Economic crisis looms large

By Umesh Moramudali and Rathindra Kuruwita

In late 2015, presenting his economic strategy in Parliament, Prime Minister Ranil Wickremesinghe said the indirect and direct tax revenue ratio in the country will be adjusted to 60-40 by 2020, currently the ratio is 80-20. This was to be done by bringing at least 60 per cent of the affluent class who were not paying taxes under the tax net.

However, those who had been keeping tabs on Wickremesinghe's economic outlook and his policies felt that the UNP leader was just playing lip service regarding the changes to the tax structure. He was compelled to say this due to the populist economic proposals made during the campaign to bring Maithripala Sirisena into power.
The UNFGG Government led by Wickremesinghe considers itself to be 'business friendly,' which translates into lower taxes for the rich. Any effort in the opening phase of the 100-day government to tax the rich and the corporate sector, through the interim budget of January 2015 were done half-heartedly.

Direct taxes
Given below is a list of direct taxes proposed by the 29 January 2015 interim budget, but were not implemented.
1. Super gain tax – any company of which the profit exceeded Rs 2,000 million – tax amount worth 25 per cent off its profit will be charged.
2. Rs 1,000 million tax imposed on television stations dedicated to sports.
3. One time tax of Rs 250 million to be paid by mobile phone operators.
4. One time tax of Rs 250 million to be paid by telecommunication providers.
5. Casino business-owners to pay
Rs 1,000 million as a tax – first payment to be made before April.
6. Vehicle assembly plants have neglected their income tax payments during the previous regime. Rs 120,000 million revenue expected through prompt payments.

Low income earners
Not only did the government not take any steps to increase direct taxes, which does not affect the low income earners, it also failed to come up with any revenue generation mechanism. For example, if a concerted attempt was made to develop the export sector, Sri Lanka could have even benefited during this patch where the rupee is at an all-time low against the US dollar. With dwindling income and a lack of investment, the government introduced sweeping increase to VAT and Nation Building Tax (NBT).
While people celebrated Sinhala and Hindu New Year the Finance Ministry announced that the Value Added Tax (VAT) is to be increased to 15 per cent from the current rate of 11 per cent with effect from 2 May. Along with the increase of VAT rate, VAT will also be imposed on supply of telecommunication services, import or supply of telecom equipment or machinery, high tech equipment including copper cables for telecom industry and supply of healthcare services. In addition to that the wholesale and retail trade (other than by a manufacturer or importer) will continue to be liable for VAT and the tax shall be charged only on liable supplies. From the budget proposals for 2016, it was suggested to remove the VAT from wholesale and retail trade, but the government decided not to implement the proposal.

Along with the increasing of VAT, the exemptions of Nation Building Tax (NBT) to the telecommunication services, electricity and lubricants were removed. That means there will be an additional tax of 17 per cent for telecommunication services as it is liable for both VAT and NBT.

Common man
VAT is a tax imposed on consumption. That means the price of goods and services which are subjected to the tax will increase. VAT is applicable to goods that are imported as well as goods that are manufactured. However, goods that are produced for exporting purposes, imported for re-exporting, and certain essential items such as rice, wheat, books and pharmaceuticals are exempted from VAT. Apart from that almost everything is liable for VAT, therefore, the increase of cost of living is inevitable.
The decision of the government to continue to impose tax on wholesale and retail industries would result in further price increase. Mostly, the wholesale and retail industries that are liable for VAT are supermarkets. Therefore, the price increase of goods that are sold at supermarkets will be increased. It should be noted that when VAT was introduced, it was not imposed on wholesale and retail trade. It was the previous government imposed VAT on wholesale and retail trade. Although the present government economic experts who were in the opposition then criticized this move, they too continue to impose VAT on wholesale and retail trade.

The imposition of VAT and NBT on telecommunication will result in the increase of telephone charges. It will increase the charges for broadband also, since import or supply of telecom equipment or machinery, high tech equipment including copper cables for telecom industry are also liable for VAT. This will certainly increase the government revenue as consumers will reduce using telecommunication and broadband by very little amount.
Imposing VAT on education and healthcare services will increase school fees, as well as private hospital fees. Although the health minister claims that imposing a maximum price of Rs 2,000 for channeling a doctor, the absence of strong regulations would result in increasing the channeling fee as well.

