Increasing government revenue is crucial for reducing the fiscal deficit and containing the public debt. If the government fails to reduce the fiscal deficit from 7.2 percent of GDP in 2015 to the targeted 5.4 percent of GDP in 2016, the economy could be in dire straits. Increasing government revenue from as low as 12 [...]


Increasing revenue vital for fiscal sustainability and debt reduction


Increasing government revenue is crucial for reducing the fiscal deficit and containing the public debt. If the government fails to reduce the fiscal deficit from 7.2 percent of GDP in 2015 to the targeted 5.4 percent of GDP in 2016, the economy could be in dire straits. Increasing government revenue from as low as 12 per cent of GDP in 2015 to at least 15 per cent of GDP this year to reduce achieve this is however a challenging task.

Increasing revenue
Increasing revenue is vital for fiscal stability and for containing the public debt. Government revenue has hardly been adequate to meet debt servicing costs in recent years. In 2013 government revenue was inadequate to meet debt servicing costs. In 2014 and 2015 debt servicing absorbed 90 per cent of government revenue. As such a high proportion of revenue is absorbed to meet debt servicing costs, most government current and capital expenditures has to be met by borrowing. This increases the public debt that in turn increases annual debt servicing costs.

Falling revenue
Government revenue as a proportion of GDP has fallen in recent years: from 20 per cent of GDP in 2005 to 12 per cent of GDP in 2012 and remained at this low level since then. This revenue to GDP ratio of 12 per cent is below levels of countries with Sri Lanka’s per capita income and one of the lowest in the Asian region.

An astonishing feature is that the tax to GDP ratio has declined with increasing economic growth and higher per capita incomes. This is owing to the nature and quality of recent high economic growth based on foreign funded costly infrastructure development, the lack of tax changes in line with changes in the structure of the economy, tax exemptions, tax avoidance and tax evasion.

Tax reform
A revamping of the tax system and tax administration is vital to achieve a significant increase in tax revenue. The current tax administration is inefficient and ineffective and the tax base too narrow to yield adequate revenue. It also lacks buoyancy to increase revenue when incomes rise. It is replete with tax exemptions, permits widespread tax evasions and tax avoidance is common. The reform of these is a staggering task.

Pragmatic taxation
Tax reforms that recognise the weaknesses of the system and adopt taxes that can be effectively collected will alone enable higher revenue collection. Taxes that are effective in other countries will not necessarily succeed here where innovative accounting, lack of proper records, intermediaries who manipulate taxes and corrupt officials result in low tax collection A pragmatic approach to tax reforms that give consideration to taxes that can be effectively collected are vital. For instance one wonders how much of taxes that are collected from customers are remitted to the Department of Inland Revenue.

In this context it is vital that effective taxation measures are implemented to enhance government revenue. The government’s program of tax reforms expects to increase government revenue by reducing tax exemptions, widespread tax evasion and considerable tax avoidance.

Opposition to VAT
Increased taxation, especially by the increase in the Value Added Tax (VAT), has roused considerable opposition. Increasing VAT on essential items from 12 per cent to 15 per cent was opposed and the government has withdrawn VAT on essential food items and medicines.

One of the reasons adduced against VAT was that it was regressive. VAT is not intrinsically a regressive tax as it is levied on consumption expenditure and higher income households that consume more would be paying higher amounts. This is especially so with the exemption of VAT on essential basic items of household consumption.

The IMF considers increasing VAT an effective means of increasing government revenue and considers it a more reasonable form of tax as there is no cascading effect on prices. However some taxation experts have pointed out that the Business Turnover Tax (BTT) was more efficient and collected more revenue.

Increase revenue adequately?
The pertinent issue is whether the increased VAT and other taxes levied this year such as the NBT would increase revenue adequately. The expectation that tax reforms would significantly reduce past fiscal slippages and increase revenue is yet to be realized. The reform in trade and excise taxes, a broader tax base and more effective tax collection are expected to achieve higher revenue collection that would reduce the fiscal deficit. Increasing revenue depends very much on the realistic nature of the tax reforms, the administrative capacity and honesty of tax collecting officers.

Regressive taxation
The country’s tax system is deemed regressive. The main argument adduced is the very low proportion of direct taxation. The direct to indirect taxes are estimated as 40:60. The 2016 Budget tilted it still further to 20:80. This disproportionate ratio that places the burden on indirect taxation is due to the inability of the tax administration to collect taxes from some of the highest earners.

It is unrealistic to think that tax collection would improve by the imposition of higher income taxes or more efficient tax collection. Therefore other means must be found to increase taxes from the rich that evade taxes. Indirect taxes whose incidence falls on the rich is a means of redress.

It is difficult to understand governments’ unwillingness to tax luxury consumption at much higher rates. Such taxation is a means of collecting revenue from the affluent who avoid taxes in diverse ways. Much higher taxes on road licences of high value motor cars and items of luxury consumption, property taxes and the implementation of provisions on undervaluation on estate duty are among such possibilities. Instead the taxation system has tended to be regressive by taxing basic food items that affect the livelihoods of the poor.

Way forward
The response of the government to inadequate revenue has been ad hoc taxes from time to time rather than a system of taxes that would be effective in collecting higher revenues. In 2009 the former government appointed a competent Presidential Commission of Inquiry to recommend the reform of the tax system and tax administration. Strangely the Report of the Commission that was handed over to the then President in all three national languages remains undisclosed.

It is important for this report to be published and a full discussion of its recommendations discussed and examined thoroughly. Its acceptable recommendations and any changes should be incorporated into a systematic and effective tax system.

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