# CONCLUSIONS AND IMPLICATIONS

Fiscal policy in Zambia reduces inequality across a broad class of fiscal policy elements. Poorer households receive a greater-than-proportional share of the government’s flagship direct transfer (the SCT program). Direct taxes also are distributed progressively in that richer households are liable for tax shares greater than their income shares. Subsidy spending is approximately proportional to income and therefore does not much reduce or increase inequality. Indirect taxes _overall_ reduce inequality.

Eliminating subsidy spending and moving to directly compensate poorer households would help fiscal policy achieve poverty reduction and even greater inequality reduction. Because the 2015-era coverage level for the social cash transfer was low, for many poor households, energy subsidy expenditures delivered their only cash benefit generated from public expenditures. If subsidies on fuel, electricity, and agricultural inputs were eliminated entirely while SCT program coverage was increased to 500,000 beneficiaries while the benefit level was increased by 100 percent over its 2015 level, the poverty headcount ratio would be expected to drop by approximately 4 percentage points (at Disposable Income) while inequality (as measured by the Gini coefficient) would fall an additional 0.5 points. This SCT reform would require resources equivalent to approximately 18 percent of the foregone subsidy expenditures.

Without reform, poor households will continue to pay more into the fiscal system than they receive from it in cash. As we have shown, the share of subsidies on electricity, fuel, and agricultural inputs among poor households is small while the benefit received is also small (relative to own income). Meanwhile, an average household outside of the bottom 10 percent of the pre-fiscal income distribution faces a tax burden from VAT, alcohol and tobacco excises, and personal income taxes higher than the amounts that are received as direct or indirect benefits from subsidies or direct transfers. As a result, the number of poor and vulnerable individuals who experience net cash subtractions from their incomes is greater than the number of poor and vulnerable individuals who experience net additions. This dynamic creates impoverishment among nearly 90 percent of the poor and vulnerable.

The FISP program should reform its standard operating procedure in order to better target poor households. Particular FISP features – that access to subsidized inputs is controlled via cooperatives, for example, or the requirement on land holdings – limit its coverage among very poor or remote households. FISP targets poor households (at least those poor households who are involved in agriculture) better than other subsidies, but the amount of program expenditure necessary to provide one FISP subsidy to a household in the bottom 10 percent does not compare favorably to, for example, the SCT transfer.

VAT exemptions reduce the indirect tax burden for all households but cannot eliminate an indirect tax burden in targeted households. Zambia in 2015 exempted over 80 percent of the average household’s consumption basket (according to LCMS 2015).<sup>37</sup> However, VAT exemptions imply that _some portion_ of value-added is not taxed. For example, producers of transport services still pay VAT charges on any nonexempt inputs and, it is assumed, pass those input-VAT charges on to the final price of transport services. As Figure 22 demonstrates, these indirect burdens are actually greater than direct VAT payments (on nonexempt goods) for all but the very richest households. What this means, in essence, is that VAT-exempted items are relatively important consumption-basket items for all households regardless of income levels. Rather than exempting consumption categories from VAT, a more efficient way to deliver net benefits to poor and vulnerable households is through targeted cash transfers at a scale large enough to compensate for the burden created across households by VAT indirect taxes.

> 37 Most food, transport, education, health, and housing services are exempt from VAT.

35