turnover tax for incorporated businesses and the consumption tax for imports, has a uniform rate of 10 percent, with a much wider tax base (Box III.1).

  • Customs revenue increased by 0.2 percent of GDP compared to 1998, reflecting the reduction in ad-hoc tax and import duty exemptions. At the beginning of the year, the government re-imposed customs duties on steel, cement, and automobiles, and reintroduced the export taxes on rubber and sawn timber. In June, the regulation regarding foreign investment was amended to reduce the scope for tax incentives for foreign investors, and in September, complex import duties on cigarettes were unified.

  • Non-tax revenues increased by 0.9 percent of GDP, reflecting efforts made to collect garment quota and forestry revenue in a transparent manner. Following the bilateral textile agreement with the U.S.6, the Ministry of Commerce conducted three auctions to allocate garment quotas among garment factories. Together with the introduction of the auctions, the government imposed a quota management fee and a garment export license fee on these factories. As to forestry revenue, the timber royalty was raised to US$ 54 per cubic meter at the beginning of the year, and maintained at this level for the rest of the year. The increase in the timber royalty served to maintain forestry revenue at the 1998 level despite a sharp reduction in the volume of logging.

15. However, in other areas of non-tax revenue, only limited progress was achieved in improving collections. Although effort was made in improving the timely transfer of revenue from the sale or lease of state-owned assets to the treasury, the government continued to experience recurring arrears from telecommunications, enterprise and immobile leases, civil aviation, and visa fees, partly due to a lack of an effective and transparent system of non-tax revenue collection. Moreover, it was clear that government’s announced intention to bring all contracts involving the use of state assets (including intangible assets) under the control of the MEF was not strictly being followed.

Reform in Indirect Tax System in Cambodia—Introduction of the VAT

The VAT system in Cambodia

In January 1999, the VAT was implemented to replace the turnover tax and consumption tax on imports. The VAT covers all incorporated businesses that are registered under the “real regime1,” which are carried out by the Large Enterprises Administration Bureau of the Tax Department located in Phnom Penh, and since the beginning of 2000, in five major provincial offices, in May 2000, the coverage was further widened by extending the VAT registration to 500 additional firms. As a result, revenue from the VAT in 2000 is expected to increase to 2.9 percent of GDP. The Cambodian VAT has a simple structure and a uniform tax rate of 10 percent. The main features of the system include: (i) covering both goods and services, (ii) including all stages of importation, production, and distribution, (iii) self-assessment and monthly payment, (iv) zero rates only for the export of goods, and services rendered abroad, (v) a small range of exemptions, (vi) no credit allowance for the VAT paid for entertainment services, automobiles, and certain petroleum products, and (vii) an accommodative refund system of excess tax credit to exporters and investment enterprises.2

The VAT has served not only to enhance revenue, but also to improve the efficiency of the tax system, by simplifying the tax structure, widening the coverage and reducing cascading, which were major shortcomings under the previous turnover and consumption taxes.

  • Simplifying tax structure: The turnover tax was unnecessarily complex. There were 3 different tax rates of 1 percent, 4 percent and 10 percent, and in some cases, taxpayers had to pay turnover tax at different rates on different parts of their turnover. On the contrary, the VAT uses a uniform rate of 10 percent, which facilitates tax administration, reduces the scope for false declarations, and helps to ensure uniformity of tax burdens on all consumer goods and services.

  • Widening the coverage: The turnover tax did not apply to agricultural products sold by primary producers, mobile traders and small permanent establishments. The coverage of the VAT is much wider than the turnover tax and consumption tax, exempting only (I) public postal services, (ii) hospital and medical services, (iii) public transportation, (iv) insurance services, (v) financial services, (vi) imports for personal use exempted from customs duties, (vii) non profit activities in the public interest, and (viii) imports of goods related to diplomatic and international organization.

