Wanted: a panacea for defective policy

Any further upward pressure on taxation could have a profound effect on consumer behaviour and it could drive people within the tax net to seek evasive measures 

By Kushlani De Silva 

Revenue is the catchword for the Sri Lankan Government in 2023, yet this remains a challenge for the Ministry of Finance despite a positive primary balance in the first half. Towering interest payments and ongoing State expenditure provide little respite to the best efforts aimed to stabilise the flagging economy. Nevertheless, recent popular opinion suggests that the Sri Lankan ship has steered unto the right direction. That ship must now set course and sail towards an effective destination.

The President with his advisors and the Central Bank, have together embarked on a reform program with contentious input from the IMF aimed at curbing the excessive spending. However, there is a considerable amount of work ahead. The Government bears a hefty wages bill, and it needs to focus serious attention on reducing State expenditure. Further increasing personal income tax and corporate tax could exacerbate the economic challenges in a nation that are already starved for consumer activity. 

What Sri Lanka needs is a wider tax net, not a higher ceiling. Only time will tell if the Government’s call for all citizens over the age of 18 to register with the Department of Inland Revenue will result in the success of this measure. However, that process will take much longer despite the promised fix of automation, as it must contend with the heavy hand of bureaucracy, and time is of great essence. 

Alongside that, authorities must pay greater scrutiny to its policy on tax on goods and services. Taxes must not only be a channel of revenue to Government, they must also be designed in a manner that drives economic value cycles. Sri Lanka’s tax policy in contrast is often driven on agendas of profiteering, personal vendettas and bad advice that often finds it hitting far off the mark.

Sri Lanka’s now long-standing policy on tobacco taxation also offers ample evidence for a mechanism that is cannibalising its espoused objective of revenue. Over the past decade, successive Governments herded cigarette pricing to unsustainable highs that have not only failed to achieve the intended revenue target but also haven’t discouraged public smoking. Taxes on cigarette have risen by over 130% in the past five years, ahead of inflation. This has resulted in creating space for smuggled foreign cigarettes to emerge. The presence of a vast unregulated beedi industry along with the smuggled cigarettes have joined forces with short-sighted policy to spawn a debate and debacle that promises no easy fix, as consumers switch to cheaper alternatives.

Personal income tax has doubled and earnings have dropped dramatically during this period, whilst unemployment has been steadily on the rise. Conventional consumer cycles across nearly every product category have collapsed over the past year, as revenue models nosedive in the face of twin hits from the economic crisis and global slowdown following the pandemic and conflict. 

Sri Lanka’s cigarette industry went through several Government-led price shocks over the past five years. In 2019, State earnings from levies on the tobacco industry dipped for the first time whilst total earnings remained flat. Total earnings took a hit in the following two years following draconian price hikes that severely impacted purchasing power. As Sri Lanka recovers from record-high inflation this year, excise tax hikes over 40% in cigarette prices in January and July in 2023 will do little to bolster long-term earnings during a period where revenue remains a critical concern.

The cigarette industry, which contributed on average 7% of Government earnings over the past five years is a case-in-point for pricing policy and industry. Cigarette prices across nearly every category are at a premium. This raises the question: where will consumers go? For daily wage earners especially in the estate sector, a single cigarette costs more than 10% of a day’s earnings. This has forced consumers to pivot to cheaper illegal alternatives, but unfortunately those offer no benefit to Government in terms of revenue. 

Outdated pricing policy has contributed to a declining legal industry and a thriving illegal one. This raises concern about the potential impact on both business and investor confidence. Investments come towards regimes that offer stability and prudent operating systems notwithstanding politics, and this is what helped nations such as India, Bangladesh and Vietnam to emerge as shining stars in business.

The Government must be prudent and real with its policy and desist from pushing the envelope with taxes that can disrupt fragile value chains. Any further upward pressure on taxation could have a profound effect on consumer behaviour and it could drive people within the tax net to seek evasive measures. This could lead to a vicious cycle of falling Government revenues and rise in illegal activities that will once again impart pressure on the public that could potentially lead to unrest. The Government must instead focus urgent attention on curbing State expenditure. We must learn to be introspective, we must learn to act based on ground realities and progressive principles. If Sri Lanka does not fix them now, it never will.