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The Voracious and Vociferous VAT

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2 May 2016 11:54 pm - 2     - {{hitsCtrl.values.hits}}

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Value Added Tax (VAT), in other words is tax on value addition. According to economists, a shirt, for instance, would cost Rs. 800 and would be sold for Rs. 1,000. In this case, Rs. 200 is the value addition and it is subjected to the VAT imposed by the government.

 

 VAT is also termed as a regressive tax as research proves that the poor pay a higher percentage of their income in comparison to what the rich have to contribute. As a result, VAT makes a deeper and harsher impact on the economy of the poor, and even the rich pay a considerably high price at the hands of the increase in VAT. However, there is an array of arguments with regards to the VAT hike from 12% to 15% from May 2, where both pros and cons are discussed. It certainly sounds like a quick fix for the government to breach their ever-expanding budget deficit. Though VAT is inequitable for the people, it surely has its rewards in terms of tax collection as it is an indirect tax. Taking into account the current status quo of Sri Lanka, where we are suffering from a severe financial crisis, it can be perceived as a solution that should be considered.
The Daily Mirror conducted a few interviews with regard to this subject. It is not a question of whether one is for or against such an action, but finding the best solution for the country facing a severe financial crisis.

Vincent Mervyn Fernando in his comments said, “When we look at the total government revenue structure in terms of tax revenue and non-tax revenue, we observe a decline in the GDP percentage. Statistically, the decline is 17% in year 2000 and 13% in year 2015. The IMF has cautioned the government to reduce the budget deficit, which should be maintained in accordance with 5.2% of the GDP. This is why the government decided to increase the VAT up to 15% from 11%.” He further stated that the IMF had asked the government to prune down unnecessary expenditure and initiate measures to ensure an increase in government income.
“However, the government has a few exceptions. Accordingly, VAT will not be applicable on medicine, utility and electricity bills. VAT changes proposed by the notice issued by the Finance Ministry include proposals to reduce the registration threshold (limit) which currently stands at Rs. 15 million per annum to Rs. 12 million per annum. Nevertheless, the highlight is that the Rs.12 million threshold would now be applicable to wholesale merchants and retailers as well,” he noted.
He elaborated that certain VAT exceptions had been removed. “The supply of telecommunication services, import or supply of telecom equipment and high-tech tools including copper cables for the telecom industry, the issue of licences to local telecom operators by TRC, supply of health care services, supply of goods or services to any specified projects other than housing projects will now be subjected to VAT.” He added, “Though it has been announced that the hike will not be imposed on essential goods, it’s noteworthy that consumers purchase other goods such as electronic items that have become essential in this modern world.”


Reasons Behind The Hike 


When asked about the motive behind the VAT increase, Mr. Fernando commented, “To receive votes and win elections, politicians promise various subsidies and increments in salaries. And once they come to power, they have to fulfill their pledges, for which there should be finances.”
He pointed out the reason behind the increase with reference to the latest Annual Report published by the Central Bank in 2015, “Revenue collection from VAT declined significantly primarily due to the reduction of the VAT rate from 12% to 11% with effect from January 2015, and the removal of VAT on excisable items such as motor vehicles, cigarettes and liquor under the interim budget presented by the new government. Accordingly, revenue from VAT as a percentage of GDP dropped to 2% in 2015 from 2.6% in 2014. In nominal terms, the revenue from VAT declined by 20% to Rs. 220 billion from Rs. 275 billion in the previous year. Thus, VAT revenue generated from domestic economic activities declined by 6.8% to 131 billion, while revenue from VAT on imports also declined by 34% to Rs. 89 billion when compared to the previous year. The revenue collection from VAT as a share of total VAT revenue dropped to 16.2% in 2015 from 26.2% in the previous year, which was the highest single contributor to tax revenue in yesteryears. Furthermore, as a percentage of total revenue, revenue from VAT declined to 15% in 2015 from 23% in 2014. This is why the governments wish to increase VAT.”
Mr. Fernando also said that there were various solutions to replace the increase in VAT, but their implementation 
processes were challenging. “You can control subsidies, but then again, people are not in favour of this. We could also print money through the Central Bank, which would, on the other hand, result in an inflationary tax which is dangerous. The third option is to obtain domestic and foreign loans, but domestic loans adversely affect the private sector. They are discouraged and our economic growth ultimately goes down. Foreign loans are ineffective in the long run. However, the previous government obtained excessive loans for infrastructure development, and as a result, we have to pay back $4 billion within the next 12 months. State institutions running at a loss should be privatized, or should collaborate with private firms. We can apply the strategy practised by the Singaporean company Temasek holdings in order to curb such expenditure.”
Discussing more feasible solutions, he said, “We have already obtained the maximum amount of loans. We need to invite foreign investors to invest in industries so as to secure job opportunities, so that the revenue of the country would flourish. We need to provide subsidies only to a selected group of people, the poor who are truly deprived. For example, the poverty line of the country is 7% while 30% of the population receives samurdhi benefits. Here we see that 23% receive samurdhi unethically.”