  • Reducing cascading: Without a proper tax credit system, the turnover tax system in Cambodia suffered from cascading. The VAT is a consumption-type tax with an invoice base, and all purchased inputs of raw materials, semi-finished and intermediate goods, and capital goods at all stages of production are designed to receive full input tax credits.

Scope for further improvement

Although the performance of the VAT was satisfactory in 1999 as the first year of the introduction, there are several concerns that need to be addressed in the near term.

  • The VAT registration base is poorly managed, encouraging non-compliance, and needs to be carefully reviewed. For example, as of end-February 2000, 1,928 taxpayers were registered for the VAT, but the actual number of VAT returns was only 1,473, of which 393 were blank. There exist many enterprises who initially registered for the VAT, but never file a monthly VAT return.

  • The VAT refund procedures are slow and delayed, due to unnecessary complex administrative procedures. During 1999, the MEF expected to refund CR 33 billion of the VAT, but only CR 14 billion in refunds was made. To avoid cascading problems, and to ensure continued good compliance with the VAT, the MEF needs to review the refund procedures so that taxpayers receive legitimate refunds in a timely fashion.

In addition, although not urgent, the VAT threshold may need to be reviewed. The coverage of the real regime, which defines the base of VAT taxpayers, is defined in terms of the ownership structure of businesses. The real regime covers incorporated businesses regardless of size of turnover, but excludes unincorporated businesses, many of which may be large enterprises.

1 Cambodia’s tax system is divided into a real regime and estimated regime under the 1997 Law on Taxation (Article 4)/ Taxpayers in the real regime are obliged to pay the VAT in lie of turnover tax, submit a tax declaration on profits based on their balance sheet and profit statements and are subject to the minimum tax. 2 Exporters and importers are entitled to the immediate refund of excess tax credit, while the refunds to other taxpayers are made only if there is a net excess for three consecutive months.

17. Expenditure policy was kept well under control. While wages exceeded the budget by 0.4 percent of GDP due to a 30 percent salary increase granted in May 1999, non-wage expenditure fell below the budget by the same amount of 0.4 percent of GDP. As to expenditure for defense and security, about 16,000 ghost soldiers and nearly 110,000 dependents who were receiving allowances were identified during 1999. Those were immediately removed from the budget, resulting in reductions in expenditure for defense after mid-19997. In addition, committed expenditure for the social sectors (health, education, and rural development) slightly exceeded budget estimates and represented a substantial increase over the 1998 level. However, this was made possible only by a rapid acceleration of the spending commitments during the last two months of the year.

2000 budget and developments in the first half of the year

18. The 2000 budget emphasized the importance of increasing revenue as well as the government’s intention to continue directing expenditure away from defense and security and toward the social sectors. The revenue forecast envisaged an increase of about 0.3 percent of GDP compared to the actual outturn in 19998. However, despite the government’s stated intention to enhance tax revenue, tax revenue as a percent of GDP was conservatively budgeted at the same level of 1999 actual outturn, while budgeted increase in non-tax revenue was ambitiously set at 0.3 percent of GDP with a large amount of arrears recovery expected from post and telecommunications. Current expenditure was budgeted to increase by 0.7 percent of GDP, including measures to redirect spending from the defense and security sector to the social sectors. Capital expenditure, which includes both domestically and externally financed public investment, was budgeted to increase by 1.4 percent of GDP, and the overall deficit was expected to widen by 1.7 percent to 6.1 percent of GDP. However, the current balance was budgeted to remain in surplus at 1.4 percent of GDP, and with increasing foreign financing, the government’s net debt position with the central bank would improve further.

19. For the first half of 2000, overall budgetary developments were broadly consistent with the approved budget. After some shortfalls early in the year, total revenue has been increasing in line with the government’s forecast, with increases in revenues accounted for more by increases in tax revenue rather than non-tax revenue. The expenditure program has been implemented with careful attention to the government’s financing targets.

