Progressive taxation policies for new era

Developing progressive tax policies can significantly enhance Government revenue and contribute to Sri Lanka’s recovery from its debt crisis

Sri Lanka has agreed with the International Monetary Fund to raise the withholding tax on deposits from 5% to 10%, while providing exemptions for lower-income brackets. The Government should consider higher rates for dividend payments, royalties, rent and sale of real estate. Revise withholding tax provisions to include digital services, ensuring that all services (e.g., technical, insurance, transportation) are taxed equitably

The Sri Lankan Government’s Treasury is currently facing a significant burden due to the lack of adequate revenue, which is severely constraining the fiscal space available for critical social protection programs, boost industries, restore development infrastructure, and elevate skills and technology.

There is a valuable opportunity to alleviate this pressure by implementing progressive tax policies in forthcoming Budgets despite the fiscal squeeze and constraints imposed by the IMF program as negotiated by the previous regime. As a result the Government spending has been capped at Rs. 4,290 billion of which interest payments will amount to around Rs. 3,000 billion.

Developing progressive tax policies can significantly enhance Government revenue and contribute to Sri Lanka’s recovery from its debt crisis. As implemented in many other countries, progressive taxation ensures that individuals and entities with higher incomes contribute a larger share of their earnings, promoting equity and increasing revenue. Here are some progressive tax policies the Sri Lankan Government can consider for future budgeting processes:

Taxes on international trade

Taxes on international trade, totalling Rs. 507 billion, include Import Duties, Export Duties, Import and Export Licence Fees, the Ports and Airports Development Levy, the Cess Levy (on both imports and exports), the Motor Vehicle Concessionary Levy, the Regional Infrastructure Development Levy, and the Special Commodity Levy.

Increase duties on non-essential imports: Introduce or increase duties on non-essential imports and luxury goods such as high-end vehicles, jewellery, liquor, and electronics, ensuring scarce foreign currency is preserved for essential imports.

Taxes on domestic goods and services

Taxes on domestic goods and services, totalling Rs. 2,215 billion, include VAT, Goods and Services Tax, the National Security Levy, Excise (Ordinance) Duty, Excise (Special Provisions) Duty, the Tobacco Tax, Stamp Duty, Debits Tax, Turnover Tax, the Social Responsibility Levy, the Telecommunications Levy, Nation Building Tax, the Tele-drama, Film, and Commercials Levy, the Cellular Tower Levy, the SMS Advertising Levy, and the Social Security Contribution Levy.

VAT reforms: Adjust the Value Added Tax (VAT) system to include higher rates on luxury goods and services while maintaining lower rates or exemptions for essential items like food, healthcare, and education. 

Revision of tax incentives: Evaluate and revise tax incentives for sectors that are not aligned with national development goals. For example, reduce excessive incentives for sectors that do not generate significant employment or export revenue. Increase nominal corporate tax rates for sectors that currently benefit from overly generous incentives.

Licence taxes and other levies

Licence taxes and other levies, totalling Rs. 16 billion, include the Luxury Motor Vehicle Tax, Transfer Tax, Betting and Gaming Levy, Share Transaction Levy, Construction Industry Guarantee Fund Levy, Environment Conservation Levy, and various other licence fees.

Digital services tax: Introduce a tax on digital services provided by multinational corporations, ensuring that they contribute to the local economy. Introduce a Digital Services Tax (DST) on gross revenues of multinational digital companies operating in Sri Lanka. For example: in France there is a 3% tax on revenues above $ 25 million generated locally. 

E-commerce tax: Implement measures to expand the tax base, ensure fair competition, regulate cross-border digital transactions, improve transparency and compliance, encourage formalisation of online businesses and enhance consumer protection and data security.

Increase betting and gaming levy: Implement measures to mitigate social and economic harms, align with international tax standards, compensate for externalities, reduce illicit gambling activities, ensure fair contribution from a profitable sector and encourage responsible gambling practices. 

Carbon tax: Introduce a carbon tax on industries with high greenhouse gas emissions to combat climate change and environmental degradation, encourage clean energy and green investments, reduce dependence on fossil fuel imports, improve public health, align with global climate commitments, encourage efficient transportation and urban planning and foster green jobs and innovation.

