Today (11th Feb), I’ve launched a new column titled ‘Smart Future’ in the Daily Mirror Business section, which will come out every Wednesday. The column will be short opinion pieces, on contemporary economic issues. My aim is to widen the debate to reach a larger readership, and advance ideas on economic reforms, innovation, and private sector development.

Tax Reform: Time to Stop ‘Kicking the Can Down the Road’

Tax matters don’t make for the most riveting of conversations. For most people ‘tax’ is that cumbersome thing that needs to be filed in time to avoid getting a ‘red notice’. Debates on tax issues in Sri Lanka rarely extend beyond the immediate days after Budget speeches. The recent Interim Budget was particularly contentious, with the imposition of a range of “one-off taxes” and taxes aimed at particular sectors and types of firms. Yet, we seem to be unable to embark on a concerted tax reform effort that transcends immediate political and fiscal concerns. The fact is that Sri Lanka’s tax performance is worrying. And in the context of reduced concessional financing (as Sri Lanka has moved in to middle-income status), finding the money from domestic sources (i.e., ‘domestic revenue mobilization’ – taxation) to finance emerging development needs in education, health, infrastructure, science, etc., becomes critical.

Low Tax Take

Sri Lanka’s tax-to-GDP ratio of below 12% is lower than many peer countries like Vietnam, Malaysia, and Thailand; lower than the middle-income country benchmark of 25%; and lower even than the low-income country benchmark of 18%. The country’s GDP has grown without a concomitant rise in tax revenue collection, and it appears that Sri Lanka’s tax system has not kept pace with changes in the economy. It has not evolved with the changes in composition (rising services sector), emerging business models and sources of income, rising informal work, etc. Unplanned and ad hoc revenue measures and long exemptions lists continue to be key features of the Sri Lankan tax system that is long overdue for streamlining. A complicated system makes collection harder and makes compliance trickier to enforce.

Shift to Direct Taxes

The country has only approximately half a million income tax payers and collects just around 25% of total taxes from direct sources (i.e., taxes on income and profits), while the rest is from indirect taxes (mainly consumption-based taxes like VAT), which hurt the poor disproportionately as they are inherently regressive. Many other countries’ have a higher direct tax proportion – Malaysia (over 60%), India (over 50%), Pakistan (around 40%), Thailand (50%), Uganda (just under 30%), and Kenya (around 42%). Sri Lanka needs to up its direct tax take – whether it is through a revisiting of the rate structure or better collection and auditing, or indeed a combination of the two. Relying on one-off and ad hoc taxes like the recent Super Gains Tax is far from ideal.

Tax Commission Report

I was fortunate to work with the Presidential Commission on Taxation 2009, which submitted a trilingual report on tax reform in 2010. The Commissioners of the PCT were leading lights in the private and public sectors and academia, and under the leadership of eminent economist Prof. W.D. Lakshman, produced a comprehensive report dealing with everything from VAT reform, tax incentive reform, revenue administration re-haul and IT systems adoption, and more. In compiling the report, I was very impressed with the extensive consultations, the lively internal debates, and the nuanced yet pragmatic approach of all the Commissioners. The analysis was anchored to Sri Lanka’s evolving socio-economic needs, realistic political scenarios, and inherent administrative constraints. It is strange as to why the report was not made public, for even the potentially controversial LLRC report was released for all to read. Under the reform-minded new government, there is a new opportunity for the Report to be taken up. The merits and demerits of its recommendations can be re-assessed, and a suitable reform programme based on them can be mapped out. These efforts can be complemented by the excellent analytical insights of think tanks like the International Centre for Tax and Development (under IDS, Sussex) – one of the few Western research institutes that focuses on tax matters with an intimate understanding of developing country contexts.

Tax Talk

We need a stronger and wider discourse on taxation that permeates through all of society; it should not be the preserve of just the business community, tax advisors and fiscal policy officials. The majority of the public feel that tax issues are not their issues. We need a tax movement that reminds more people that whenever they buy food or other household items in a ‘kade’ or a supermarket, or whenever they pump fuel in their vehicle, they are paying indirect taxes like VAT to the state. We must also remind people that the little tax revenue that is collected should not be wasted due to mismanagement of public funds and state resources. For example, one-third of income tax collected in 2013 was wiped off by the aggregate losses of just 12 loss-making State-owned Enterprises (SOEs), and these losses wiped off Rs. 26 out of every Rs. 100 that was paid as VAT by you and I in 2013.

Running Out of Road

Tax reform won’t be easy. It will be politically challenging and administratively time-consuming. Yet, without a clear and comprehensive tax reform programme, Sri Lankan authorities will have to keep undertaking ad hoc measures to raise revenue, and inconsistency in tax policy hurts business sentiments and hurts the country’s attractiveness as an investment destination. Sri Lanka cannot continue to kick the tax reform can down the fiscal road. Soon, we may run out of road.

‘Smart Future’ is a column dedicated to advancing ideas on economic reforms, innovation, and private sector development.