“A letter forwarded by the Finance Ministry Secretary to the Inland Revenue Department Commissioner General clearly stated that the increase in VAT would be 15% and that it would also apply to those whose quarterly turnover is Rs. 3 million. Basically, if the daily turnover of an individual who runs a business is Rs. 33,350, then he would be required to pay 15% as VAT,” JVP Parliamentarian Vijitha Herath said.
“This hike affects everyone. The price of many goods and services will increase subsequently. Everyone’s economy will collapse. Long-term investments would be affected compelling people to curtail the use of consumables. Rs. 44 of a Rs.100 reload would be taxes. This 44% tax includes 25% as communication levy, 15% as VAT, 2% as cess and 2% as NBT (Nation Building Tax). Hence, only Rs. 56 is ultimately enjoyed by the consumer.”
When asked if the VAT rise could be justifiable as the revenue earned would eventually serve the ordinary citizen, Mr. Herath said, “It is true that governments cannot run without levying taxes, but an increase should be absolutely rational. We can’t agree with the justification provided by the government. The government is wasting money. In example, the Telecom Board has decided to provide a housing allowance of US$ 5000 to the SLT chairman, and on the other hand, we witness an increase in the number of ministers.”
Referring to solutions, Mr. Herath said the previous government stated that finances could be secured through the reduction of corruption. “But the government has not succeeded in reducing wastage, bribes and corruption.”
“The government should have a strategic plan to increase finances. They should have both short and long term plans to increase production. They should give subsidies to fishermen and farmers. But the government has failed to attend to these so far. 
The government could reduce the tax percentage if they focus on increasing production. And when there is no growth in production, the resort to increase VAT rates, cut down certain reliefs, obtain loans and sell government property,” he added