  • On the revenue side, overall performance was broadly consistent with the budget mainly owing to strong performance of the profit tax and the VAT. The MEF extended

  • the real regime system to five additional provinces, which resulted in an increase in the profit tax and VAT collections. Revenues from direct and indirect taxes are now expected to exceed the initial budget projection, offsetting some shortfalls in revenue collections from trade tax and non-tax revenue items. The slowdown in trade tax started in the last quarter of 1999 reflects declines in cigarette imports, which accounted for nearly 20 percent of customs duties revenues in 1999 (Chart III.3)

  • On the expenditure side, overall current expenditure is well under control, although full implementation of the budget for the social sectors will require an acceleration in spending during the second half of the year. Total expenditure for education, health, and rural development in the first half of the year was only 30 percent of the initial budget The execution of spending has been affected by technical difficulties in implementing the budget by the line ministries9. Further, improvements in spending will require a strengthening of institutional procedures described (see Box III.2).

Chart III.3
Chart III.3

Cambodia: Structure of Customs Duties

Citation: IMF Staff Country Reports 2000, 135; 10.5089/9781451821758.002.A003

Source: Data provided by Cambodia authorities, and Fund staff estimates.

C. International Comparison of Revenue Performance

20. Some insight into revenue potential can be obtained by comparing the revenue structure in Cambodia with that in comparable low-income countries, including other post conflict countries. Fiscal revenue may be negatively affected by tow per capita GDP, high dependency on the agriculture sector, a large informal sector, and an unstable political and social situation. All of these are applicable to the current situation in Cambodia. Table III.1 provides some comparisons with PRGF countries in Asia and Sub-Saharan Africa. The facts observed in the table are:

  • While there is a tendency for the tax revenue ratio to correlate positively with per capita GDP, Cambodia’s tax revenue ratio is even below other low-income countries’. Cambodia (an average of 6.3 percent of GDP in 1995–98) is lower than Nepal (8.8 percent), Mali (12.6 percent), Tanzania (11.5 percent), and selected post conflict countries (10.6 percent), although per capita GDP in Cambodia is higher than all of these countries.

  • Similarly, while high dependency on agriculture tends to constrain revenue collection10, the ratio in Cambodia is lower than in other comparable agriculture dependant countries. For example, agriculture in Lao P.D.R., Nepal, Cameroon, Mali, and Tanzania accounts for more than 40 percent of GDP, compared to Cambodia’s agriculture share of 39 percent, but the tax revenue ratio of all these countries exceeds that of Cambodia,

  • Post conflict countries (such as Burundi, Congo Dem., Ethiopia, Mozambique, Rwanda, Sierra Leone, and Uganda, which suffered from repeated internal and political instability) have difficulty in generating fiscal revenue11. The revenue ratio is lower in Cambodia than in all of these post conflict countries except Democratic Republic of the Congo and Sierra Leone.

  • In Cambodia, the level of non-tax revenue in comparison with tax revenue is among the highest. Cambodia’s non-tax revenue is equal to 43 percent of tax revenue, much higher than similar Asian countries (26 percent) and Sub-Saharan African countries (23 percent)12. This reflects the low level of tax revenue in Cambodia.

Improving Government Spending to the Priority Sectors

Government spending on basic health and education services in Cambodia is among the lowest in the world. To make lasting reductions in poverty, particularly in rural areas, it will be necessary to improve the delivery of these essential services, as well as to increase spending for agriculture and rural development. The PRGF program targets a re-orientation of budgeted resources toward the priority sectors and away from defense, security, and other public activities.

To re-orient expenditure, as part of the PRGF/SAC programs, the government has prepared medium-term expenditure targets covering 1999–2002 for the four priority areas (agriculture, rural development, health, and education). The share of government spending for the four priority sectors would increase from 23 percent to 32 percent, while defense and security would fall from 42 percent to 29 percent. The government has committed to meet the annual budgetary targets for these sectors, with a more equal allocation of spending during the course of the year. Under the program, should revenue deviate in a significant way from projections, adjustments would be made in a manner that favors the priority sectors (i.e., the ratio of actual to budgeted expenditures for the priority areas will be at least as high as for the remaining parts of the budget).

