Taxing taxes

It is often said the only two certainties in life are death and taxes. The States from the time of monarchies have relied on tax money to run the affairs of the Governments. Taxes have never dominated the public discourse in the contemporary history of this country, as they have done over the last two years. Many citizens are unaware as to why they need to pay taxes to the Government from their hard-earned incomes.

The expansion of the direct tax net since 2022 has created a lively debate about this contentious topic across the mainstream as well as social media. Compared to indirect taxes, direct taxes are politically unpopular. The PAYE tax, which was reinstated by the Wickremesinghe administration last year, has infuriated the educated professionals like bankers and medical practitioners. 

There are only four countries in the world that do not impose income taxes, namely, Bermuda, Monaco, the Bahamas, and the UAE. As this column has previously pointed out, Sri Lanka cannot be a country with low income taxes because social welfare has been an intrinsic legacy of the island since independence. The President too touched on this point during the Budget Speech by posing the question whether the country aspires to be a low-tax nation with limited public services or high-tax country with a large Government involvement?

Unlike oil-rich States in the Middle East that have access to royalty income, Sri Lanka has no option but to extract taxes from its citizens to carry out public services. The benefits of such public spending may not be visible at the first glance. Nevertheless, the general public do get rewards for their tax money indirectly. For instance, prisons that are maintained by the Government from the public funds ensure wrongdoers do not get the opportunity to interact with the society and thereby, cause harm to law-abiding citizens.

Unfortunately, Sri Lanka has a bloated public sector and public servant salaries and pensions represented roughly 55% of the tax revenue during the first four months of this year. Due to the impact of COVID and irresponsible tax cuts in late 2019, the equivalent expenditure in 2020 accounted for almost 87% of the tax income. The aforementioned statistics would explain why the tax base had to be expanded while the rates had to be hiked.

Who is responsible for the massive public sector cadre? At the end of 2001, Sri Lanka’s public sector employment (excluding semi-government agencies) was 863,993 according to the Central Bank. After the conclusion of the two-year Ranil Wickremesinghe administration, it had declined to 785,756 (2003). During the 2004 Parliamentary Election campaign, the JVP-inspired, UPFA coalition lambasted Wickremesinghe for curtailing recruitments to the public sector, and they promised to the electorate that unemployed graduates would be given State-sector jobs upon assuming power. Graduates from State universities (particularly, unemployed) represent a core element of the JVP/NPP vote base. 

Over the decade until 2014, the UPFA administration recruited a number of graduates as Development Officers purely on political considerations. Consequently, the employment in the State sector had increased to 1,068,773 (2014) when the UPFA left office.

As part of tax reforms, online filing of returns has been made mandatory for both corporate and individual income taxpayers. Treasury Secretary Mahinda Siriwardena last week during a public speech expressed hope digitisation would greatly reduce interactions between tax payers and the tax authorities. Meanwhile, as pointed out by Dinesh Weerakkody to this newspaper last week, focus must be directed towards improving revenue collection rather than continuing to increase tax rates and squeezing the existing taxpayers who have been already hard hit.

In the long-term, efforts need to be undertaken to rationalise public expenditure to achieve fiscal discipline without entirely depending on tax hikes, however, politically challenging it might be. In this regard, subsidies given to certain sections of the society, whose support is critical at national elections, need to be terminated as they contribute towards misallocation of resources.