Single-use plastic and pollution tax: Tax single-use plastics to reduce environmental damage and generate additional revenue.

Taxes on income and profits

Taxes on income and profits totalling Rs. 1,080 billion include Corporate Tax, Non-Corporate Income Tax, Withholding Tax and Capital Gains Tax.

Corporate tax

Eliminate sectoral tax benefits: Introduce of a percentage cap (say 3%) of net income to the tax benefits that corporations can apply, preventing the abuse of these tax expenditures.

Surcharge on the financial sector: Introduce a surcharge on the statutory tax rate to ensure fair contribution from a high-profit sector, manage excessive profit margins and speculation, encourage responsible financial practices, and addressing social discontent and inequality.

Minimum corporate tax: Introduce a minimum corporate tax rate to ensure that all profitable companies pay a baseline level of tax, regardless of deductions and credits. The aim of the OECD’s International Finance global minimum tax (Pillar Two) is to ensure large multinational enterprise pay a minimum level of tax on the income arising in each of the jurisdictions where they operate. 

Introduce minimum global tax: Implement a minimum corporate tax rate of 15% for multinational companies with global revenues exceeding a specific limit, in line with the OECD/G20’s global tax framework. 

Significant Economic Presence (SEP) for multinational companies: Introduce a SEP rule where multinational companies, with gross revenues exceeding a local currency limit or serving a specific number of local customers, are subject to taxation in Sri Lanka. This ensures that digital giants and other multinationals operating in Sri Lanka contribute fairly to the tax base, even if they lack a physical presence.

Windfall tax: Introduce windfall profit tax (surcharge to the corporate tax) up to 15% on profits in selected industry sectors to capture excess profits for public benefit, counter inflationary pressures by discouraging profiteering and encourage responsible corporate behaviour.

Royalty payments: Eliminate provisions that allow extractive industries and companies to deduct royalty payments from their corporate income tax.

Increase statutory corporate tax: For free trade zones users, increase the statutory corporate tax rate but with the condition of presenting and deploying an “internationalisation plan” and as long as their net income from operations other than the sale of goods or services to the rest of the world does not exceed a threshold.

Non-corporate income tax

Introduce more tax brackets and higher top rates: Introduce higher tax rates for top income earners and more tax brackets to enhance tax progressivity and equity, reduce the tax burden on low- and middle-income earners, address wealth concentration and inequality, reduce fiscal dependence on indirect taxes and enhance government credibility and tax compliance.

Elimination of loopholes: Close tax loopholes and exemptions that disproportionately benefit high-income earners, ensuring a more equitable tax system.

Cap on tax incentives: Introduce a cap on tax incentives in absolute terms to prevent top earners from excessively eroding the tax base. For example, once a taxpayer reaches a certain threshold of tax benefits, they cannot claim additional incentives.

Withholding tax

Introduce withholding tax: Introduce a withholding tax that collect taxes at source to enhance tax compliance and reduce evasion, ensure timely tax payments, simplifying tax administration, encourage formalisation of the economy, prevent profit shifting and base erosion, and encourage foreign investment with proper tax treaties.

Increase rate and widen tax net: Sri Lanka has agreed with the International Monetary Fund to raise the withholding tax on deposits from 5% to 10%, while providing exemptions for lower-income brackets. The Government should consider higher rates for dividend payments, royalties, rent and sale of real estate. Revise withholding tax provisions to include digital services, ensuring that all services (e.g., technical, insurance, transportation) are taxed equitably.

Capital gains tax

Increase tax rate: Introduce or increase capital gains taxes on profits from the sale of assets like stocks, bonds, and real estate. This ensures that income from investments is taxed similarly to earned income. Raise the capital gains tax rate from the current low level to ensure that income from investments is taxed more equitably compared to wage income. Many of the richest citizens derive a significant portion of their income from capital gains, which are currently taxed at lower rates than wages. 

Wealth related tax

Introduce wealth tax: Implement a wealth tax on high-net-worth individuals with net wealth exceeding a certain threshold (Sri Lanka’s top 1% hold 20% of the wealth whilst bottom 50% hold just 14% - World Inequality Database), targeting assets such as real estate, luxury vehicles, and significant financial holdings. Rates could range from 0.5% to 1.5%, depending on wealth levels. Improve asset valuation methods, including real estate, financial assets, and offshore holdings, to ensure accurate assessment of net wealth.