The World Bank is supporting institutional changes to improve the delivery of government services. Priority Action Programs (PAP) will protect critical expenditures for such programs as primary education, basic health, and rural roads from possible revenue shortfalls. Health spending will also be enhanced by the use of the Accelerated District Development program which is an advance payment system to ensure timely disbursement to district health centers. Finally, with effect from the 2000 budget, a Budget Strategy and Enforcement Center (BSEC) has been created in the Ministry of Economy and Finance. The establishment of the BSEC, which is still in the very early stages, is expected to improve the operational efficiency of expenditure by avoiding slow and irregular disbursement of funds, and streamlining the budget execution procedures in implementing the PAP. Continued strong efforts by the authorities, supported by technical assistance, will be necessary to make the BSEC fully operational.

Recurrent Spending on Health and Education

(Commitment basis; in percent of GDP)

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Fund staff estimates based on a sample of 23 PRGF and PRGF-eligible countries.

21. A positive correlation between tax revenue and per capita GDP may partly reflect the fact that low-income countries generally suffer from a limited size of the formal sector—which is relatively easy to tax—and governance problems. For most poor countries in the table, the formal sector is limited to the public sector, natural resource extraction (such as mineral and petroleum), and large manufacturing and retail establishments. This reduces the scope for the domestic tax base. Accordingly, these countries have a tendency to rely more on trade taxes than domestic taxes. Cambodia also depends highly on trade taxes, which reflects the fact that (i) most large manufacturing and retail businesses in Cambodia benefit from tax exemptions under the Law on Investment, and (ii) extensive tax erosions prevail due to governance problems and weak enforcement by the authorities. In addition, as in most low-income countries, governance problems are aggravated by poorly trained tax and customs officials, weak management, low salaries, inadequate equipment and supplies, as well as insufficient tax and customs legislation.

22. In sum, international comparisons reveal that there is considerable scope for improving Cambodia’s fiscal revenue. While revenue potential for Cambodia may be limited due to low per capita GDP, high dependency on the agriculture sector, limited scope of the formal sector, and the legacy of past history, large numbers of other developing countries that are in a similar development stage, and have a similar experience of political and social problems, generate higher fiscal revenue than Cambodia. In fact, Cambodia’s tax revenue ratio in the 1960s, before the war and internal conflict period, was much higher at 13–15 percent of GDP than that in the present13.

D. Existing Weaknesses and Reform Agenda

23. The recently improved revenue performance has been largely accounted for by the successful introduction of the VAT. Further comprehensive reform in the revenue system is essential for enhancing growth and alleviating poverty in Cambodia. The following summarizes underlying weakness in the current fiscal revenue system and the reform agenda.

Narrow tax base

24. As emphasized above, Cambodia’s tax base is extremely narrow compared to other countries, and needs to be broadened. Nearly half of tax revenue is collected from international taxes, and more than 75 percent of this revenue is accounted for by a limited number of import items14. More effort needs to be made to expand both the domestic and international tax bases. In this context, issues that need to be addressed include:

  • Effectiveness of direct taxes (profit tax and wage tax). Revenue from direct tax accounted for only 8.6 percent of total tax revenue in 1999. One of the factors that explain the ineffectiveness of these taxes lies in the level of exemptions. For example, with a threshold of CR 6 million of annual turnover for the profit tax, more than 90 percent of companies filing turnover tax returns can be exempted from the tax. With the monthly income threshold of CR 500,000 for the wage tax—about six times per capita GDP—the tax is withheld from only 6,500 employees in the whole country. However, increasing the scope of direct taxation can only be done commensurate with improvements in tax administration.

  • Generous tax incentives under the Law on Investment. The provisions under the Law on Investment regarding profit tax and customs duty exemptions extremely limit the scope of the tax base and the scope of dutiable imports15. Currently, half of total imports are not dutiable, and apart from foreign aid- related imports, the majority of exemptions (about 70 percent of total exempted imports) are made under the Law on Investment (Box III.3).

