Govt. to raise VAT to 18%  to meet IMF revenue targets

• Cabinet approves President Ranil Wickremesinghe’s resolution for VAT rate increase
• New 18% VAT rate set to take effect from January 1, 2024; to be applied to previously exempted goods and services
• IMF has withheld the second tranche due to Sri Lanka’s failure to meet revenue targets
• Tax revenue increased by 51% in the first nine months of 2023, yet falls short of IMF targets
• Sri Lanka has one of the lowest tax-to-GDP ratios globally, estimated at 7.3% in 2022
• However, uncertainty surrounds the ability of new taxes and increased rates to aid Sri Lanka’s economic recovery
• People already struggling with declining real income may resist higher tax rates

The government yesterday announced plans to hike Value-Added Tax (VAT) to 18 percent from the current 15 percent to meet the revenue targets set by the International Monetary Fund (IMF).
Cabinet Spokesperson Bandula Gunawardana yesterday told reporters in Colombo that a resolution forwarded in this regard by President Ranil Wickremesinghe as the country’s Finance Minister was approved by the Cabinet of Ministers. 
The increased VAT rate is scheduled to come into effect from January 1, 2024.

The Department of Government Information said in addition to raising the VAT rate, the new rate will also be applied to specific goods and services that were previously exempted from VAT. VAT is a consumption tax levied on goods and services ultimately paid by the end consumer. It is often considered a regressive tax because it tends to have a disproportionate impact on lower-income individuals and households. “Sri Lanka so far hasn’t received the second IMF tranche because we couldn’t meet the revenue targets set by the IMF,” Gunawardana said, explaining the rationale behind the Cabinet’s decision to approve the VAT hike.

He said even though the tax income has risen by 51 percent in the first nine months of 2023 compared to 2022, such income has not yet reached the targets set by the IMF.
“Government revenue increased to Rs.1.7 trillion in the first nine months when compared to last year.But this amount is barely sufficient to pay public sector salaries, meet welfare payments and other recurrent expenditure,” Gunawardana said.

According to IMF estimates, Sri Lanka is likely to fall behind achieving the revenue targets agreed with the multilateral lender by 15 percent by end of this year. As per the agreed targets, Sri Lanka needs to raise government revenue equivalent to 12 percent of GDP by 2024. 
 Sri Lanka secured a staff-level agreement with the IMF on the first review of its US$ 3 billion Extended Fund Facility recently.

But the disbursement of the second tranche of the facility, which amounts to about US$ 330 million, is subject to IMF Executive Board approval. 
And the Executive Board’s approval is contingent upon the government implementing all the prior actions—which include revenue targets—and reaching a debt restructuring deal with the country’s external creditors.

The statement issued by the IMF on October 19 following the staff level agreement said, “All indicative targets were also met except the one on tax revenues.”
According to the World Bank, Sri Lanka has one of the lowest tax-to-GDP ratios in the world. Sri Lanka’s tax-to-GDP ratio in 2022 was estimated at 7.3 percent. Also, the country’s tax system stands out with its small base and complexity.
Sri Lanka’s significant tax cuts in 2019, combined with the pandemic, are widely seen as the primary factors contributing to the unprecedented economic crisis that the island nation experienced in 2022. 

In mid-2022, the incumbent President Ranil Wickremesinghe revised these tax cuts and implemented a series of additional measures aimed at improving the country’s fiscal stability. Analysts and economists expect further revenue raising measures in the upcoming 2024 budget in November, which could include the introduction of new taxes.
However, the extent to which the new taxes and increased tax rates can contribute to Sri Lanka’s economic recovery remains uncertain, especially as the country has been grappling with a severe economic downturn since 2021. Also, the increased tax rates may not sit well with a population already deeply affected by the economic crisis, as their real income has indeed declined over the past two years. Sri Lanka’s economy contracted by 7.8 percent in 2022 and 7.9 percent in the first half of 2023.