• New Advocata report says economy heading towards a “precipice”
• Proposes substantial review of current tax system to increase State revenue 
• Wants income tax threshold to be lowered; reduce reliance on indirect taxes 
• Economic analysts largely expect increase in taxes and introduction of new taxes from the upcoming budget 

An improvement in Sri Lanka’s revenue mobilisation effort requires an urgent and extensive review of the tax system, to ensure the government can meet its expenditure commitments, while the country is in the midst of one of the worst macroeconomic crises in its history, economists said.

Pointing out that the national economy is heading towards a “precipice”, Colombo-based economic think-tank Advocata Institute asserted in its latest publication titled ‘A Framework for National Recovery,’ that the “serious erosion” in government revenue and its implications for macroeconomic stability call for a comprehensive review of the tax system.

According to the report, some of the areas that require attention include; reducing the tax threshold and widening the tax base, reintroducing the PAYE and WHT, reducing the excessive reliance on indirect tax as it is currently at about 80 percent, rationalising tax incentives, introducing new taxes, and strengthening the tax administration.

Currently, the income tax threshold in Sri Lanka is four times its per capita GDP, and also higher than the tax threshold in countries with per capita incomes that are several times that are of the island nation. The report recommends bringing down the threshold while also adopting measures to bring in employees into the formal sector so the tax base is widened.

With regard to changing the composition of the current tax structure where the indirect to direct tax ratio is about 80:20, the report pointed out the need to look at effective means to strike a better balance in this regard. The reason being, at the current scenario, it is the lower-income earners who bear a higher burden of taxation. 

There is also a significant concentration of taxes collected from a few commodities such as tobacco, liquor, motor vehicles, and food and beverages, which needs addressing since it increases the regressive nature of the tax system given the items are considered essential and form a higher proportion of the consumption basket of low-income earners.

Furthermore, on strengthening the tax administration, as highlighted over the years, Advocata too asserted the need to facilitate compliance. 

“It also needs to have an effective monitoring system in place. Modern tax administration can be more effective and be made more seamless through the use of technology. 

However, both political will and support of the public are required to put in place a tax system that is both efficient and equitable,” the report stated. 

Sri Lanka last had its comprehensive review of the tax system in 2009 carried out by the Presidential Commission of Taxation under the Chairmanship of Prof. W.D Lakshman, the outgoing Governor of the Central Bank of Sri Lanka (CBSL).

The Commission aimed at fulfilling two main objectives; to facilitate accelerated growth after the end of the 30-year conflict, and secondly, to reverse the revenue decline. However, the report was never published nor the recommendations made were implemented.

The government of President Gotabaya Rajapaksa slashed taxes significantly at the end of 2019 aiming to create aggregate demand in the economy, which was lagging for the last five years.

However, the ill-fated move, shadowed by the emergence of COVID-19, didn’t yield the expected results, but instead it led to global rating agencies to downgrade Sri Lanka’s sovereign credit rating on revenue concerns amid heightening debt repayment risks. The rating downgrades effectively closed doors for Sri Lanka to raise moneys from international capital markets to rollover its foreign currency debt. The country is currently experiencing a foreign exchange crisis on top of a massive debt crisis. 

Analysts expect the government to announce increases in taxes and the introduction of new taxes in the upcoming budget.