Progressive property tax: Introduce a progressive property tax system where higher-value properties are taxed at higher rates. This can include luxury homes, commercial properties, and large landholdings.

Land value tax: Consider the design of a land value tax that taxes the unimproved value of land, encouraging efficient use of land and generating revenue from underutilised properties.

Inheritance tax: Reinstate or increase inheritance taxes on large estates, ensuring that wealth transfers are taxed progressively to reduce wealth inequality, encourage economic productivity, encourage charitable giving and prevent dynastic wealth accumulation.

Gift tax: Implement or increase taxes on significant gifts to prevent tax avoidance through wealth transfers.

Administrative reforms

Addressing tax avoidance and evasion

Addressing tax avoidance and evasion requires a multifaceted approach that combines legal reforms, international cooperation, enhanced enforcement, and public awareness. Sri Lanka can adopt key strategies to tackle these issues effectively:

Beneficial ownership register: Establish a publicly accessible beneficial ownership register to identify the true owners of assets and prevent tax evasion through complex ownership structures. Mandate beneficial ownership disclosure to prevent the use of shell companies and trusts for tax evasion.

Exit taxes/offshore asset taxation: Introduce exit taxes for individuals relocating assets or residency to low-tax jurisdictions.

Double tax treaties: Revise Sri Lanka’s 48 double tax treaties to align with the UN Model Article 12B, which addresses the taxation of digital services.

Information sharing: Strengthen collaboration with international organisations to access data on offshore holdings. Join the OECD’s Common Reporting Standard (CRS) to improve access to information on offshore assets held by Sri Lankan residents.

Promoting international cooperation: Implement OECD’s Combat Base Erosion and Profit Shifting (BEPS) framework to prevent multinational corporations from shifting profits to low-tax jurisdictions. Adopt mechanisms such as the Common Reporting Standard (CRS) to facilitate global tax data sharing and Automatic Exchange of Information (AEOI). Pressure offshore jurisdictions and tax havens to comply with global tax transparency standards and eliminate harmful tax practices.

Country-by-Country Reporting (CbCR): Require multinational companies to disclose profits, revenues, and taxes paid in each jurisdiction.

Implementation and compliance

Strengthening tax administration and enforcement: Invest in modernising the tax administration system to improve efficiency, reduce corruption, and enhance compliance. Equip tax agencies with better resources, technology, and expertise to detect and prevent tax evasion. Ensure regular audits and impose stricter penalties on tax evaders to deter non-compliance.

Automation and digitalisation: Use technology to automate tax collection and reporting processes, reducing opportunities for evasion and improving accuracy.

Public awareness campaigns: Conduct public awareness campaigns to educate citizens about the importance of paying taxes and the benefits of a progressive tax system. Strengthen protections for whistleblowers who expose tax fraud. Encourage businesses to adopt fair tax policies as part of their corporate social responsibility (CSR) commitments.

Strengthening legal frameworks: Government should review and amend tax laws to close loopholes that allow corporations and individuals to exploit legal ambiguities. Introduce General Anti-Avoidance Rules (GAAR) and Specific Anti-Avoidance Rules (SAAR) to prevent aggressive tax planning.

Monitoring and evaluation

Regular audits: Conduct regular audits of high-income individuals and corporations to ensure compliance with tax laws.

Transparency and accountability: Publish detailed reports on tax revenues and expenditures to build public trust and ensure accountability.

EU tax observatory model: Collaborate with organisations like the UNDP to replicate the EU Tax Observatory’s Progressivity graphs, using official tax data to measure how the tax system is structured to tax people based on their income.

By implementing these progressive tax policies, the Sri Lankan Government can increase its revenue base, reduce income inequality, and create a more sustainable fiscal environment to address the debt crisis effectively.

(The writer is a co-founder of the Institute of Political Economy (www.ipe-sl.org) and a former elected Local Councillor for London in the United Kingdom. He could be reached via email [email protected]. Tweet: @ipe_sl.)