# **1. Introduction**

Sound fiscal policy is central for macroeconomic stability and growth, as well as for poverty and inequality reduction. This can happen both through its influence on macroeconomic conditions (economic growth, employment, and inflation) and through the distributional implications of taxes and public spending. For instance, public spending that is well-targeted to poor and vulnerable households can effectively alleviate the incidence and depth of poverty, support broader distribution of the benefits of economic growth (de la Fuente et. al 2017), while at the same time leaving scope and resources for public interventions in other areas. Fiscal policy thus plays a direct role in poverty and inequality reduction through redistributive effects and how resources are collected and spent influences whether the fiscal toolkit achieves povertyreducing and equalizing goals. In the case of Cambodia, so far a comprehensive analysis of the distributional implications of fiscal policy has been missing and this study aims to fill this gap.

In the decade to 2019, Cambodia sustained macroeconomic stability, including prudent fiscal management, and robust growth. Strong and inclusive growth contributed to substantial poverty reduction and shared prosperity. According to official statistics, poverty nearly halved nationally from 33.4 percent in 2009 to 17.8 percent in 2019/20. Inequality remained moderate in international comparison with a Gini coefficient estimated at 0.32 in 2019/20, although this level of inequality represents a slight increase since 2014.<sup>5</sup> This paper assesses the redistributive effects of Cambodia’s 2019 fiscal policy and its individual elements. We apply an internationally recognized methodology developed by the Commitment to Equity (CEQ) Institute to assess how taxes and social spending affect poverty and inequality.<sup>6</sup> The present analysis relies on the 2019/20 Cambodia Socio-Economic Survey (CSES) and 2019 administrative data on taxes, transfers, and social spending. The CSES is collected by the National Institute of Statistics (NIS) and the fiscal administrative data is compiled by the Ministry of Economy and Finance (MEF).

The paper seeks to answer the following questions: How much are social spending, subsidy, and tax policies contributing to redistribution and poverty reduction goals? How are specific taxes and government spending contributing to equalization and poverty reduction? How would fiscal policy reforms that change the size and/or progressivity of a particular tax or benefit affect inequality and poverty? Within the limits of fiscal prudence, what could be done to make taxes and transfers more “propoor”? Such evidence can inform policy makers and other stakeholders in assessing existing fiscal instruments and in designing reforms.

The 2019 fiscal system in Cambodia, and many of its elements, reduced inequality but also left poor households out-of-pocket in the short term.<sup>7</sup> According to the Fiscal Incidence Analysis using the CEQ methodology, the modeled fiscal system in Cambodia decreases the Gini index by 0.95 percentage points. Spending on primary education shows the largest benefit on inequality, complemented by direct taxes,

> 6 See Lusting and Higgins (2018) for a description of the CEQ methodology.

> 7 Note, some of the findings of this paper are featured in the 2022 Cambodia Poverty Assessment.

5 World Bank (2022a).

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