Policy note recommends restoration of efficient tax collection methods dismantled in 2020 to boost govt. revenue

• Sri Lanka Economic Policy Group by Verite Research proposes three policy options, which will help increase tax collection, without making any changes to existing rates of taxation

As the government is in dire need to increase its revenue to GDP by 3-4 percent in the next two years, an effort that is mandatory to improve debt sustainability dynamics, the Sri Lanka Economic Policy Group by Verite Research pointed out that the objective can be achieved by opting for “simple” policy options, which would offer immediate and significant progress. 

In the preliminary assessment carried out by the core group that consists of four leading economists, the policy note stressed the need to focus on reversing the current methods of collecting taxes. The paper called for the restoration of efficient tax collection methods that were dismantled in 2020. 

In January 2020, President Gotabaya Rajapaksa announced major tax policy changes, which led to a reduction in the tax revenue from 11.6 percent of GDP in 2019 to 8.1 percent of GDP in 2020. This reduction in revenue led to a fiscal position that made debt servicing unsustainable and to a credit rating downgrade. All in all, the move locked Sri Lanka out of global financial markets.  

The policy group presented three policy options the authorities can opt for, which will help increase tax collection, without making any changes in the existing rates of taxation. 

Required will be reinstating methods that improve the efficiency of tax collection. 
The proposed options are: (1) to reinstate PAYE at current tax rates and thresholds, (2) reinstate WHT at 5 percent on interest, fees and other income and (3) reinstate WHT at 10 percent on interest, fees and other income. 
With policy options one and two, Sri Lanka can improve tax collection by Rs.40.9 billion from June to December 2022 and Rs.101.5 billion in 2023. 

Whereas with policy options one and three, Sri Lanka can improve tax collection by Rs.75.4 billion from June to December 2022 and Rs.184.2 billion in 2023. The first option mix will help increase revenue by 0.4 percent of GDP in 2023, while the second mix will help increase revenue by 0.7 percent of GDP in 2023.  

The recommendation comes from a core group of economists comprising of Prof. Dileni Gunewardena, Prof. Mick Moore, Dr. Nishan de Mel and Prof. Shantayanan Devarajan. 

The Sri Lanka Economic Policy Group attempted to isolate and identify what share of the decrease in income tax revenue was due to the removal of the PAYE collection method and what share was due to the change in tax eligible income threshold and taxation rate.  

The effort was carried out by assuming the scenario where the PAYE method had not been abolished but the revisions to the tax eligible income threshold and income taxation rates had still taken place.  

Further, using the Labour Force Survey (LFS) data from 2019, the ‘expected’ tax revenue for each year was calculated. For the purpose of this exercise, it was assumed that the income distribution pattern of the employed population in Sri Lanka did not change between 2019 and 2021 and is similar between the formal and informal sectors.