Reduction of revenue
The government was forced to impose VAT due to continuous tax revenue reduction. In 2011, the government revenue as a percentage of GDP was 13.6 per cent and it had declined to 11.7 per cent from the GDP in 2014. This had resulted due to the gradual decline of the tax revenue. In 2013, the tax revenue as a percentage of the GDP was 11.6 per cent which had declined to 10.7 per cent in 2014. While revenue is declining the government expenditure remains close to 20 per cent of the GDP widening the budget deficit, hence raising revenue is not an option, but a must.
Although the previous government attempted to raise the tax revenue and set ambitious targets it ended up in failure. The government was able to collect tax revenue only amounted to 10.7 per cent from the GDP when the target was to collect tax revenue amounted to 12.6 per cent from the GDP. It is in that context, the present government estimated to increase the total tax revenue from 11.4 per cent from GDP in 2015 to 12.7 per cent in 2016.
In developed countries, tax revenue amounted at least more than 30 per cent of the GDP. In Denmark, tax revenue is 50.9 per cent from the GDP while it 45.2 per cent in France and most of these taxes are direct, such as income tax.

"Accordingly, revenue collection from major sources, including VAT on both domestic activities and imports and excise duty especially on liquor, motor vehicles and petroleum products, as well as Telecommunication Levy, PAL and Cess Levy, increased in 2014. Revenue from direct taxes as a percentage of GDP, as well as in nominal terms declined while the contribution to the tax revenue also declined to 18.9 per cent from 20.4 per cent in 2013. The share of tax revenue in total revenue declined marginally to 87.9 per cent in 2014 from 88.4 per cent recorded in the previous year," Central Bank Annual Report stated.

Income tax revenue reduced
According to the Central Bank of Sri Lanka (CBSL) Annual Report, income tax collection as a percentage of GDP declined to 2.0 per cent in 2014 from 2.4 per cent in 2013, while in nominal terms, it declined by 3.7 per cent to Rs 198.1 billion in 2014 from
Rs 205.7 billion in the previous year.

It further states that the revenue collection from VAT, which is the highest single contributor to total tax revenue, increased in 2014, mainly due to the expansion of the VAT base by reducing the threshold level applicable to wholesale and retail trade to Rs 250 million per quarter from Rs 500 million per quarter. Accordingly, revenue from VAT increased by 9.8 per cent to Rs 275.4 billion in 2014 from Rs 250.8 billion in the previous year, mainly as a result of the increase in contribution from manufacturing and financial services. However, as a percentage of GDP, it declined marginally to 2.8 per cent in 2014 from 2.9 per cent.

Taxes on education and health
Private education institutions and hospitals have been imposed with a VAT of 15 per cent. Apparently these sectors were not previously subjected to VAT, and private school and hospital owners complained that this would inconvenience the people as school fees and hospital charges would increase.

"There are close to 300,000 students who are studying at private schools. The proposed 15 per cent tax will affect them directly and some children might be compelled to give up schooling," founding Chairman of the International Schools Association, Frank Jayasinghe said.

VAT was not charged from private schools and hospitals, however, the government has decided to charge VAT from these institutions.

"International schools are also included in the category of private education institutions. Most of the students are not from rich families. Most of them are from lower middle class and middle class families. Majority of their parents work in the private sector and they pay income tax. With this they will be burdened with more taxes. This will be a great burden," he added.

Skyrocketing profits
However, it is well-known that private education and healthcare institutions are doing well and that their profits would skyrocket given the demographical and socio-economic trends. However, as the government is 'business friendly' it will not impose a direct tax on these institutions, but will impose a VAT which can easily be transferred to the consumer.

Given the economic outlook of the government one should not be surprised that it turned to VAT, instead of imposing direct taxes or increasing revenue streams, to overcome the current economic crisis. Economic policy stems from the ideology that the leaders of the nation hold, thus one must not be surprised that similar methods are taken in the coming years, as Sri Lankan economy stagnates.

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