Sri Lanka is betting on tax hikes; perceived downside risks than gains

ECONOMYNEXT – Sharp income tax hikes in Sri Lanka are seen as a gamble with the corporate sector and individuals are set to be hit hard by the move as investable capital turns into current government spending.

The move could discourage and strangle investment, analysts say, though they see boosting tax revenues as well as cutting state spending as the main tools for reducing deficits and debt over the medium term.

The tax hikes come after Sri Lanka declared default on its sovereign debt in April this year. Sri Lanka ran out of reserves after authorities cut taxes and printed stimulus money for two years, ignoring repeated warnings about debt and external sustainability.

The new tax hikes will take the country beyond a pre-2019 tax system with higher corporate tax rates and higher marginal personal income tax rates, although the tax on the added value is back to 15%.

Spectacular creep of the support
The tax exemption threshold is 100,000 rupees per month, as before 2019, but the rupee is now worth around half its previous value, with the dollar collapsing from 182 to 360 against the US dollar in one case. spectacular slice drift.

The highest marginal rate is 36% compared to 24% in 2019.

Corporate taxes which were 28% have been increased to 30% under the new amendments. The 14% preferential rate for exports will no longer be available.

Former President Gotabaya Rajapaksa shortly after his election in 2019 reduced Value Added Tax (VAT) to 8% from 15%, along with several other tax cuts such as Pay As You Earn (PAYE) tax, withholding tax on interest, debit tax on banks and financial institutions and Nation Building Tax (NBT) on household goods.

However, analysts say some tax hikes are needed.

“If you make reforms, there must be a consensus with the people. If you go by force, it will backfire profusely,” economic analyst Umesh Moramudali told EconomyNext.

“In the big picture, everyone in general benefits. Without the tax increases, there will be no IMF finalization and we will not move to the recovery.

Moramudali further stated that without raising taxes, Sri Lanka will print more money or borrow more, which has more negative effects than higher tax rates in an economy.

“For the proper functioning of the economy, it’s a huge task,” he said.

“But in the absence (of tax), the situation is likely to be much worse,” he said, adding that political mistakes are the main reason for the country’s current situation.

While the public greeted the value-added tax hikes with little protest, income tax was pushed back sharply. People pay value added tax as they spend, but income taxes are levied on unspent money and must be paid in a lump sum.

State charge
Members of the public see a bloated civil service filled with unemployed graduates, and dozens of ministers and ministers of state wonder why they should pay taxes for an inefficient state.

However, the flip side is that when people pay income tax and feel it, they may become more aware of increased government spending, such as giving free jobs to jobless graduates and loss-making state enterprises in the future, according to some observers.

One of the issues that led to the current crisis, according to some critics, was “revenue-based fiscal consolidation”, an unusual strategy where expenditure-based consolidation (cutting costs), a necessary part of what commonly referred to as fiscal consolidation, has been abandoned.

As a result, expenditure relative to GDP has increased from 17% to around 20% of GDP from 2015 to present.

Trevor Mendis, an economic strategist, said people in Sri Lanka have insufficient incomes with rising cost of living, which is creating a burden on a certain sector of the economy, mainly for parents with sent children. abroad and the elderly.

“Long term, the tax base, tax records and tax rates need to be increased to support economic recovery,” Mendis said.

Sri Lanka’s government revenue to gross domestic product (GDP) fell to a record low of 8.7% in 2021, from more than 20% in the 1980s, according to official data.

“Kimbula Bunis”
The opposition claims that taxes are too high right now.

Opposition lawmaker and chairman of the Committee on Public Finances (COPF), Harsha De Silva, said the government should introduce affordable tax rates to make further reforms before people go down the drain. street.

“What the government is doing is like shoving a kimbula banis down the throats of the people, which is like choking and dying,” Silva said at a press briefing last week.

Others say that businesses also need a better environment to operate, and it is balancing itself out.

Murtaza Jaferjee, chairman of Colombo-based think tank Advocata, said incentives for private companies to generate profits are more important than paying taxes once profits are made.

“Government incentives should be focused on reducing regulatory hurdles and reducing the time it takes to complete projects and reducing upfront taxation,” Jaferjee told EconomyNext of the tax drop.

“While this discourages risk taking, the focus should be on expanding the country’s economy,” he said.

A problem with income tax is that the government takes away investable capital before the investment decision is made.

As a result, in countries with little or no income tax, such as in the GCC region and the Middle East and at one time in the Maldives where there was no income tax, l employment exceeds population by several times. Sri Lankans are looking for jobs in these countries.

Unlike turnover taxes, income taxes can be volatile and procyclical.

The proposal will go to parliament for a vote and it is unclear if any changes will be made given the critical state of state revenues.

President Wickremesinghe said wealth tax could also be on the way, another potential minefield where people could be forced to pay taxes on assets that don’t generate cash. (Colombo/October 13, 2022)