Sri Lanka explores reforms to tax collection

Sri Lanka has had a poor history of revenue collection. Tax revenues as a percentage of GDP have declined from above 20% in the early 1990s to about 12.2% in 2014. In comparison, Malaysia and Thailand are at about 15%, while Singapore is about 13%. India, however, is at 10%, although it also contains a far larger informal economy.

So while the country has done a good job of increasing per capita income, it has done a poor job of capturing the fruits of that growth. The low levels of collection are the result of tax exemptions and other measures that the government implements to encourage economic activity, but also tax evasion and a weak tax administration. In the World Bank’s “Doing Business 2015” report, Sri Lanka was ranked 158th in terms of paying taxes, far below the country’s overall score of 107.

To boost revenues, Sri Lankan governments have often instituted ad hoc or one-off taxes, but these have not helped in terms of sustainable collection, and have often made the system more complex, and compliance enforcement more difficult.

Critics also note that the country’s previous governments have depended too heavily on indirect taxes, which sometimes affect those least able to afford to pay them. Sri Lanka has a set of customised tax regimes. Efforts to consolidate public debt have historically been based on cuts to the expenditure side and not on improving efficiency in revenue collection. Going forward, debt consolidation will be a necessary centrepiece to reforms. Future revenue increases must come from quality and sustainable sources, which is likely to require a serious look at tax policies.

IMF Advice

The IMF has been pushing for better tax collection and a simplified tax code, and believes that comprehensive reform is needed if the country is going to effectively deal with its fiscal shortfalls. The IMF forecasts that revenues as a percentage of GDP will fluctuate between 12% and 13% from 2015-16, and that the ratio will rise to 13.1% in 2019 and 13.6% in 2020. As with many countries, it is not so much the tax rate itself that is important as the need for a stable, predictable revenue collection system without myriad concessions that erode the overall tax base.

The IMF notes that after 40 years, the annual lobbying cycle has transformed taxes in Sri Lanka to instruments of promotion rather than a means of generating revenue. Simply cutting rates would not increase the total revenue take, as it would not expand the tax base. The IMF has also expressed doubt about the introduction of electronic tax collection as a means to increase the revenue take. It has been critical of the tax policies of the Maithripala Sirisena government, as they are considered to have created uncertainty and have not helped in the development of an effective tax system.

Reform-Minded

Tax reform is particularly important, as the country has moved into middle income status. That means it can no longer rely as much on concessional financing and must generate more funds internally for spending on health, education and infrastructure. The new government is planning work around a better structuring of its tax system. Prime Minister Ranil Wickremesinghe said in late 2015 that he would like to institute reforms that would decrease the ratio of indirect taxes as a percentage of the overall tax take. His government is also taking aim at the system of tax benefits and incentives which were granted in the past because of the civil war, but which peace in the country has made unnecessary. In March 2016, the cabinet of ministers approved an array of tax reforms, including re-introduction of capital gains tax on the wealthier segments of society, retention of corporate income tax at pre-2016 budget levels, and a uniform value-added tax rate of 15%.