Expenses of the West, taxes of the East
View(s):This is the “budget week” in Sri Lanka, but I did not have time to wait for the Budget Speech to complete today’s column. Therefore, this is not about an analysis of the Budget. However, many are waiting for the government’s annual budget every year to conduct pre-budget and post-budget analyses. Real time analyses are also becoming popular on television and radio channels to present expert views, while the Budget Speech is being aired.
File picture of IMF officials speaking at a media briefing in Colombo. The IMF is also pushing for reforms particularly on SOEs.
Yet, once the dust settles, the national conversation fades. The budget cycle becomes a fleeting moment of fiscal reflection, only to be revived again the following year. What we often miss is the deeper, structural conversation about the sustainability of our fiscal choices—something far more critical than the numbers read aloud on budget day.
Moving target
Rather, I wish to touch upon a few fundamental economic issues to ponder the question: Why Sri Lankans are where they are today. More importantly will they be better off in the years to come?
Recently, someone raised the question: When will Sri Lanka be able to achieve 8 per cent rate of real GDP growth? It is not only achieving a higher growth momentum at around 8 – 10 per cent a year, but also maintaining it for the next 20 – 25 years, which would unveil a path for Sri Lanka to become a rich country or a high-income country.
This goal is a moving target. The global threshold for high-income status rises each year, meaning Sri Lanka must not only grow rapidly but also keep pace with global economic shifts. Achieving and maintaining a growth rate of 8–10 per cent annually is the only viable path to crossing that threshold within two decades.
While I am eager to be optimistic, realism must temper that hope. At present, Sri Lanka is not adequately prepared to break free from its natural growth of around 5 per cent. That rate may fluctuate with changing circumstances, but without deep structural reforms and a long-term strategy, transformative growth remains elusive.
Western style
Let me begin with the government budgetary operations. My opening statement shows a substantial difference between Western countries and Eastern countries. Average government expenditure in the European Union (EU) countries, for instance, is closer to 50 per cent of GDP.
In order to meet such high spending requirement, the EU countries also maintain high taxation – as high as 40 per cent of GDP. Throughout the post-war era, European countries have developed expansive welfare states characterised by high levels of government expenditure.
Rooted in the social democratic traditions of Western Europe, these systems prioritise universal healthcare, public education, pensions, and social protection. By the 1970s, many EU nations had institutionalised generous public services, which required substantial fiscal resources. As a result, government spending in the EU has consistently hovered around 45–50 per cent of GDP, among the highest globally.
To sustain this level of expenditure, EU countries rely on robust taxation frameworks. Tax-to-GDP ratios in most of the EU countries often range between 40 – 50 per cent, supported by progressive income taxes, value-added taxes (VAT), and social security contributions.
Irreversible spending
The EU’s approach underscores a historical preference for state-led social provisioning. While this model has delivered high living standards and reduced inequality, it continues to evolve in response to globalisation, ageing populations, and shifting political priorities across member states.
This fiscal model reflects a collective commitment to equity and redistribution, though it has also sparked debates about efficiency, competitiveness, and fiscal sustainability—especially during economic downturns and demographic shifts.
Whether the Western style of expenditure pattern could be maintained or not, is thus a debatable issue. In fact, historically its sustainability has also been subjected to crucial tests, particularly during crisis times compelling them to undertake unpleasant reforms and impose austerity measures.
East Asian economies – the late comers, which have embarked upon their development drive much later than the Western countries – have chosen a different fiscal model. They favoured leaner governments with lower tax burdens on people. These countries have emphasised economic growth, fiscal prudence, and limited welfare commitments. It allowed people themselves to take the responsibility on their own, limiting government commitments – these nations prioritised infrastructure, education, and export-led development over expansive social spending.
As a result, government expenditure in many countries typically ranges between 20 – 30 per cent of GDP—significantly lower than in Europe. Taxation is also modest, with tax-to-GDP ratios often below 25 per cent, reflecting a preference for low direct taxes and efficient public administration. This model supports competitiveness and investment, though it offers more targeted rather than universal social protection systems.
Sri Lanka’s fiscal dilemma
Historically Sri Lanka has chosen the expenditure model from the West and taxation model from the East. Apparently, it is true that Sri Lanka inherited the Western model through its exposure to the West.
However, the contradiction rose as Sri Lanka gradually tried to expand the Western-styled expenditure pattern from the Eastern-style taxation model. The fiscal outcome of this contradiction has been the growing budget deficit, leading to debt-piling up.
Fiscal consolidation is a pre-requisite of the path to recovery from the economic crisis. This unveiled a new policy dilemma for fiscal operations of the country. The government must curtail and rationalise its spending, but the economy in crisis does demand more spending. Government needs to raise its tax revenue, but economic contraction in a crisis does not permit generating more revenue.
Fiscal consolidation becomes truly meaningful and progressive only when it is anchored in sustained economic growth. In economies facing severe crises—where household incomes have been eroded by more than two-thirds—imposing high tax rates, both direct and indirect taxes, can be counterproductive.
Squeezed with taxes
These elevated rates place an undue burden on already struggling individuals and businesses, further suppressing consumption, investment, and entrepreneurial activity. Rather than relying on tax hikes, governments should focus on stimulating growth, which organically expands the tax base.
When aggregate demand increases, it leads to higher consumption, thereby boosting indirect tax revenues like VAT and sales taxes. Similarly, as employment and wages recover, income tax collections rise without altering tax rates. Corporate tax revenues also improve when businesses grow, expand operations, and generate higher profits.
This virtuous cycle of growth-driven revenue mobilisation is far more sustainable than punitive taxation, which risks stalling recovery and deepening economic distress. In essence, fiscal consolidation should be growth-friendly—prioritising policies that revive demand, support livelihoods, and encourage investment—rather than relying on aggressive tax measures that may undermine long-term development and social stability.
Pressing need of the time
Therefore, the pressing need of the moment is to launch an aggressive and comprehensive reform programme aimed at accelerating economic growth and ensuring its sustainability over the long term. Such reforms must go beyond superficial adjustments and tackle deep-rooted structural challenges that hinder productivity, investment, and innovation.
This includes streamlining regulatory frameworks, enhancing the efficiency of public institutions, improving infrastructure, and fostering a more competitive business environment. Equally important is the need to invest in human capital through education, skills development, and healthcare, which are critical for long-term resilience and inclusive growth.
By prioritising reforms that stimulate demand, attract investment, and boost employment, the economy can move from stagnation to a dynamic growth trajectory. These efforts must be bold, well-coordinated, and supported by sound fiscal and monetary policies that reinforce stability while enabling expansion. In short, reform is not just an option—it is an imperative for transforming short-term and a temporary recovery from the crisis into long-term prosperity.
(The writer is Emeritus Professor at the University of Colombo and Executive Director of the Centre for Poverty Analysis (CEPA) and can be reached at sirimal@econ.cmb.ac.lk and follow on Twitter @SirimalAshoka).
Hitad.lk has you covered with quality used or brand new cars for sale that are budget friendly yet reliable! Now is the time to sell your old ride for something more attractive to today's modern automotive market demands. Browse through our selection of affordable options now on Hitad.lk before deciding on what will work best for you!