Sanjeewa Jayaweera, whose chosen title is “Politics, Taxation and the Need for Consensus”
The editorial in last Sunday’s Sunday Island, captioned “Fuel Crisis: Beyond Price Debate,” deserves to be applauded because it called on both the government and the opposition to stop playing politics over fuel prices. The editor concluded by stating, “It is hoped that the government and the opposition will stop fighting over fuel prices and address the serious issues that threaten the country’s energy security and economic stability.”
I believe that most Sri Lankans would agree with that sentiment, except perhaps those engaged in politics whose primary objective appears to be the attainment of power, often regardless of the cost to the country.
Unfortunately, opposition parties seldom assess government policies on their merits. This was also true of the NPP when it was in opposition. There is, however, an important difference between exposing political hypocrisy and opposing sound economic policies. Criticism of policy reversals is legitimate, but it should not undermine reforms essential to the country’s economic recovery and long-term stability.
TAX REVENUE-TO-GDP RATIO
The most important indicator of a government’s capacity to finance public services is its tax revenue-to-GDP ratio. In 1990, Sri Lanka’s tax revenue-to-GDP ratio stood at approximately 19%. Over the following three decades, however, successive governments steadily eroded the country’s tax base through tax concessions, exemptions, rate reductions, and weak enforcement. As a result, the ratio declined significantly and averaged between 10% and 12% before collapsing to around 8% following the sweeping tax cuts introduced by the Gotabaya Rajapaksa administration in late 2019.
The economic consequences that followed were devastating. Government revenue fell sharply. The resulting fiscal imbalance contributed significantly to the economic crisis that culminated in sovereign default, shortages of essential goods, inflationary pressures, and widespread social unrest.
The World Bank considers a tax-to-GDP ratio of around 15% to be the minimum required for developing countries such as Sri Lanka to provide basic public services and maintain fiscal sustainability. According to the latest available figures, Sri Lanka has now increased its ratio to approximately 15.5%, thereby reaching that minimum threshold.
While this represents a significant achievement considering the depth of the crisis, it is hardly a cause for celebration. To place matters in perspective, neighbouring India has achieved a tax-to-GDP ratio of approximately 19.6%, despite operating a far larger and more complex economy. Many developed countries record ratios well above 25%.
Sri Lanka’s recovery in tax revenue has been driven largely by substantial increases in taxation. Value Added Tax (VAT), which is an indirect tax, has increased to 18%, while the top personal income tax, a direct tax, now stands at 36%. These measures have imposed a considerable burden on taxpayers, particularly in the aftermath of inflation reaching nearly 70% in September 2022. Although inflation has since fallen substantially, the prices of most goods and services remain significantly higher than they were before the crisis;
Consequently, many taxpayers feel aggrieved. They are paying more taxes while simultaneously struggling with a higher cost of living. Their frustration is understandable.
THE ONLY CERTAINTIES IN LIFE ARE DEATH AND TAXES
The famous saying that “the only certainties in life are death and taxes” is attributed to Benjamin Franklin in 1789. Yet, for much of Sri Lanka’s post-independence history, large segments of the population have effectively avoided direct taxation.
Successive governments, driven by short-term political considerations, frequently reduced tax rates, expanded exemptions, or abolished taxes altogether. Over time, this fostered a culture in which many citizens came to view direct taxes, such as personal income tax, as unusual or even unfair. Once such attitudes take root in public thinking, they are difficult to reverse.
What has understandably angered many taxpayers, however, is the perception that the burden of personal income tax and corporate income tax has been borne disproportionately by a relatively small segment of the population employed in the formal sector.
For instance, a person employed in the formal economy and earning a monthly salary of Rs. 350,000 would pay Rs. 32,000 in Advance Personal Income Tax (APIT). By contrast, a person earning a similar amount in the informal sector may remain entirely outside the tax net.
THE NEED TO BROADEN THE TAX BASE
Sri Lanka has a serious problem with tax evasion. This challenge is compounded by the fact that the informal economy is estimated to account for nearly 65% of overall economic activity. Therefore, a significant portion of the workforce and businesses operate outside conventional tax structures and regulatory oversight.
While many workers in the informal sector legitimately earn incomes below the personal income tax threshold, it is equally true that numerous business owners generate significant incomes while remaining largely outside the tax net. Many of these businesses fall within the category of small and medium-sized enterprises.
As a consequence, a relatively small group of individuals and corporations shoulder a disproportionately large share of the country’s direct tax burden. Such an arrangement is neither equitable nor sustainable in the long term.
