• In 2021, 80% of  taxpayer money was used for salary and pension payments in the State sector
• According to Budget 2023, recurrent expenditure is set to reach Rs. 4.6 trillion in 2023 from Rs. 3.5 trillion in 2022, while the total revenue is estimated to be Rs. 3.4 trillion

In 2021, 80% of Sri Lanka’s taxpayer money was used for salary and pension payments in the State sector. According to Cabinet Spokesman Minister Bandula Gunawardana, this was when Sri Lanka lost over Rs. 500 billion in tax revenue following the 2019 tax cuts by former President Gotabaya Rajapaksa.

Fast forward to 2023, the Government, which is following the Extended Fund Facility (EFF) of the International Monetary Fund (IMF), has imposed higher tax rates to collect revenue to eventually achieve debt sustainability.

“Ambitious revenue-based fiscal consolidation is necessary for restoring fiscal and debt sustainability while protecting the poor and vulnerable. In this regard, the momentum of ongoing progressive tax reforms should be maintained and social safety nets should be strengthened and better targeted to the poor. 

“For the fiscal adjustments to be successful, sustained fiscal institutional reforms on tax administration, public financial and expenditure management, and energy pricing are critical,” IMF Managing Director Kristalina Georgieva said in the statement issued upon the approval of the EFF to Sri Lanka.

Sri Lanka’s Government has implemented a progressive tax reform package since May 2023 in line with IMF expectations such as raising the marginal Personal Income Tax (PIT) rate schedule, reducing the PIT tax-free allowance, and introducing mandatory withholding taxes starting from January 2023.

Moreover, further measures included raising the statutory Corporate Income Tax (CIT) rate from 24% to 30% and removing almost all sector-specific CIT exemptions from October 2022, raising the Value Added Tax (VAT) rate from 8% to 12%  in May 2022 and to 15% in September 2022, reducing the VAT registration threshold from September 2022, raising fuel prices to yield 0.3% of GDP in January 2023, and bringing the tax-to-GDP ratio to at least 14% by 2025. 

“These tax policy reforms focus on base-broadening and progressive measures to mobilise revenue while promoting economic efficiency and equity,” the IMF Staff Report on Sri Lanka said.

However, taxpayers are unhappy with the heavy burden set upon them given their lack of trust in the Government’s fiscal management which brought Sri Lanka to its knees, leading to questions regarding how taxpayers’ money is spent in Sri Lanka.

Although it is difficult to pinpoint precisely how tax money is used, The Sunday Morning decided to break down the basics of how taxpayers’ money is used. 

However, before looking into this, an examination is needed into whether Sri Lanka is able to meet its tax revenue targets for 2023 and how it manages expenditure.

Tax authorities will fail to achieve tax targets 

Speaking to The Sunday Morning, tax expert and Gajma Founder and Partner N.R. Gajendran said that Sri Lanka had perennially failed to meet its revenue targets due to optimistic revenue estimation in the budget, while expenditure was pessimistically estimated.

Sri Lanka, which achieved around Rs. 2 trillion in revenue in 2022, is trying to push this number to Rs. 3.4 trillion in 2023, which cannot feasibly be achieved in a country in which the economy is shrinking despite rate increases.

For instance, Gajendran pointed out that in terms of achieving the revenue target of Rs. 1.2 trillion of Sri Lanka Customs, there would be a shortfall of about Rs. 500 billion as the bulk of Customs levies were derived from the importation of vehicles. 

He noted that the Inland Revenue Department (IRD) had achieved about 40% (Rs. 697 billion) of its annual revenue target of Rs. 1.6 trillion in the first six months of 2023.

“If Sri Lanka is unable to meet its revenue targets, it will cause our deficit to balloon again, unlike what is projected,” Gajendran said. 

However, the IMF programme is pushing for a Central Government revenue of Rs. 2,940 billion by the end of 2023. 