Prof. Danny Atapattu elaborated on the consequences of the increase in VAT on the general public. “The increase will definitely affect the public through its impact on prices. Further, all imported items will be subjected to VAT. A large number of imported raw materials are used in domestic production, and therefore, the cost of locally produced goods will be inevitably affected by VAT. That is unavoidable. In order to bring stability in public finances and exchange rates, we need this sort of short-term corrective measures.”
The professor said, “The main objective of any tax imposition is to raise the revenue of the government. Imposing taxes on goods or services enjoyed by a niche audience is inefficient as it does not raise adequate revenue for the government. Therefore, from the perspective of increasing tax revenue, VAT is an efficient tax. However, from the equity point of view, indirect taxes such as VAT are extremely undesirable, particularly to those who are in the low-income strata of society, since it directly affects the price levels of goods and services. It is a regressive tax because the burden of the tax as a percentage of income would be much higher on the people with low income when compared to those with high income.” 
Why VAT has to be increased
“All forms of indirect taxes contribute to price increases. Thus, the ideal situation would be to rely more on direct taxes in order to raise government revenue. However, Sri Lanka is still a lower Middle-Income country and the proportion of population with taxable income levels is rather low. Therefore, the scope for direct taxes in Sri Lanka is still very limited. Further, our tax system is inefficient and compliance is low. Even people with taxable income levels attempt to evade paying direct taxes. It has been reported that the number people registered with the Inland Revenue Department to pay income tax was trivial. Yet, this cannot be an excuse for the government to increase indirect taxes. The government should bolster the tax administration mechanism to improve the rate of tax compliance,” he said.
“At present, the government is facing a grave public finance crisis due to the inadequate growth in tax revenue along with a rapid increase in government expenditures. This results in widening the budget deficit. This crisis has been aggravated by the urgent need for servicing the accumulated huge public debt over the years. Especially, the servicing of external debt has resulted in heavy pressure on the limited external reserves of the country. External value of the rupee is perpetually depreciating. Under the circumstances, the government has been bound to seek financial assistance from the IMF under the Extended Fund Facility. Although we could have continued to borrow from the global commercial sources as we have done under the previous regime, the repayment cost would be unbearable as their interest rates are very high. In contrast, the IMF has very concessional rates for its member states. Hence, in order to get the IMF assistance, the government will have to prove that they are following appropriate policies to improve the public finance situation of the country. Especially by refining tax administration and introducing new taxes such as VAT, capital gains tax, nation building tax etc., the government would be able to control the budget deficit. With this in mind, the government proposed to raise the VAT rate as a short-term solution to address the current financial crisis. The current VAT rate is 11%. The previous budget, proposed to have two bands for the VAT, where it is 8% and 12.5%, but that was not implemented.” Talking about the feasibility of VAT in the long run, he said, “It’s not the best solution in the long run. If we consider the long run, we should opt for direct taxes. As a solution, we must improve the tax administration and raise the income levels of the country. We are still at the status of a lower Middle-Income country. Hence, the majority of the people are not in the taxable income level. In the long run, I suppose, if we follow the correct economic policies, we can move from a lower Middle-Income country to a higher Middle-Income country or even a developed country.”
He further elaborated whether the increase in VAT was a viable solution to solve the financial crisis at hand, “Considering the current financial status of the economy, the increase in VAT as a short-term measure. If the country fails to take corrective measures at least at this stage, the general public will have to face much more severe hardships in the near future. The receiving of IMF financial assistance would also be at risk if Sri Lanka delayed the implementation of tax reforms.”
“The increase in VAT rates is not purely an advice of the IMF alone. Any rational person could perceive, that since our budget deficit is constantly widening, there is an urgent need for taking apt measures such as the introduction of new taxes to enhance tax revenues. The proposition that increase in VAT would affect the welfare of the general public adversely is based on the assumption that other things remain constant when the tax is imposed. But, it should be noted that once financial stability is established through prudential policy measures, the other macroeconomic variables such as economic growth, employment, income and exchange rates would respond in a more positive manner in the medium term. Hence, the tax burden on the people would not be a serious issue in the long run,” he added.

 

“The better solution would be a better tax collecting system which is lacking in our country. When there is a more efficient tax collecting system, compliance will be high and tax rates will be low. Discussions have been held for many years with regard to the inefficient tax administration of our country. We need to also simplify and broaden our tax base. In an effective tax collecting system, the tax administration will be computer based and therefore, we would know who has paid taxes and the magnitude of tax evasion. In the current context, taxes such as income tax are at a lower percentage of tax revenue of the government. In an inefficient tax collecting system, the government has to rely on VAT, as collection of VAT is certain. We can introduce higher direct taxes, but tax compliance is low in the country. This is because of the attitude of the people regarding taxes. There is a lack of transparency and in some cases the government uses hard earned tax money for unacceptable activities. This makes the people disillusioned,” Prof. Sirimal Abeyratne said.


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  Comments - 2

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  • sathees Wednesday, 04 May 2016 03:46 AM

    I will never ever vote for UNP in the future!

    Achini Udugama Friday, 13 May 2016 11:30 AM

    Very good article


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