Tax reform: Time to stop ‘Kicking the can down the road’

2015-02-11 03:41:00

By Anushka Wijesinha

Tax matters don’t make for the most riveting of conversations. For most people ‘tax’ is t hat cumbersome thing that needs to be filed in time to avoid getting a ‘red notice’. Debates on tax issues in Sri Lanka rarely extend beyond the immediate days after Budget Speeches.

The recent Interim Budget was particularly contentious, with the imposition of a range of ‘oneoff taxes’ and taxes aimed at particular sectors and types of firms. Yet, we seem to be unable to embark on a concerted tax reform effort that transcends i mmediate political and fiscal concerns.

The fact is that Sri Lanka’s tax performance is worrying. And in the context of reduced concessional financing (as Sri Lanka has moved into middle-income status), finding the money from domestic sources (i.e., ‘domestic revenue mobilization’ – taxation) to finance emerging development needs in education, health, infrastructure, science, etc., becomes critical.

Low tax take
Sri Lanka’s tax-to-gross domestic product (GDP) ratio of below 12 percent is lower than many peer countries such as Vietnam, Malaysia and Thailand, lower than the middleincome country benchmark of 25 percent and lower even than the lowincome country benchmark of 18 percent.

The country’s GDP has grown without a concomitant rise in tax revenue collection and it appears that Sri Lanka’s tax system has not kept pace with changes in the economy. It has not evolved with the changes in composition (rising services sector), emerging business models and sources of income, rising informal work, etc.

Unplanned and ad hoc revenue measures and long exemption lists continue to be key features of the Sri Lankan tax system that is long overdue for streamlining. A complicated system makes collection harder and makes compliance trickier to enforce.

Shift to direct taxes
The country has only approximately half a million income tax payers and collects just around 25 percent of total taxes from direct sources (i.e., taxes on income and profits), while the rest is from indirect taxes (mainly consumptionbased taxes like VAT), which hurt the poor disproportionately as they are inherently regressive.

Many other countries have a higher direct tax proportion - Malaysia (over 60 percent), India (over 50 percent), Pakistan (around 40 percent), Thailand (50 percent), Uganda (just under 30 percent) and Kenya (around 42 percent). Sri Lanka needs to up its direct tax take - whether it is through a revisiting of the rate structure or better collection and auditing or indeed a combination of the two. Relying on one-off and ad hoc taxes like the recent Super Gains Tax is far from ideal.

Tax Commission report
I was fortunate to work with the Presidential Commission on Taxation (PCT)2009, which submitted a trilingual report on tax reform in 2010. The Commissioners of the PCT were leading lights in the private and public sectors and academia and under the leadership of eminent economist Prof. W.D. Lakshman, produced a comprehensive report dealing with everything from VAT reform, tax i ncentive reform, revenue administration re-haul and IT systems adoption and more.

In compiling the report, I was very impressed with the extensive consultations, the lively internal debates and the nuanced yet pragmatic approach of all t he commissioners. The analysis was anchored to Sri Lanka’s evolving socio-economic needs, realistic political scenarios and inherent administrative constraints. It is strange as to why the report was not made public, for even the potentially controversial LLRC report was released for all to read.

Under the reform-minded new government, there is a new opportunity for the report to be taken up. The merits and demerits of its recommendations can be reassessed and a suitable reform programme based on them can be mapped out. These efforts can be complemented by the excellent analytical insights of think tanks like the International Centre for Tax and Development (under IDS, Sussex) - one of the few Western research institutes that focuses on tax matters with an intimate understanding of developing country contexts.

Tax talk
We need a stronger and wider discourse on taxation that permeates through all of society; it should not be the preserve of just the business community, tax advisors and fiscal policy officials. The majority of the public feel that tax issues are not their issues. We need a tax movement that reminds more people that whenever they buy food or other household items in a ‘kade’ or a supermarket or whenever they pump fuel in their vehicle, they pay indirect taxes like VAT to the state.

We must also remind people that the little tax revenue that is collected should not be wasted due to mismanagement of public funds and state resources. For example, onethird of income tax collected in 2013 was wiped off by the aggregate losses of just 12 loss-making state-owned enterprises (SOEs) and these losses wiped off Rs.26 out of every Rs.100 that was paid as VAT by you and I in 2013.

Running out of road
Tax reform won’t be easy. It will be politically challenging and administratively timeconsuming. Yet, without a clear and comprehensive tax reform programme, Sri Lankan authorities will have to keep undertaking ad hoc measures to raise revenue and inconsistency in tax policy hurts business sentiments and hurts the country’s attractiveness as an investment destination. Sri Lanka cannot continue to kick the tax reform can down the fiscal road. Soon, we may run out of road.

‘Smart Future’ is a column dedicated to advancing ideas on economic governance, innovation, and private sector development. Anushka Wijesinha is an Economist and Policy Advisor, with a MA in Economics from the University of Leeds. He blogs at and is on Twitter @anushwij.

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