Revenue Structure of Customs Duties and Law on Investment

Structure of customs duties

In 1999, 80 percent of tax revenues were collected by the Customs and Excise Department of the MEF (customs duties, export duties, VAT on imports, and excises on imports). Customs duties account for more than half of these international tax revenues, and although tariff rates are gradually declining in line with AFTA requirements, revenue from customs duties is still expected to be an important resource in the short and medium term, at least until domestic tax collections improve. Revenue potential from customs duties would be even greater if not for the narrow scope of dutiable goods.

In 1999, only 56 percent of total imports were subject to customs duties, and the rest were exempted (Chart III.3). About ¾ of total customs duties were collected from a limited number of dutiable goods, i.e. cigarettes, cement and steel, garments, motorcycles and vehicles, and petroleum products. Due to the narrowness of the dutiable base, customs duties are vulnerable to fluctuations in import values and volumes for these limited goods. In fact, in the last three months of 1999, revenue from customs duties dropped significantly, reflecting substantial declines in recorded imports of cigarettes and petroleum products, due in part to increased smuggling. Imports of petroleum products seem to have increased recently, but imports of cigarettes continue to be low, reflecting a decline in re-export trade to neighboring countries.

Law on investment

One of the reasons for the weakness in the structure of customs duties lies in the provisions under the 1994 Law on Investment, which provide generous tax incentives to investors.

The authorities have committed to rationalize the tax incentive scheme. In December 1997, faced with serious problem of tax erosion due to extensively granted tax and customs duties exemptions under the law, the government implemented Sub-decree 88, which: (i) limits the scope of exemptions for profit tax and customs duties, (ii) clarifies the scope of investment activities that are eligible for the exemptions, (iii) requires all enterprises granted a 9 percent reduced tax rate to prepay profit tax, and (iv)requires all enterprises regardless of profit tax exemptions to pay the minimum tax. In June 1999 to further limit the scope of tax incentives, the sub-decree was amended. Major changes are (i) raising the minimum investment capital of selected investment sectors (such as garments), (ii) removing production of consumption goods and exploitation of minerals and industrial equipment from the list of selected investment sectors, and (iii) specifying that imports of all kinds of fuel, lubricants and other petroleum products are not subject to customs duty exemptions.

There has been some progress in rationalizing the tax incentive schemes to reduce the extent of tax erosions, but the measures taken so far have not sufficiently improved revenue performance. While various tax incentives are provided in all neighboring countries, several features of the Law on Investment provide overly generous incentives compared to these countries. For example, (i) tax holidays are permitted up to eight years, (ii) profits are taxed at a reduced rate of 9 percent (instead of the normal rate of 20 percent) after the end of the holiday period, (iii) reinvestment of profits is tax free, and (iv) repatriation of earnings and other incomes is tax free. Under the PRGF and the World Bank SAC programs, the government is committed to further revise the Law on Investment to rationalize tax and customs duty exemptions.

Weak tax administration

25. It is critical to strengthen tax administration capacity so that domestic taxes can be collected effectively and in a transparent manner. Major problems include:

  • Non-compliance and tax arrears problems under the “real regime.” In 1999, the MEF conducted an audit for about 300 enterprises (pertained to 1995 and 1996 tax years), and almost all of these cases were found to be subject to penalties, raising a major concern about non-compliance16. A comprehensive improvement will be necessary in all areas of administration, such as verification, cross-checking, compilation of appropriate data, research and analytical skills, and auditing.

  • Highly discretionary tax assessments under the “estimated regime.” Under this regime, turnover tax is estimated by individual tax officials in consultation with the taxpayer, and profit tax is calculated based on this estimated turnover tax. There is neither computerization for data compilation nor adequate independent internal audit, spot-checking and explicit sanctions in cases of corruption.

