The main purpose of taxation is to raise resources to finance government expenditure in a way that is equitable, fair, efficient, and accountable. A tax system that is not designed to fulfil these criteria will be counterproductive with negative impacts on macroeconomic indices such as economic growth, public debt, fiscal deficit, and inflation. Serious concerns have been raised regarding the effectiveness, fairness, transparency, and accountability of the recently introduced taxation changes as per the Inland Revenue ( Amended) Act, No. 45 of 2022 on 19 December 2022. 

These drawbacks have resulted in a failure to achieve the desired objectives of taxation. This report will discuss why recent revisions to the taxation system in Sri Lanka are unfair, unethical, unsuccessful, and damaging to the country’s economy in the long term. It will also propose short-, intermediate-, and long-term recommendations for a fair, equitable, transparent, and accountable taxation for the country’s economic recovery.

 1. Why is it unfair and unethical?

While the businesses are taxed based on their net income, leaving out the expenses, employees are taxed based on their gross income without considering that there are expenses incurred in providing their services. It was based on this principle that employment relief was provided prior to 2019. The current revision has completely ignored this fundamental.

Lack of transparency and accountability: The taxpayers have the right to information on what is happening to the monies they pay as tax. Currently, there is no such transparent and accountable system in Sri Lanka.

 2. Why will it be unsuccessful?

 According to the 2023 budget proposals, government revenue has declined to 8.3% in 2021. One of the most significant contributory factors is the VAT component, leading to a loss of more than 1% of gross domestic product (GDP). Planning to recover this huge loss by putting an unrealistic emphasis on PAYE tax is bound to fail.

The Government’s attempt to increase the income from personal taxes at a time when the country’s economy is shrinking, purchasing power is drastically declining, and interest rates are getting worse, is highly impractical. The skyrocketed inflation (CCPI based YoY inflation in January 2023 is 54.2% – CBSL), leading to a decrease of purchasing power, increasing the cost of living and diminishing disposable income, and has led the Sri Lankan middle-income category falling deeper into crisis.

Tax evasion and Tax avoidance: When the tax percentages are unfairly high, the tendency is to evade and avoid tax. Research shows that, beyond a particular point where the maximum revenue could be achieved, the income generated will continuously decrease as the tax rate increases. Entrepreneurs are more likely to hide their income and be reluctant to disclose their earning sources, invest abroad and also resort to exploiting the existing loopholes in the tax system to avoid being taxed. According to Global Financial Integrity, this has led to a loss of $ 40 billion between 2008 to 2018.

3. Why is it damaging to the country? 

The imposition of high taxes is a disincentive for the people who work hard and for their businesses trying to generate more revenue by increasing production. An economy with dwindling productivity and diminishing growth, cannot achieve the desired GDP while having a high level of taxation. Unfair taxation is a demotivating factor and deterrent to productivity. Therefore, such disincentive of productivity will have serious negative impacts on Sri Lanka’s attempt for economic recovery.

The migration of highly skilled professionals: The tax burden beyond tolerable limits to meet daily necessities will force the impacted professionals to migrate to other countries which provide better income and living standards. Therefore, unreasonably high taxation will result in the country losing highly skilled professionals. This will lead not only to the loss of decades of knowledge and experience gained by these experts, but also national and international networks established and maintained by them. In a catastrophic situation such as this, it will be an irreplaceable loss to Sri Lanka.

MNCs (Multinational Corporations) leaving the country: The unfavourable economic environment further aggravated by a heavy tax burden will result in the MNCs seeking alternative destinations to establish their businesses. This will result in negative social and economic externalities such as the loss of FDIs, foreign exchange and creating unemployment.

Proposals and recommendations

Short term

 1. Make the tax imposed bearable and tolerable for employees

· Increase the tax-free allowance to Rs. 2.4 million per annum/implement employment relief.

· Commence taxation rates at 4% and increase as multiples of 4 (4%, 8%, 12%, 16%, 24%)

· Increase the taxation slabs from Rs. 500,000 to Rs. 600,000 per annum.

 2. Alternative avenues to increase government revenue

· Reintroduce Economic Service Charge of 0.5%

· Introduce 1% share transaction levy for share market (The annual volume of the Share market  is Rs. 800 billion. Even if a 1% share transaction levy is imposed, this works out to Rs. 8 billion per annum)

 Intermediate term

 1.      The Government should widen the tax base rather than merely increasing tax rates and establish an efficient system to collect the taxes by expanding the tax net, and by making sure the corporates are paying the correct taxes. Increase the efficiency of the three main sources of collecting Government revenue; the Inland Revenue, Excise and Customs Departments.

2.      Establish an efficient electronic system linked to the NIC number, in which each transaction is monitored to ensure the transparency of the tax collected and how it is utilised and thereby it will create a sense of trust in the taxpayers and encourage them to be supportive to the tax system.

3.      The establishment of an independent tax commission and tax ombudsman, and ensuring the smooth functioning of it without any political intervention.

Long term

1.      Economic policies should be based on in-depth analysis of the economic environment (both micro and macro including PESTEL factors).

2.      Establishing a transparent, accountable taxation policy and system that will benefit the citizens of Sri Lanka.

Conclusion

The Professionals’ Trade Union Alliance, the largest-ever trade union alliance of professionals in Sri Lanka, consisting of over 40 trade unions, pledge to stand by the people of Sri Lanka and continue its endeavour for a fair, transparent, and accountable taxation system for the benefit of the nation.

The views and opinions expressed in this article are those of the author, and do not necessarily reflect those of this publication.