Past policy blunders haunt revenue expectations, 2024 offers hopes of a fix

It is also imperative for the Government to apply brakes on its failed excise tax strategy; better still to reverse it. Narrow-minded draconian tax policy has all but killed the golden goose, with contributions from the cigarette and alcohol industry plummeting

By Lal Gunatunga

With revenue still a primary concern in the fight to resuscitate the flagging economy, policymakers must learn to depart from tradition to bolster efforts. This becomes imperative in the absence of proactive measures to reduce cost.

Year 2024 would likely be a difficult one for the global economy and pose multiple impacts to Sri Lanka. On top of the Middle Eastern crisis, the slowdown in Europe and the US would impact exports and earnings, thereby managing costs and income becomes crucial. With the economy and a public pressed to the wall in an election-year, this could present an opportunity to undo some of the policy blunders made previously in the name of populism, propaganda and politics.

Effective steps needed to widen tax net

In the first place, the Finance Ministry must adopt effective measures to widen the tax net. There is no space to increase taxes on an already bludgeoned middle class, and the Government must take necessary steps to expand the net to those evading the system. Collections are far below projections for this year, despite the claimed infusion of technology. It is imperative to link the Inland Revenue Department with the Land Registry and the Motor Vehicles Department to achieve this end. Such connectivity has been achieved in more complex markets such as India, and for a country (Sri Lanka) producing technology that powers some of the largest stock exchanges in the world, this linkage should be a mere cakewalk. It is encouraging to see budgetary proposals that seek to further introduce technology in the tax collection mechanism which would result if not streamlined, in indiscriminate collection of taxation.

It is also imperative for the Government to apply brakes on its failed excise tax strategy; better still to reverse it. Narrow-minded draconian tax policy has all but killed the golden goose, with contributions from the cigarette and alcohol industry plummeting. Similarly, the growth of illicit markets and their impacts have become discussion points in Parliament, amply demonstrating the failure of the prevalent policy. High taxes have made Sri Lanka a global hot spot for smuggling, especially tobacco products, and detections are reported every week. Prices of tobacco and alcohol products in the country are so high that it has become cheaper to consume certain Schedule-II and III drugs listed by the US Drug Enforcement Administration.

Illegal tobacco products flood the market

The impact on the legitimate tobacco trade and its returns to the government have been the hardest hit, as the authorities deal with a wave of illegal tobacco products flooding the market. Sri Lankan smokers have been driven underground by short-sighted pricing measures adopted by successive governments. Despite lobby groups claiming this as success against smoking, the growth of smuggling and the burgeoning unregulated beedi trade is evidence that the policy has failed. Sri Lankans are still smoking at the same level, but the Government is losing revenue while spawning a wave of criminal activity.

With a gradual increase in nominal cigarette excise revenues from 2015, the Treasury earned up to Rs. 121 billion in 2022 from the legal tobacco trade. LKR 109 billion in returns represented on average around 6-7% of total tax revenue over the past few years, despite a volume decline. However, revenues should be expressed in real terms and not nominal as inflation erodes the purchasing power of money. If one is to calculate the real excise revenue from the legal tobacco trade, it can be seen that it has actually fallen by Rs. 54 billion between 2015 and 2022. Unfortunately, it is projected to fall further in 2023 with the excise shocks. The Government would do well to safeguard this revenue stream and make it a sustainable source, and not give in to vested pressures. After all, it is prudent to ensure those who choose to smoke are smoking legitimate products as opposed to those that proffer greater harm to health and the coffers.

Government’s excise tax strategy a failure

The same rings true with pricing of alcohol products. Volumes have dipped dramatically, and an industry that yielded over Rs. 250 billion in revenue annually witnessed a drop of 13% early this year. The 13% drop in revenue was before a further 20% excise price increase in June this year, which would pose further pressure on earnings. Over the years, Sri Lankans have earned a reputation for being some of the greatest tipplers in the world, with per capita consumption ranked among the highest by the WHO driven by illicit alcohol. As reported by the Excise Department this year, price hikes have done little to reduce consumption as more consumers have turned towards illicit brew, posing grave harm to health and earnings. Hence, the Government’s excise tax strategy is a failure.

The reform agenda must sit high on the Government’s list of things to do. The country has little time to spare, and a concerted effort must be made to enhance confidence in Sri Lanka among the stakeholders both internal and external. The Government hopes to conduct a first round of reforms and restructure loss-making state institutions by the end of the first quarter of 2024, and it would be prudent to drive implementation before the full force of the election campaign kicks in towards the second half of the year. Remarkably, the Government through its Appropriation Bill has sought to enhance public expenditure despite the revenue shortfall, with the onus on the Defence Ministry and the Treasury.