  • Delays in VAT refund approvals. In some case, it could take about a year to refund the VAT collected to taxpayers, which may result in discouraging taxpayers to comply with the tax obligation. This could reflect a failure of taxpayers to submit sufficient documentation. Alternatively, bureaucratic and inefficient procedures of the tax authorities could also slow the processing of refunds. Implementation of a credible refund system is essential for sustaining the VAT.

  • Lack of strategic tax payer education. There is almost no effort at taxpayer education or consultation, and many taxpayers are not familiar with the current tax system.

Weak customs administration

26. Customs administration suffers from fundamental weaknesses in all major aspects. With a porous border, smuggling is a continuous problem, and the potential revenue loss could be enormous. Given the importance of revenue from international taxes, while waiting for the development of the domestic economy to generate more domestic tax revenue, strengthening of customs administration is essential for overall revenue enhancement. There are several areas to be addressed:

  • Outdated legislation. The current basic legislation 1989 Law on Imported and Exported Goods is very limited in scope, and the law includes provisions that are inconsistent with modernization of customs procedures. These deficiencies in the law include the requirement for every import to be physically checked, inadequate valuation provisions, lack of provisions for computerization, and inadequate penalty provisions17.

  • Limited human resources. The current human resources are extremely weak, and levels of technical customs knowledge and managerial skills need to be improved.18.

  • Poor infrastructure. The current computer hardware and software are slow and outdated, and prevent the authorities from compiling an accurate and informative database. The material infrastructure, including offices, and enforcement aids (e.g. patrol vehicles), also need to be improved.

  • Complex customs control. While the Customs and Excise Department has the main responsibility over custom controls, other government agencies, notably the Ministry of Commerce and the Ministry of Interior, engage in customs controls. This duplicative control raises concerns about transparency and efficiency in customs procedures.

  • Necessity of PSI. Until the administrative and enforcement capabilities of the customs administration are strengthened, the recent reinstallation of pre-shipment inspection for imports should help sustain revenue performance. With the PSI system, customs revenue could be raised by improving the accuracy of reporting of customs value, and customs administration could be further strengthened by the transfer of skills and knowledge from the PSI service provider.

References

  • Abed, Greorge, T., and others, 1998, “Fiscal Reforms in Low-Income Countries Experience under IMF-Supported Programs,” IMF Occasional Paper No. 160 (Washington: International Monetary Fund).

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  • Burgess, Robin, and Nicholas Stern, 1993, “Taxation and Development,” Journal of Economic Literature Vol. XXXI, pp. 762 –830.

  • International Monetary Fund, 1997, “Cambodia: Recent Economic Developments,” IMF Staff Country Report No. 97–9 (Washington: International Monetary Fund).

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  • Prud’homme, Rémy, 1969, “L’Économie du Cambodge,” Presses Universitaires de France.

  • Stotsky, Janet G., and Asegedech WoldeMariam, 1997, “Tax Effort in Sub-Saharan Africa,” IMF Working Paper 97/107 (Washington: International Monetary Fund).

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  • Tanzi, Vito, and Howell H. Zee, 2000, “Tax Policy for Emerging Markets: Developing Countries,” National Tax Journal Vol. LIII, pp. 299 –322.

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  • World Bank, 1999, “Cambodia: Public Expenditure Review,” (Washington: World Bank)

1

A considerable amount of externally financed capital projects are executed outside the government budget by donors and NGOs. Hence, the figure reported in the budget data understates the actual amount of externally financed capital projects.

2

Actual revenue collections in 1994 exceeded targets under the previous ESAF supported program, and actually exceeded the targets that had been set for 1996 under the program (9.1 percent).

3

Under the second annual arrangement under the previous ESAF (requested in 1995), the government’s target was to increase revenue to 10 percent of GDP by 1997, and under the third annual arrangement (requested in 1997), to 11 percent of GDP by 1998.

4

It was projected that these measures would generate revenue of 1.5 percent of GDP on an annual basis.

