Carefully considered tax actions will ensure viable revenues

By Kumar Ranaweera
Raising revenue is a vital function of tax to combat fiscal constraints. In addition to financing activities of the state, it is also an important element for maintenance of law and order. Ideally, taxes should minimise discrimination in favour of or against business and consumer choice and reduce costs of compliance on organisations and government.

Tobacco taxes are central to government budget discourse and will no doubt figure significantly in the state’s revenue plan for 2022. Sri Lankan smokers have long been a cornerstone of government revenue, puffing out billions of rupees to fund the state machinery, development and national security measures. 

However, the past 15 years have witnessed a significant growth in government expenditure alongside dwindling revenues. To bridge this gap, governments effected a raft of tax and price changes to a multitude of products, with cigarettes bearing the brunt of the pain. A packet of cigarettes in Sri Lanka is today the most expensive in the world, reports the World Health Organisation (WHO) in its Global Tobacco Epidemic Report of 2021.

Considering Sri Lanka’s prevalent predicament, the government must exercise caution with revenue measures and adopt a balanced approach over the medium term. Cigarette price hikes between 2016 and 2019 have led to a drop in government revenue, which fell by as much as Rs.15 billion over the past two years. Revenue fell as much as Rs.10 billion in 2020, with volumes of legal cigarettes dipping 13 percent. 

Cigarette taxes attract attention from a myriad of vested groups. The once hallowed WHO too has descended to the depths of a mouthpiece for such organisations, for the purpose of funding, which has dried up in recent years. The WHO and affiliated agencies in Sri Lanka will no doubt call for a hike in cigarette prices once again, claiming this to be the panacea for all that ails revenue. But can we really afford one? Can we really eke a further Rs.20 billion by hiking cigarette prices when all indicators point otherwise. 

Since 2015, the cigarette prices in Sri Lanka have increased as much as 117 percent, whilst annual inflation stood at about 4 percent. In 2019, the cigarette prices increased by much as 17 percent. The resulting impacts to the government revenue are reflected in flagging earnings, as alluded to above. 

The volume decline translated into a drop in state revenue generated through excise, other levies and taxes for the first time in history. The government needs to effect urgent measures to significantly enhance revenue and the process entails a careful consideration of all sectors and how the existing tax regimes are affecting performance. “It was not curiosity that killed the goose that laid the golden egg but an insatiable greed that devoured common sense,” averred one Bucchianeri.

With Sri Lanka’s headline inflation at 6 percent in August and consumer spending power severely hampered due to the pressures of the economic downturn, further price hikes will significantly erode government earnings from the sector. 

A European Commission report on Sri Lanka from July this year concluded: “High levels of food insecurity and disruptions across domains such as income, asset ownership and agriculture could have short- and long-term effects on people’s health, nutrition and well-being.” 

Naturally, people will spend less on cigarettes this year. To compound an already anticipated revenue shortfall with a negative price measure will only burn deeper holes in government pockets.

Furthermore, excessive pricing leads to increased incidence of smuggling. The WHO and its agencies accept evidence that high prices of cigarettes can motivate smuggling– a very pertinent problem in Sri Lanka, resulting in a revenue erosion, as much as Rs.40 billion annually. Perhaps, the most effective way to raise revenue from tobacco by a further Rs.20 billion, would be for government to curb illicit activity and drive sales toward legal products. 

However, authorities and lobby groups pay scant regard to large-scale illicit activity and the losses incurred. In its presentation titled ‘Illicit Trade In Tobacco’, the WHO says, “The evidence does show that price and tax differences can motivate bootlegging by individuals, especially in border or transit areas” and that “highly organised, large-scale smuggling is typically the main threat to the government’s tax base and to public health.” 

These enabling factors must be curbed and the industry appears to share the standpoint of the WHO. 

To quote from Ceylon Tobacco Company’s (CTC) annual report last year: “Allowing the illicit trade to continue unchecked will not only threaten the government’s ability to generate sustainable revenue but also hamper the delivery of its public health commitments. CTC continues to stress the necessity for a more stringent policy and regulatory framework to fight this disturbing phenomenon. Since an illegal trade has a far-reaching impact on the country, greater public awareness on the issue, effective enforcement and increased penalties are needed to curb its spread. It is CTC’s firm belief that restricting illicit trade is essential for the sustainable growth of state revenues and for protecting the rights of the legitimate industry.”

An efficient and level tax system will contribute to effective tax collection and compliance leading to greater levels of productivity and higher revenue to the government - tobacco taxes in Sri Lanka being a good case-in-point. 
(An undergraduate of the University of Colombo, Kumar Ranaweera also serves as Research Assistant at a leading audit firm in Sri Lanka)