The global Covid-19 pandemic disrupted economies around the world and Cambodia was no exception. While the government had made significant strides in tax reform and revenue mobilisation, the pandemic led to a sharp decline in tax collection. 

As the economy steadily recovers, there is an urgent need to reinvigorate and build on the success of previous tax reforms. Strengthening tax policies, enhancing compliance and modernising the tax system will be critical to securing long-term fiscal sustainability and driving the country’s development goals.

Pre-pandemic success

Before the Covid-19 outbreak, Cambodia was on a roll when it came to tax collection. Thanks to several smart tax reforms, the country’s tax revenues rose rapidly. Cambodia enjoyed a high tax buoyancy ratio – the responsiveness of tax revenue to GDP growth – of nearly two between 2011 and 2019. This means that as the economy grew, tax revenues grew almost twice as fast.

The strong tax collection was attributable to robust reforms that broadened the tax base, modernised the tax system and improved the audit and enforcement capabilities of tax officials. By 2019, the tax revenue-to-GDP ratio had risen to an impressive 16.2 per cent from 9.8 per cent in 2013. The government seemed to have landed on the right formula to generate funds for national development.

The pandemic’s impact

In 2020, the Covid-19 pandemic hit the world. In Cambodia, businesses closed and jobs were lost, resulting in a fall in tax collection. Tax buoyancy fell by half from 2021 to 2023 compared to pre-pandemic. Part of the reason was the pandemic's immediate impact – less income meant less tax revenue. Another big factor was that the government stepped in to help affected businesses by suspending certain tax liabilities, particularly for the badly hit tourism sector.

The economy began to recover in 2022. Instead of bouncing back, tax revenues in 2023 shrank by three per cent. That was mainly due to a fall in value-added tax (VAT) and excise taxes on imports as well as weakened tax buoyancy in direct taxes. The fall in revenue collection from VAT and excise taxes on imports had a big impact as these taxes usually account for around a third of Cambodia’s total tax revenue. Furthermore, direct taxes, such as profit tax and payroll tax, which account for a quarter of total tax revenue, grew slower than nominal GDP growth.

The revenue challenge

To expand the tax base, the Cambodian government last year launched the National Strategy on Informal Economic Development 2023-2028 to bring more economic activities into the formal economy by incentivising informal businesses to register and file tax declarations. Informal economy business operators who voluntarily register would receive training in business planning, bookkeeping and regulatory compliance without any tax obligations for two years. 

However, there was a significant backlash as business owners mistakenly thought they would need to pay taxes immediately after registration. The government eventually put this policy on hold until wider consultation is done. 

Prime Minister Hun Manet also announced in August 2024 a one-year extension of tax exemption for the tourism sector in Siem Reap province until June 2025 to help businesses recover more fully, which would in turn benefit the broader economy.

In addition, the government's tax coffers are impacted by the Law on Investment which offers enhanced incentives such as exemptions from VAT and excise taxes on imported equipment and construction materials for businesses. 

In 2023, Cambodia experienced a significant drop in tax revenues, particularly from excise taxes on imports, even though the economy was picking up speed. This is a warning sign. If policies do not respond adequately, there is a risk that tax revenues would not grow as quickly as previous boom times.

Promoting tax reforms

Cambodia is at a crossroads. On one hand, the country needs to provide fiscal incentives for retaining and attracting businesses, especially in a competitive region like Southeast Asia. On the other hand, it needs to ensure that the various tax breaks and incentives do not lead to insufficient funds for other priority expenditures.

The recent tax relief measures again highlight the ongoing challenge of finding the right balance. The government’s decision to support struggling sectors like tourism and small businesses is necessary to secure a broad-based economic recovery. However, these measures have held back the expansion of the tax base at a time when the country needs to rebuild its fiscal strength.

Although negative tax buoyancy is not expected to persist, structural shifts affecting tax collection, such as the new Law on Investment and other tax relief measures, suggest that tax buoyancy could be lower in the future. This could result in lower tax revenues, adversely impacting Cambodia's overall fiscal health and its ability to invest in development.

As Cambodia moves beyond the aftermath of the pandemic, it should focus on creating a more resilient tax system, ensuring both individuals and businesses contribute fairly to the country's development. Raising tax buoyancy back to the pre-pandemic levels through continued tax reforms will enhance fiscal sustainability and ensure that tax incentives are offset with other measures to broaden the tax base.

The need to continue and to build on Cambodia’s past tax reforms is greater than ever. The pandemic has dampened revenue collection efforts. Without a renewed commitment to reform, Cambodia risks further setbacks in its fiscal health and in meeting development objectives. By broadening the tax base and enhancing compliance, Cambodia can secure the revenues needed to drive post-pandemic recovery and achieve its long-term development goals. 

Paolo Hernando is a senior economist with the ASEAN+3 Macroeconomic Research Office (AMRO). The views expressed are the author’s own.