5

Previously, responsibilities for the tax assessments, audits, and collection were scattered among various departments in the MEF, resulting in a complicated administration structure that undermined efficient tax collection. The responsibility of this Bureau is to manage the real regime, which covers all incorporated businesses in Cambodia. The Bureau closely administers the tax return, conducts tax audits, and verifies compliance with tax laws.

6

In January 1999, the United States and Cambodia reached agreement on a new bilateral three-year textile agreement under the Generalized System of Preferences of the United States. This agreement contains a labor provision, and Cambodia is able to receive an annual quota increase of 6 percent plus an additional increase of 14 percent (at a maximum) if the United States finds that Cambodia is in substantial compliance with its labor laws and internationally recognized core labor standard. In May 2000, it was announced that the United States awarded an additional 5 percent garment quota increase in recognition of progress made by Cambodian government in the enforcement of the labor standards.

7

Expenditure savings due to the removal of ghost soldiers and dependants are estimated to be about ½ percent of GDP on an annual basis.

8

Excluding revenues from garment quota auction, which raised exceptional revenue of 0.8 percent of GDP in 1999, the underlying revenue increase was about 1 percent of GDP.

9

In part, this reflects the fact that the line ministries were occupied with executing the large budget allocations carried over from the last two months of 1999.

10

The agriculture sector is considered to be difficult to tax due to many reasons: inefficiency in collecting taxes from large numbers of small farmers, difficulty in measuring taxable values or incomes, and social reluctance in taxing subsistence goods. In addition, in case of Cambodia, the lack of legally clear land ownership reduces the possibility to effectively collect revenues from this sector, which may be one of the explanations for Cambodia’s low revenue ratio compared to other agricultural countries.

11

Given that tax collection process requires highly efficient administration skills in registering taxpayers, collecting taxes, enforcing tax collection, auditing, and encouraging taxpayers to comply with tax legislation, loss of administration skills due to war is damaging.

12

In case of non-tax revenue, there is not a clear correlation with other development indicators. Non-tax revenue seems to be more volatile and more dependent on country specific factors. High level of non-tax revenue in Cambodia partly reflects that tax revenue is too low.

14

Cigarettes, motorcycles and spare parts, vehicles and spare parts, and petroleum products.

15

Investors can benefit from exemptions of profit tax of up to eight years beginning from when the project derives its first profit. For customs duties, 100 percent exemption for capital goods and raw materials is allowed.

16

Even the VAT, which was considered to be successfully introduced, suffers from noncompliance problems. For example, although approximately 2,000 companies are registered as VAT taxpayers (as of end-March), only about 1,500 companies are filing VAT returns.

17

Currently, the customs code is being amended and is expected to be finalized soon.

18

Currently, the customs department is introducing measures such as (i) rotating customs officials periodically to reduce irregularities, (ii) enacting tough discipline and measures against customs officials in violation of the customs code, and (iii) building capacity through training with assistance from other countries.

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Cover IMF Staff Country Reports
Cambodia: Selected Issues
Author:
International Monetary Fund
Volume/Issue:
Volume 2000: Issue 135
Publisher:
International Monetary Fund
ISBN:
9781451821758
ISSN:
1934-7685
Pages:
63
DOI:
https://doi.org/10.5089/9781451821758.002
  • Chart III.1
    View in gallery
    Chart III.1

    Cambodia: Fiscal Development, 1990–2000

    (in percent of GDP)

  • Chart III.2
    View in gallery
    Chart III.2

    Cambodia: Current Revenue and Domestically Financed Expenditure, 1994-2000

    (in percent of GDP)

  • Chart III.3
    View in gallery
    Chart III.3

    Cambodia: Structure of Customs Duties

Chart III.1

Cambodia: Fiscal Development, 1990–2000

(in percent of GDP)
Chart III.2

Cambodia: Current Revenue and Domestically Financed Expenditure, 1994-2000

(in percent of GDP)
Chart III.3

Cambodia: Structure of Customs Duties