Tax axed? Tax fixed?

Sri Lanka’s Cabinet of Ministers gave the green light to increase the revenue collections of the Government. The tax policies in place that were axed in an effort to garner popularity in 2019, subsequently causing macro-economic turmoil, are now back - reinstated in greater force. Expecting to raise tax revenue of Rs. 125 billion for the rest of the year and Rs. 195 billion in total for 2022, the Government is to impose the new tax system from October.

Personal income tax is to be raised to 34% at the highest bracket and corporate tax to 30%. Taxes on individual earnings are considered to be ‘progressive’ as they are implemented within brackets at increasing rates. This raises the amount payable for excess earnings past certain points while avoiding the burden passed on to lower income groups. A significant change would be the new personal income tax level starting at earnings of Rs. 1.8 million per annum. This means that workers earning over Rs. 150,000 per month ($ 429) would be required to open a tax file. According to Finance Minister Ali Sabry, Sri Lanka lost about a million taxpayers over two years following the 2019 cuts. A reversal of administration practices through the imposition of collection at source systems, such as PAYE and WHT, would also prevent previously seen tax avoidance.

Flat taxes that would increase the cost of the item regardless of the purchaser’s income group have also been increased. The telecom levy at 15% and value added tax being raised an additional 4%, while usually considered to be regressive, is necessary given the mammoth task of raising slumped Government tax incomes. 

Following the current announcement, which also includes changes to corporate exemptions and significant increases to import tariffs, no other major tax change is to be expected in the current climate. With import and export imbalances flattening out with time, the expected increases to Government coffers would reduce stress on finances and reserves. A disciplined budget that will not tolerate previously seen populist stances would benefit the Central Bank as well. Money printing would not be a dependent source of funds. This was reflected in the market on Wednesday with auction results seeing bids at lower rates, indicative of lower perceived volatility and financial risk.

Certain tariff impositions on commodities such as electricity and fuel would largely mitigate the subsidisation impact on ineffective and loss-making ventures and state-owned enterprises, albeit, at the cost of the consumer. In the recent past, the Government and central bank have flirted with the idea of asset sales and reform to the public sector. This too would greatly ease pressures on the twin deficits that are the Government budget deficit and the current account deficit on the balance of payments. However, given the time lags for the processes in play, these positive results are unlikely to materialise in the next six to 18 months. 

In 2021, the Government budget deficit stood at Rs. 2 trillion as a result of the 2019 slashes to tax and untamed public spending. Currently, there is unlikely to be a significant change to expenditure, other than the savings on the dollar denominated debt as a result of the strategic default. This too would likely be channelled to other sectors in the economy. With these tax proposals in place, greater revenue mobilisation and a strengthened Central Bank, the current economic fire fighting is our best fix.