The Sunday Times Economic Analysis                 By the Economist  

Taxing the poor: Tax reforms to safeguard poor
A former Min-ister of Finance, Ronnie de Mel pointed out that the country's revenue proposals were such that the burden of taxation fell on the poor, while the rich contributed little. During the Budget debate on the Finance Ministry vote, Mr. De Mel blamed the government for creating a dangerous trend of economic and social tension through increasing the disparity between the poor and the affluent.

He pointed out that the budget for next year sought to obtain 70 per cent of its revenue from both the rich and the poor classes through consumption taxes, but only 17 per cent would come from the rich through direct income taxes. Mr. de Mel asked: "Is this fair for any country? In many countries like Sri Lanka both direct and indirect taxes are made on an equal basis. I warn the government not to create economic discontent in the name of a free economy," Former Finance Minister Ronnie De Mel argued: "How can you have a free economy and a just society where a major part of the revenue of the budget comes from the less affluent sections of society and only 17% from the affluent?"

The low collection of direct income taxes has been one of the notable features of the Sri Lankan fiscal system. Owing to this governments continue to rely heavily on indirect taxes. In 2001 consumption based taxes accounted for 83 per cent of total tax revenue. In a poor country like Sri Lanka the burden of indirect taxes fall on the poor, as taxing those commodities that the rich consume do not yield adequate revenue. This in spite of the fact that there are variations in the rate of taxation in the VAT system designed to reduce the rate on widely consumed items and higher rates on those commodities that are consumed by the richer sections of society.

But by virtue of the fact that the rich are a small proportion of the population, these indirect or consumption taxes do not yield much. In 2001, for which year we have the figures, personal income taxes accounted for only 6 per cent of total taxes. Most of these taxes came from PAYE deductions rather than from income tax declarations. The incapacity and inefficiency of the Department of Inland Revenue in collecting direct taxes has meant that the government has to rely on consumption taxes that are mostly paid by the poorer sections of the population. Mr. de Mel alleged that the reliance on consumption taxes was due to these being easier to collect. "But should an entire people suffer for the inefficiencies and corruption of the Income Tax Department?" Mr. De Mel asked.

There are two ways by which the government could remedy this situation. First, there could be much higher specific taxes on commodities that are obviously consumed by the very rich. An example of such a tax was the tax on the use of large motor vehicles, introduced some time ago and then withdrawn. It is true that such a single tax too would not bring in large revenue.

Yet a series of such taxes could bring in more revenue. That is not the only benefit. It would also reduce the consumption of such items and reduce imports. The curtailment of " conspicuous consumption" has both direct economic benefits and indirect social and political benefits. The social discontent that Mr. De Mel spoke of in the same speech could also be contained.

The other approach is the taxation of income at source. Since the income tax authorities are unable to track down income such taxation at source could be an effective means of gathering taxes from the better off sections of the population. Yet these taxes too have been attempted. When they are resisted by the people the government tends to withdraw them in order to ensure their popularity. Since we have to accept the inefficiency and incapacity of the tax authorities to collect taxes from the affluent, it is a more pragmatic measure to confine direct taxation to corporate taxes and do away with personal income taxes. The loss in revenue could be more than made up by all sources of income being taxed at source.

Such a system has certain attractions apart from its tax efficiency. Much of the resistance of people to direct income taxes is the bother of having to fill forms, keep records and the recognised fact that the tax department harasses the few who send in their returns. This has been openly stated at many for and the Finance Minister Chocksy has himself admitted this. He has recognised this in bringing in a provision to debar the tax authorities from questioning the tax returns beyond a few years. He has also taken a step in the right direction in taxing share incomes at source as the only tax. This in fact reduces work for the taxpayers, as well as the Department of Inland Revenue in the processing of tax returns. The bank debit tax and the tax on interest income were other such taxes. Yet the government tends to adopt such measures and remove them when there are objections. If these measures are put in place, direct personal income taxes could be removed, a larger amount of taxes collected from the relatively better off and the burdens of indirect taxation of the poor reduced.

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