It is budget season again. For mainstream economists, budgets are mainly about fiscal discipline, and they focus on the impact of state expenditure on the budget deficit and government debt. For international agencies like the International Monetary Fund (IMF) and World Bank, it is about whether state expenditure will be cut to address their conditions and interests, including shrinking the role of the state, privatization and free markets.
Discussions and debates around the budget tend to focus on state expenditure. Yet, state expenditure is not possible without state revenues, unless the country takes on more debt. Although state revenues depend on taxation, the latter is seldom discussed in relation to the budget, and rarely features in national debates, except when there is a tax increase. Furthermore, taxation in the form of redistribution is at the core of sustaining social welfare, necessary for a decent economic life and to reduce the ever-widening inequalities in the country.
"Discussions and debates around the budget tend to focus on state expenditure. Yet, state expenditure is not possible without state revenues, unless the country takes on more debt"
Sri Lanka can be proud of its post-colonial history of state investment in free education, free healthcare and social welfare more broadly, at least until the devastating open economic reforms of 1977. Such levels of investment in social welfare were possible, for the most part, due to decent levels of state revenues in the decades after independence. However, taxation and tax collection centred on trade instituted in the 1930s, did not significantly shift to income, corporate and wealth taxes; this stagnation of the tax base has contributed to the decline in state revenues and undermined social welfare in recent decades.
In ‘The Political Economy of Long-Term Revenue Decline in Sri Lanka’ (ICTD Working Paper 65, 2017), Mick Moore provides a historically grounded analysis of taxation in Sri Lanka. He shows us that government revenues as a percentage of GDP were on the order of 21% from 1948 to 1990, but declined drastically thereafter with revenues over the last decade much lower at about 13% of GDP. According to Moore, proposed explanations for this sharp fall in taxation during the last quarter century include an archaic revenue collection system, reluctance on the part of successive governments to implement higher levels of taxation given their liberalization orientation, and changes in politics, policies and institutional structures that have led to declining state revenues.
Taking up the latter argument, Moore explains how a combination of political, economic and institutional changes, including electoral pressures co-opted by clientalistic politics, donor aid flows allowing for larger deficits, tax exemption policies, weakening advocacy from the finance ministry for tax collection and reliance on taxes on imports, have all contributed to this decline in state revenues. This dynamic analysis of broader political economic changes are a refreshing entry point for a much needed debate on taxation in Sri Lanka.
"Instead of addressing the root causes of declining state revenues, neo-liberal propagandists push for austerity measures, including cutting state services by blaming state expenditure for the budget deficits"
The crucial issue in contemporary times is that the decline in state revenues and increasing budget deficits are used as weapons by those advocating economic liberalization and particularly privatization. Instead of addressing the root causes of declining state revenues, neo-liberal propagandists push for austerity measures, including cutting state services by blaming state expenditure for the budget deficits. In reality, state expenditure is on the order of 20% of GDP in Sri Lanka, quite low for a so-called middle income country.
Ideological arguments about the inefficiency of the state sector are deployed to further the agenda of a shrunk state and free market economy. The undermining of free education and healthcare, draw from such an attack on state services. In reality, the private healthcare industry for example is subsidized by the state, by allowing public sector doctors to moonlight in private hospitals and clinics.
When fiscal pressures mount and international donor agencies demand reductions of budget deficits, governments resort to increasing indirect taxes including the VAT. The VAT is a regressive form of taxation, with a flat levy on all consumption without considering incomes and equity, whereby the poorer sections of society pay a much larger fraction of their incomes in taxes.
Following on the IMF Agreement of June 2016, the VAT rate was increased from 11% to 15% in November 2016. As a result, total VAT revenue was 26.6% and domestic VAT revenue was 16.5% of total tax revenue in 2017; the latter alone was more the than total income tax revenue. In 2017, income taxes were 16.4%, domestic consumption taxes were 31.8% and imports based taxes were 49.2% of total tax revenue (Finance Ministry Annual Report 2017).
It is no secret that contrary to the stated positions of successive governments to increase direct taxes, indirect taxes have been well over 80% of state revenues. The continued increase in indirect taxes has shifted the tax burden to the broader public and made a mockery of the idea of progressive taxation and redistribution.
"It is no secret that contrary to the stated positions of successive governments to increase direct taxes, indirect taxes have been well over 80% of state revenues"
State, class and citizens
Expanding on Moore’s analysis, I would argue that these problems of lopsided taxation, declining state revenues and the undermining of social welfare spending are tied to a central political question. What is the relationship between state, capital and the citizens, or more simply put, how does the government relate to the wealthy classes and the working people?
The political demands in Sri Lanka for social welfare, since the late colonial period, have been in the form of claims on the state for services rather than for redistribution per se. With neo-liberal policies in 1977, calls for state support have been reduced to hand outs, including paltry poverty alleviation schemes, as opposed to redistribution leading to the strengthening social welfare including universal education and healthcare programmes. Today, demands from ordinary working people tend to focus on subsidies and even trade unions only call for piecemeal pay hikes. Sadly, even after the Budget is announced, the spotlight remains on subsidies to farmers, price cuts to food items or salary hikes for state employees.
Why are corporate and income taxes of the wealthy sections of the country so low? Why is directly redistributing wealth through taxation hardly discussed? Even Nobel Prize winning mainstream economist Joseph Stiglitz advocated wealth taxes including on property, when he visited Colombo two years ago for the Economic Forum. However, economic debates in Sri Lanka are yet to address class inequalities including those of incomes and wealth.
At the height of a recession in the US in 1992, Bill Clinton turned around a major presidential election in his favour with the slogan, “It’s the Economy Stupid.” Speaking about the economy and jobs in neo-liberal America created a shift in the political debate solidifying that phrase for decades. If we are to go further, and debate the need for redistribution and equality as central tenets of tax policies and budget making in Sri Lanka, we may have to start with the slogan, “It’s Class Stupid.”