Sri Lanka continues to flout key principles of tax policy: economist

• Ideal tax systems should raise revenue without distorting economic incentives, according to economist Dr. Sharmini Coorey
• Points out that Sri Lanka’s tax system relies heavily on indirect taxes and favours taxing labour over capital, which raises fairness concerns
• Says personal and corporate tax increases are positive steps, but indirect taxes still disproportionately impact low-income households
• Stresses that reliance on Gazette notifications for major tax policy changes creates uncertainty and corruption risks
• Highlights that complex tax systems with multiple rates, exemptions, and arbitrary decision-making enable power abuse and serve vested interests

By Shabiya Ali Ahlam

COLOMBO (Daily Mirror) - Although Sri Lanka’s tax system saw some improvement with the reforms implemented in 2022, the island nation still violates all key principles of tax policy, a senior economist said.

In an ideal scenario, a tax system should generate revenue without distorting incentives related to any specific economic activity or choice. According to Presidential Advisor and former International Monetary Fund Director Dr. Sharmini Coorey, Sri Lanka has not achieved success in this regard.

The first indicator of Sri Lanka’s shortcomings in this area is its excessive reliance on indirect taxes over direct taxes, as well as its preference for taxing labour over capital.

“Both aspects violate the principle of fairness as indirect taxes shift the tax burden towards the poor who spend more of their income on goods and services, while capital income accrues mainly to the rich,” said Dr. Coorey, addressing the 73 Annual oration of the Central Bank of Sri Lanka last week.

She noted that the increases in personal and corporate taxes, which fall under direct taxes, are a positive step.

However, indirect taxes still represent a larger proportion of pre-tax income for households in the bottom income decile, standing at 11 percent, compared to the 8 percent share for households in the top decile.

The second piece of evidence that confirms the violation of tax principles is that corporations continue to benefit from substantial tax holidays.

With the tax reform of October 2022, most companies are now subject to a standard 30 percent corporate tax rate, however, projects continue to receive wide-ranging tax exemptions under the Strategic Development Projects Act. 
Under this Act, based on vague criteria, projects can negotiate exemptions from eight different tax laws, including corporate, personal, VAT, excise, and customs for as long as 25 years.

“Such extensive tax holidays cannot be justified. Let’s be perfectly clear that tax exemptions are the equivalent of a cash payment from the government to special interests. It’s as if the corporation paid the standard tax and the government gave an equivalent amount to the corporation instead of spending it on social needs or repaying public debt,” asserted Dr. Coorey.

Given that the tax exemptions mainly benefit the shareholders of corporations who are not merely rich, but are super rich, Sri Lanka typically extends welfare for the rich and the super-rich that far outweighs the small amounts the government transfers to the poor through programmes like Aswesuma, she added.

The third example of poor governance in taxation in Sri Lanka is the reliance on Gazette notifications for implementing major tax policy changes, which makes the tax system uncertain and increases opportunities for corruption.

Dr. Coorey pointed out that the initial step in addressing this issue is to establish transparency and simplicity, as both are essential for ensuring good governance.

Complex tax systems with multiple rates, exemptions, and scope for arbitrary decision-making open room for abuse of power and benefit vested interests.  

She pointed out that by contrast, a uniform tax system, rules-based, and grounded in clear, simple principles promotes not only fairness but also fiscal sustainability through higher tax revenues because of limited leakages and increased compliance.

"Two aspects of the tax system—tax policy and tax administration—need to be considered. But generalisations are not enough, we need specifics,” she said.

10-point action to improve governance on tax policy
 

• Pass an overarching tax law requiring tax rates to be set in a uniform, non-distortionary manner: Any deviations or exemptions from standard schedules would need to be justified through an impartial cost-benefit analysis by the Ministry of Finance that is published and presented to Parliament for approval.
• Reset existing tax exemptions to end in 3-5 years: If performance criteria—in terms of investment and job creation—had been set at the time the exemption was granted, discontinue the exemption until the corporation has proved it has met all criteria.
•  Abolish the Strategic Development Projects Act and the Special Commodity Levy Act. 
•  Suspend granting tax concessions under the Colombo Port City Act and bring any proposals for new tax concessions under the Ministry of Finance: Amend the Port City Act to make this a permanent feature.
• Create a single tax policy department within the Ministry of Finance even before formal legislation is passed: Transfer authority to that department to design and evaluate customs duties, excise taxes, and any new tax concessions, including in Port City, based on clearly defined criteria.
• Ministry of Finance should independently quantify all existing and new tax expenditures under the various tax acts every year: including revenue foregone in each Port City or other project, and report them in a transparent, disaggregated format on a public website.
•  Strengthen the management of the revenue departments and oversight by the Treasury Secretary and the Auditor General: The three revenue departments are after all departments within the Ministry of Finance, therefore they have to take on the responsibility, and the Secretary to the Treasury must supervise them properly.
• Prioritise the Large Taxpayer’s Unit: Staffing and empowering this unit with the skills needed to track and minimize tax evasion by the super-rich is essential.
• Reduce opportunities for corruption by digitising tax collections by Customs, Excise, and IRD, including by fully operationalising the RAMIS system.
• Pass a Tax Administration Act: One that applies to all taxes and contains provisions to effectively deter corruption by imposing strict penalties, including criminal charges, on taxpayers as well as tax officials for offering or taking bribes or aiding tax evasion.