The shaken “Tax Raj”
View(s):A few months ago, I came to know that one of our local companies had shifted part of its business to Vietnam. In fact, many local companies have been expanding their businesses into other countries in the region. But this is a different story. 
In a globalised world, it is no surprise about capital outflows largely from rich countries to developing countries. Wow! Sri Lanka must be rich too!
On the contrary, however, Sri Lanka has never been a capital-receiving country, and it has a poor track record of capital inflows. And it never maintained higher growth momentum over longer period, mainly due to the lack of private investment flows, including foreign investment.
Therefore, the news actually surprised me, and I asked why. The answer was that in Vietnam, business taxes and duties on imported raw materials are both low so that the cascading effects of high and multiple taxes on the prices are competitively low. The outcome is that businesses are more profitable and price competitive.
I checked the corporate tax differences: Vietnam has a 20 per cent corporate tax rate, whereas Sri Lanka has 28 per cent. In addition, we need to look at the other taxes applied on business, as well as the taxes on inputs. Inputs might be originating from domestic sources (locally produced) as well as from foreign sources (imported) all of which would be adding up to the price of the final product.
That was on the production side. Let’s look at the consumption side too. High cost of living was reported to be one of the most common issues that the public had reported at the time of the Presidential Elections a few weeks ago. The two underlying factors of the problem was the tax incidence on the prices of the consumer goods on the one hand, and the slimming down of incomes and slower economic activity growth, on the other hand.
That was the ground level, but let’s also look at the middle level. A wide range of taxes tend to limit competition eliminating the incentives for product development and quality improvement, but subsidies are used to keep some of the prices down.
Policy dilemma
Sri Lanka has developed a complex tax system over the years with high tax rates and multiple taxes discouraging investment and businesses, and penalising the public as consumers. The outcome has also been complex. Economic activities and businesses have been slowing down, which continued to reflect through a slowing down of economic growth. On the flip side, less-business and less-consumption have led to a slowing down of the government’s tax revenue too.
Here is the government’s policy dilemma: Taxes have to be lowered, and some of them have to be eliminated, but there is the need for generating more tax revenue to meet the rising expenditure. And finally, we end up in achieving neither of them. And up to date, there is no mechanism to identify the direct tax payers, so that the government ended up every year depending on indirect taxes hurting production, consumption and trade.
The banks in Sri Lanka are considered to be paying more than half the profits, perhaps as high as 60 per cent of the profits as effective taxes. They have to pay corporate tax at 28 per cent, and value added tax (VAT), debt repayment levy all on profit basis, and nation building tax (NBT) and economic service charge (ESC) on turnover basis.
The non-financial business companies have been paying corporate taxes at 28 per cent of profits, in addition to VAT, NBT, and ESC on turnover basis. They also have to bear the higher input prices, escalated due to above taxes on inputs. Some of the inputs are locally produced by some other firms, while some of them are coming through imports. Therefore, taxes create a multiplier impact on the price of a final product – a good or a service that we buy as consumers. 
Business-friendly countries
Sri Lanka is among the countries in the region with high corporate tax rates. China, India, Malaysia, Bangladesh and Pakistan are among the countries with higher corporate tax rates above 25 per cent. Corporate tax rate is 15 per cent in the Maldives, 17 per cent in Singapore, and 20 per cent in Thailand. Business enclaves in West Asia such as Dubai and Abu Dhabi offer tax havens for businesses, because the UAE has no corporate taxes.
The problem is not necessarily related to the imposition of corporate taxes, but the complications imposed on businesses with the use of other domestic taxes and trade taxes as well the use of multiple taxes. Sri Lanka is again among the countries with highest GST or VAT rates such as China, India, and UAE. It is not the businesses that have been taxed in the UAE, but the consumption. Malaysia, Maldives, Singapore, and Thailand all offer less than 10 per cent commodity taxes.
A big tax issue in Sri Lanka has emerged with the effective import taxes with the application of multiple taxes. In addition to the customs duty, imported commodities may be subject to port and airport levy (PAL), Cess, VAT, NBT, and excise duties.
Go for more
Referring to Sri Lanka’s import taxes, the US Department of Commerce’s International Trade Administration says: “In addition to the import tariff, a number of supplementary taxes and levies on imports, taken together with tariffs, can total 100 per cent or more of the value of some food and consumer goods, making them prohibitively expensive to import and sell.”
Here is a question to ponder in relation to protectionist arguments. If our imports are already taxed as above sometimes going even beyond 100 per cent, the protectionist argument says that “it is not enough; tax them more”.
Among the countries in the Asian region, Sri Lanka is, perhaps, the No.1 in terms of collecting the highest percentage of tax revenue from international trade, as high as 20 per cent of the revenue. India’s tax on trade is 11 per cent, Thailand 3 per cent, Malaysia 2 per cent, and China 2 per cent. The best performers are Singapore which has taxes on trade at nearly zero and the UAE where trade taxes account for only 0.1 per cent of the revenue. Except for a handful of imports such as motor cars, tobacco and liquor, all imports to Singapore are almost duty-free. The UAE too imposes only 5 per cent import duty, except for a few products such as in Singapore.
While the Sri Lankan tax issue is not limited to the high taxes and multiple taxes, “paying taxes” is also a complicated issue. According to the “ease of paying taxes” index, Sri Lanka is ranked at 141 position out of 190 countries, implying that it is a more difficult job or complex processes for tax payers.
Stimulus with tax cut
The Tax Raj was shaken last week as the government announced a series of tax cuts on personal income and consumption. Many were wondering what would be its implications on the tax revenue of the government.
Apparently, there would be a reduction in tax revenue affecting the budget deficit as well as the debt obligations. There could be, however, many ways to face that issue too – a couple of credit lines or investment projects or even some other radical remedies might ease the problem. The government has also emphasised its ambition of frugality.
The main issue that I have is a different one, and a long-term one: Much more than the short-term adjustment costs, we could target the long-term improvement of the fiscal management as well as the increased tax revenue through business expansion and economic growth. The positive effects of the tax cut could be optimised, when it becomes an integral part of the comprehensive changes.
(The writer is a Professor of Economics at the University of Colombo and can be reached at sirimal@econ.cmb.ac.lk).