A just tax system

The poor pay a relatively larger portion of their income in taxes compared to the middle class and wealthy in Sri Lanka

Government revenue plummeted since President Gotabaya Rajapaksa came to power. This was driven by tax cuts to corporations and the wealthy, in a bid to increase investment and spur economic growth. Instead of vistas of prosperity and splendour, President Gotabaya brought the country to an economic standstill. His government has failed the current, future and previous generations. 
To restart the economy, we need to earn the trust of our own citizens and of the international community. Our citizens need to see politicians and civil servants working for their benefit, and not for themselves. The international community needs to know that we are on a sustainable path to recovery. Successful negotiations with the International Monetary Fund (IMF) is crucial to this second point. As part of any reform package, we will need to implement significant revenue measures with stable, predictable tax policy and undertake cost rationalization. 
A country’s tax policy reflects its priorities. It shapes a country’s economic behaviour, but also its social and cultural practices. Taxation chooses winners, and by definition, losers. We have a historical moment to realign government finance with our values. This article will explore certain principles that such revenue-based fiscal policy should adhere to. 

Burden should fall on those who can carry it

We are used to boasting about Sri Lanka’s gorgeous natural beauty, ancient culture, and delicious food. Two more things to this list: having one of the world’s lowest tax-to-GDP ratios, and a highly regressive tax system. This means that as one’s income rises, their tax burden falls. The poor pay a relatively larger portion of their income in taxes compared to the middle class and wealthy in Sri Lanka. 
Many imported consumer goods are expensive because of high para-tariffs. This hurts the end consumer, and disproportionately impacts the poor. It also hinders competitiveness in the local economy. As a country, we decided that we were comfortable with lower income families paying higher taxes if it benefited the pockets of rent-seeking businessmen. Is this the type of economic system we want to have? 

"President Gotabaya Rajapaksa introduced the tax amnesty bill as a quick fix to this problem. Similar to his 2019 tax cuts, the Finance Bill rewarded the rich, the corrupt, and the dishonest"

Avoid tax exemptions

Sri Lanka has a history of using tax exemptions as a policy tool to encourage Foreign Direct Investment (FDI). This practice needs to stop. More often, the tax exemptions have functioned as concessions for leaders of local industry, protecting them further from building more competitive businesses. Let’s not forget that a large portion of the tax policy that President Gotabaya implemented in November 2019 was driven by rent-seeking businesses and professional bodies. 
Research shows that preferential tax incentives are not enough to attract foreign investment and industrial development if the overall environment is not conducive for business. Companies care about simplicity and stability in a country, especially when the cost of doing business is high. Instead, it would be better for Sri Lanka to invest in physical infrastructure and human resources, cut red tape and streamline processes. Investors are encouraged to enter a country if the returns on investment is larger than the risk they would be taking. Tax exemptions are not enough to diminish the risk of investing in Sri Lanka for investors if there is no economic and political stability. 

Rationalize excise taxes

One other place where we can improve tax revenue is through excise taxes on cigarettes and alcohol. During the Yahapalanaya government, we had introduced a formula that indexed cigarette taxes to income and inflation. Verite Research has found that reverting to the formula could lead to additional revenue of Rs. 45 billion in 2023. 
Taxing cigarettes leads to healthier outcomes for people and higher revenue for the government, without destroying the industry. This type of taxation policy for cigarettes is commonplace in many places. Many worry that an increase in cigarette taxes could lead to an increase in beedi smoking, which has worse effects on people’s lungs. However, this claim is not well substantiated.  

Strengthen compliance

Tax compliance comes down to the value of fairness. Sri Lankan citizens do not want to pay taxes if they think others are not also paying their fair share of taxes. This sense of unfairness can lead to moral justifications for tax avoidance and tax evasion. Why should a teacher or a private sector employee pay regular taxes if a businessman, and recently sworn in Member of Parliament did not pay Rs. 1,150 million of taxes from 2015 onwards for the businesses he owns? 

It is important to ensure that everyone is treated equally under the law, and that all those who avoid taxes are dealt with under the full force of the law. The Financial Crimes Investigation Division (FCID) could be strengthened to respond to tax irregularities. Ensuring compliance of corporations and wealthy individuals can also increase morale and trust in government – which is sorely needed at present. 

President Gotabaya Rajapaksa introduced the tax amnesty bill as a quick fix to this problem. Similar to his 2019 tax cuts, the Finance Bill rewarded the rich, the corrupt, and the dishonest. It allowed those with undeclared mansions in Sri Lanka, stacks of gold, and overflowing US dollar bank accounts to regularize these assets by paying a tiny penalty. The Bill did not just legitimize tax evasion. It allowed tax evaders, who have committed a crime, to keep the gains from their fraud. This was also Sri Lanka’s 14th tax amnesty – clearly a tried, tested, and failed policy. This type of legislation needs to end. Instead, we need to focus on tax collection and tax enforcement. 

Next steps

Tax policy needs to be realigned with our country’s values. If we are serious about social justice, then we need to ensure our tax system does not overburden the poor. We can mobilize government revenue through corporate tax, income tax and Pay-As-You-Earn (PAYE) tax. Increasing rates, reducing thresholds, and removing exemptions while strengthening compliance measures is the first step. 

The author is a former VP - Citibank and Director/CEO, National Development Bank