Derek Francis argues against bringing in high levels of income

tax

Finance Minister Sam Rainsy is attempting to centralize and massively

increase the government's taxation base through new laws instituting a 20

percent corporate profits tax, and a 30 percent personal marginal income tax for

annual earnings over $8000. Wager earners getting between $4000 and $8000 will

be slugged with 20 percent taxation, while 10 percent will be taken from annual

earnings of between $400 and $4000, under the proposals.

The reforms

look unnervingly similar to the tax regimes in many Western countries, which

evolved over many decades. Striving for redistributive ideals is not in itself a

bad thing, but to move so fast, without reference to the country's rudimentary

institutional framework and tiny economic base, may be dangerous. In fact Rainsy

himself appears unenthusiatic about instituting the reforms - the main pressure

is coming from the International Monetary Fund and lawyers who stand to make a

boon from the tax avoidance industry.

Western countries can only now

pursue lavish taxation regimes because their GDP is huge. Importantly, their

wealth only evolved from minimalist taxation while the economy was in its

infancy, just as Cambodia's is now. Private sector GDP is not now big enough to

sustain taxes that would allow the government to even start effectively

providing needed infrastructure and basic social services.

All taxes

destroy Gross Domestic Product and as taxes increase the rate at which GDP is

destroyed goes up by its square. Thus for example if a 5 percent tax destroys

$25 million of GDP, a 30 percent tax will destroy $900 million in GDP -

approximately two fifths of the Cambodian private sector economy!

However there is much evidence to suggest the taxes will be largely

avoided. Cambodia is mainly a cash economy in which no contracts are signed, no

records are kept and there is no registration of workers' incomes, this largely

unorganized community would have no problems dodging income tax.

Even

harder to track are the many families who engage in barter trade, such as the

farmer who tills a small paddy of rice and trades some of it with their

neighbors fruit crop. However, the honest young entrepreneur who sets up a small

textile factory could be caught by the taxman. The dishonest entrepreneur who

sets up a similar factory could, of course, easily pull the wool over the

taxman's eye with false records and the connivance of his staff. In turn he

would thus have little trouble in driving out honest tax-encumbered competitors.

The underground economy and black marketeering would grow rapidly.

Cambodia's big business, medium-level manufacturing and

internationally-competitive industries, such as tourism, would struggle to

legally avoid the tax.

These powerful business groups may unite with a

common purpose to impede Rainsy. By a common economic rule of thumb the

institution of his tax reforms would devalue their income generating assets by

about one third.

If backed into this kind of corner Cambodia's bigger

businesses might back any clandestine movement seeking to overthrow the

government as well as bribing tax-inspectors and faking

accounts.

Further, new immoral industries spearheaded by lawyers would

sprout, with the sole aim to assist business avoid tax. The government lacks the

requisite control of the public service to competently combat tax

evasion.

The net effect of a large personal income and corporate profits

tax would be that it would place an unfair and disproportionate tax burden on

companies conducting their affairs by the book, which are more important to

ecomonic growth. The taxes would provide them with strong incentives to become

corrupt. The taxes would not discourage inefficient or dishonest companies to

reform.

If Cambodia wishes to grow it must reverse these incentives -

encourage business and encourage unproductive farmers to join the urban economy.

Foreign investors would struggle to legally avoid, and be highly

sensitive to, a tax increase. Cambodians have been perhaps

ultra-nationalistically paranoid over foreign entrepreneurs making 'quick'

investments which allegedly plunder the economy and make huge profits through

the sweat, and at the expense, of Cambodians.

The government cannot

think it can tax such profits, and give the wealth created from such investments

to the Cambodian people, without destroying the incentive to invest.

The

other principle beneficiary of foreign investment is, of course, Cambodia

itself. The country gains much needed modern infrastructure. The value of land

and the income streams which flow from it increase exponentially. Employment is

generated, skills and knowledge are passed to Cambodians.

Over the next

few years we may expect some investors, probably foreigners, to make 'quick'

obscene profits due to the uneven, inconsistent and thin spread of information

in Cambodia. Importantly, the investments made will generate as much benefit as

longer term projects through the dissemination of knowledge through society. The

investors should not necessarily be disparagingly viewed as 'cowboys'. In fact

Cambodia desperately needs such people who have, or can acquire, this very

scarce and uncertain information about profitable ways to generate wealth in

this country.

It was the spirit of these 'cowboys/entrepreneurs' which

led to historically unparalleled growth and wealth in nineteenth century

America. Given their high mobility, and the inhospitable environment, at the

first whiff of a major tax most of these 'cowboys' would leave. If there is no

rebate given for corporate tax these entrepreneurs will face an effective tax

rate of 44 percent, higher than most Western countries!

Of course,

foreign volunteers "with a calling", would be affected to a lesser degree by the

new taxes, and would probably stay. However some would argue they generally do

more harm than good.

The government does need money, where should it

come from if not from higher income taxes? Cambodia is fortunate in that offers

of untied foreign aid have flooded in. Why not use this to fund the public

sector and the provision of public goods?

Further, there is great

potential to increase fiscal revenue through targeted consumption taxes on

specifically, cigarettes, alcohol, petrol, brothels etc. These taxes are easy to

administer and cause little detriment to the economy.

The government

could dramatically reduce military spending. by lobbying the UN for an

international peace keeping force to be redeployed in the gray areas to hold the

Khmer Rouge at bay.

Increasingly Western governments realize major tax

reform is a quasi-constitutional process - it cannot be done without the support

of business groups, trade union leaders and workers. That community debate,

consultation and discussion - the consensual approach has not happened is

evidence of the impoverished nature of the political economy in Cambodia.

Indeed, in most Western countries election campaigns revolve primarily around

party's proposed tax and expenditure plans. It is time Cambodia had such open

debate. Without it, the government lacks any mandate to engage in significant

tax reform; and the public will continue to feel it is legitimate to employ

underhand methods to protect their property from taxation.