The objective should not necessarily be to increase tax rates further, but rather to ensure that more participants contribute to the system. When a greater number of taxpayers contribute, the burden on existing taxpayers can potentially be reduced over time. Equally important, a broader tax base enhances transparency, improves record-keeping, and encourages businesses to operate within the formal economy.
THE GOVERNMENT’S DECISION TO REVERSE THE VAT THRESHOLD REDUCTION
Against this backdrop, it is disappointing that the government has decided to retreat from an important tax reform by reversing the reduction of the annual VAT registration threshold from Rs. 60 million to Rs. 36 million.
The proposed reduction was a modest but meaningful step towards broadening the tax base and bringing more businesses into the formal economy. Requiring businesses to register for VAT would also have facilitated proper accounting records to be maintained, especially for sales, which in turn would help determine taxable profits for income and corporate tax purposes. However, following public criticism and political pressure, the government reversed course.
At a recent meeting of the Committee on Public Finance (COPF), its Chairman, Dr Harsha de Silva, asked officials from the Ministry of Finance how many additional businesses would be brought into the VAT system through the proposed reduction of the threshold. The officials estimated the number to be approximately 10,000, although they appeared unable to provide a definitive figure.
What was particularly striking during the discussion was that several participants appeared not to fully understand how the VAT system actually functions in Sri Lanka. This is unfortunate because informed public debate requires a sound understanding of the facts.
For example, a substantial proportion of the turnover of even a large supermarket consists of goods that are exempt from VAT. When I served as CFO of a leading supermarket chain, approximately 40% of turnover came from VAT-exempt goods. Although that percentage may have declined over time, it remains significant. In a typical neighbourhood grocery store, the proportion of VAT-exempt sales is likely to be even higher.
Consequently, many smaller retailers would not have been affected by the reduction in the VAT threshold, as their taxable supply would have been well below the threshold. Therefore, the claim made by Dr Harsha De Silva in a post on the X platform that “This Govt was about to fine your local shop Rs. 1 million for not registering for VAT’ is misleading.
The claim that the withdrawal of the proposed reduction in the threshold is a victory for consumers, too, is incorrect. Sri Lankan law requires manufacturers and importers to display a Maximum Retail Price (MRP) on all consumer products. In practice, this means that the retail price of a bottle of Coke is the same regardless of whether it is sold through a VAT-registered supermarket or a smaller retailer.
Ironically, the non-VAT-registered grocery store earns a higher margin than the taxcompliant supermarket. Therefore, the assertion that reducing the VAT threshold would have imposed an additional burden on consumers purchasing goods is incorrect and misleading.
The situation is somewhat different for service providers. Businesses supplying services that became subject to VAT may have sought to pass some or all of the tax burden on to consumers through higher fees. However, that possibility should not obscure the broader objective of expanding the tax base and improving compliance.
There were further criticisms that businesses were given only two weeks’ notice before implementation and would need to invest Rs 200,000 in a POS machine. Yet the government’s intention to reduce the threshold had been announced when presenting the budget about seven months ago. Therefore, it is difficult to understand where the claim of a two-week notice came from. Equally, it is not unreasonable to expect a business generating turnover of Rs. 36 million annually to purchase a POS machine to maintain adequate records of its sales.
A VALUABLE OPPORTUNITY LOST
In my view, a valuable opportunity to widen the tax net has been lost. What should have been a rational discussion on tax policy instead became another example of political pointscoring, misinformation, and a failure to properly explain the operation of the VAT system to the public.
It is therefore difficult to understand why Dr Harsha De Silva has been such a strong critic of reducing the annual VAT threshold to Rs. 36 million, given that during his time as a minister between 2015 and 2019, the threshold stood at only Rs. 12 million.
This type of political gamesmanship serves neither the government nor the opposition. More importantly, it does not serve the country’s interests. Sri Lanka’s economic recovery requires difficult decisions, honest public debate, and a willingness among political leaders to place national interests above short-term political advantage.
That is precisely why the Sunday Island editorial was correct. The country needs less politics and more policy. On issues as fundamental as taxation, energy security, public finances, and fiscal sustainability, consensus is not a sign of weakness. It is a prerequisite for long-term economic stability and national progress.
The challenge before Sri Lanka is not merely to collect more taxes. It is to create a tax system that is fair, credible, broad-based, and capable of supporting the services and infrastructure that citizens expect from the state. Achieving that objective requires competence, transparency, and political courage.
(The views and opinions expressed in this article are solely those of the author and do not necessarily reflect the policy or position of any organisation or institution with which the author is affiliated).
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