In one of his budget speeches Dr. N.M. Perera, one time Finance Minister, said that you can’t even fry an egg without money. It was his way of emphasising the importance of revenue for the country’s budget. The government is facing a severe revenue crunch owing to inadequate revenue collection. Unless the government is able [...]


Tax reforms and reform of tax administration vital for success of national development plan


In one of his budget speeches Dr. N.M. Perera, one time Finance Minister, said that you can’t even fry an egg without money. It was his way of emphasising the importance of revenue for the country’s budget. The government is facing a severe revenue crunch owing to inadequate revenue collection. Unless the government is able to increase revenue much above recent amounts, the proposed National Economic Development Plan will remain a theoretical construct.

Inadequate revenue
Adequate revenue is vital for reducing the fiscal deficit, ensuring economic stability and enabling economic growth. For sometime now government revenue has been hardly adequate to meet debt repayment obligations. In some years, government revenue was inadequate for debt repayment and interest costs. In others over 90 per cent of government revenue was expended on debt servicing alone, leaving hardly any money for all other recurrent expenditure such as salaries and pensions, defence, health and education. Consequently capital expenditure was either drastically reduced or inadequately met through domestic and foreign borrowing. Consequently the public debt continued to grow to an unacceptable 76 per cent of GDP in 2015 and its debt servicing cost a huge burden on the public finances.

Unless government revenue is increased substantially there would be no fiscal space for increasing expenditure on education, health and the development of infrastructure. It would also mean that macro economic fundamentals would be weak and unstable. Economic stabilisation and economic growth are impossible without increased revenue. Many facets of the proposed National Economic Development Plan would require additional revenue.

Revenue decline
There has been a significant decline in revenue as a proportion of GDP since 2000. Such a decline during a period when GDP has been growing has been a startling economic feature. Professor Mick Moore of the Institute of Development Studies of the University of Sussex has pointed out that “Sri Lanka holds the world record for the longest and largest unplanned decline in government revenue collection. Over a quarter century from 1989, the ratio of government revenue collection to GDP fell by a half, from 21% to 10.4% (in 2014).”

Revenue too low
Sri Lanka’s revenue collection of 13 per cent of GDP in 2015 is far below that of countries with a comparable GDP. It is one of the lowest in the world. While the experience of the rest of the world is a higher revenue collection ratio with increases in per capita income, the opposite is the case in Sri Lanka. Some economists have even suggested that this was due to the GDP figure being exaggerated.

The serious implication of lower government revenue when the economy is growing is that the government has been unable to tax increasing incomes from growth sectors and high income earners. The affluent have been exempted from payment of taxes, or avoided or evaded taxes. Tax rates are also low and tax administration is weak, inefficient and corrupt.

The means
The elimination of tax exemptions and the minimisation of tax avoidance and tax evasion are the means of achieving a higher revenue collection. However conventional approaches to resolve these issues are unlikely to succeed due to innovative and creative methods of tax avoidance and tax evasion, inefficient tax administration and rampant bribery and corruption. Therefore tax reforms must develop a tax system where tax avoidance and evasion are minimized and the affluent pay higher taxes. Expecting to increase tax revenues by resolving the deficiencies in tax administration is impractical in the short run. There should be efforts to improve the tax administration but the results of such efforts would take time.

Tax administration
A root cause for tax short falls has been the inefficiency and corruption in tax administration. Unless this is remedied no amount of tax reforms are likely to bring in adequate revenue. As Devan Daniel has pointed out quite rightly: “Tax officials are known to collude with tax evaders and many people in the tax office that have access to tax files without supervisory approval. There is no record of who handles what, so files get misplaced or data manipulated. Good tax officials are demoralised with little career prospects and departments are under-funded, easy prey to tax evaders.” The Presidential Tax Commission of 2011 said “the success of any reform hinges on a robust and credible tax administration. Reducing taxes and rates will not broaden the tax base if revenue authorities are incapable of enforcing compliance.”

Way forward
Therefore other ways and means have to be found to gather in more revenue. The way forward is to have taxes that are difficult to avoid such as withholding taxes on incomes, increased property taxes, and increased license fees on “conspicuous consumption” such as high value motor taxes and implementation of stringent rules on undervaluation of stamp duties on high value property transfers.

A compulsory declaration of annual changes in assets by all professionals with deterrent punishment on those who fail to declare assets and incomes is essential. An expenditure taxation system is more likely to succeed and be progressive provided it is the consumption expenditure of the affluent and not the lower and middle income earners consumer items that are taxed. These suggestions are indicative of the thrust taxation should take.

Taxation Commission
It is incomprehensible as to why the previous government that appointed the Presidential Taxation Commission in 2011, as well as the present government has not considered the valuable suggestions and tax proposals made in it. Those proposals could be used to reform and strengthen the tax system to enhance tax revenue.

Concluding reflections
Sri Lanka’s precarious fiscal situation is the root cause of the country’s current economic instability. Much higher revenue collection is essential for fiscal consolidation without which economic development would be a mirage. Unless government revenue is enhanced and the fiscal deficit is brought down to targeted levels, the IMF may not give the remaining tranches of the Extended Fund Facility of US$ 1 billion. The IMF’s withholding of it would erode international confidence that could create a severe crisis in external reserves.

It is imperative that the government puts in place a taxation system that is able to increase revenue substantially to achieve fiscal consolidation. The implementation of the pragmatic proposals contained in the Report of the 2011 Presidential Commission on Taxation is a means of achieving it.

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