Moreover, Gajendran said that while the Budget reflected where the collected tax revenue of the Government went, due to a lack of accountability, responsibility, and good governance by the Government, this revenue had not been spent fruitfully nor productively in the past. 

He pointed out that in any country, tax revenue was required for five main activities; internal security, utilities, education, health, and looking after the vulnerable.

According to Budget 2023, Sri Lanka’s recurrent expenditure is set to reach Rs. 4.6 trillion in 2023 from Rs. 3.5 trillion in 2022, while the total revenue is estimated to be Rs. 3.4 trillion.

Primary balance helps deal with past rupee debt 

Frontier Research Head of Macroeconomic Risk Advisory Chayu Damsinghe said that although the Government’s tax revenue had gone up by about 50% in the first half of 2023 to about Rs. 1.2 trillion, the non-interest expenditure had increased by about 10%, resulting in a primary balance of Rs. 30 billion.

Moreover, he said that the Government’s performance on the fiscal side under the IMF programme had been quite satisfactory, having overperformed in terms of achieving a primary surplus of Rs. 30 billion, when a primary deficit of Rs. 113 billion had been expected for the first half of 2023.

According to the EFF programme, through Budget 2023, Sri Lanka aims to reduce the primary deficit to 0.7% of GDP in 2023 from 3.8% of GDP in 2022, with tax revenue targeted to reach about 10% of GDP.

However, he said that the overall Budget was still in a deficit as the Government had a massive sum of rupee borrowings, which was mainly interest on Treasury bills.

He noted that Treasury bill debt was not typically paid on maturity, but was rolled over in most countries, similar to what was done in Sri Lanka, although interest cost continued to accrue. 

He added that if Sri Lanka had a primary deficit, it would mean taking on new loans to cover the deficit and not simply rolling over past debt, which would make it difficult to keep debt below GDP growth.

“Having a primary surplus only helps to deal with past debt and not add any new debt,” Damsinghe said, adding that since the Government was currently borrowing heavily in short-term Treasury bills, which needed to be rolled over every three, six, and 12 months, there was a short-term compounding effect which would lead to further borrowing in the short term.

However, he noted that the Government would have to repay Treasury bills at some point by issuing a new Treasury bond. As of the fourth week of August, the Central Bank has issued Rs. 1.6 trillion worth of Treasury bills in 2023.

Addressing the prevailing medical shortage, Damsinghe said that the issue was not foreign currency or tax revenue being directed to the health sector, but a procurement issue which had always existed in the health sector due to bureaucratic problems.

He noted that although politicians had tried to sidestep bureaucracy and issue contracts directly to suppliers, this method had its own problems and was not necessarily a solution.  

Prioritising three areas for taxpayer money 

Speaking to The Sunday Morning, State Minister of Finance Ranjith Siyambalapitiya said that it was difficult to precisely outline the expenses covered by tax revenue, since once taxes were collected in the Consolidated Fund, they were used to meet multiple expenses.

However, he said that based on the IMF programme, Sri Lanka was prioritising meeting expenses related to health, education, and looking after the vulnerable while meeting the salary and pension payments of the State sector.

The IMF Staff Report on Sri Lanka notes that expenditure rationalisation is not expected to compromise spending on health, education, and social protection. 

The EFF has set a floor of Rs. 187 billion on Social Safety Net (SSN) spending in 2023, which will allow the four major SSN programmes (Samurdhi cash transfers and support for elderly, disabled, and chronic kidney disease patients) to mitigate inflation-eroding per household benefits. Beyond 2023, the authorities have been asked to maintain SSN spending at least at 0.6-0.7% of GDP. 

Following a steady increase in the wage bill in recent years, high inflation had significantly reduced real current spending in 2022. The authorities have decided to restrain wage and pension increases to well below inflation in 2023. While excessive cuts to capital spending should be avoided under the programme, fiscal space for capital spending will be constrained. To address this, the authorities will have to take measures to raise public investment efficiency and strengthen the processes to prioritise capital projects.