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Budget 2022: Taxation the need of the hour?

25 Sep 2021

By Skandha Gunasekara With import restrictions already pressing consumers, and speculation rife on the upcoming Budget 2022, economists opine that it is crunch time for the Government to take tough policy decisions to increase its revenue and/or curtail expenditure by at least 25% – both of which could cause the Government further loss in popularity. Shedding some light on the upcoming budget, State Minister of Finance Shehan Semasinghe told The Sunday Morning that the Government hopes to prioritise a production-based economy while continuing ongoing development projects. “The focus will be on accelerating infrastructure and development programmes and helping self-employed individuals increase their income with the aim of increasing production. The expected results will be twofold: One is that national productivity will go up and secondly, there will be more contribution to the economy in monetary terms and the individual households will increase their income,” he said. Meanwhile, newly appointed Central Bank of Sri Lanka (CBSL) Governor Ajith Nivard Cabraal, speaking to the media recently, said that while the import restrictions would be lifted gradually, the Government would do so in a manner that wouldn’t lead to the further depreciation of the rupee. “We don’t want to keep import restrictions going for too long, but at the same time, we also want to make sure our rupee is stable, and any additional imports could damage that,” Cabraal said, speaking to an international media outlet earlier this month. However, economists heavily downplayed the need for import restrictions, particularly on food items, and emphasised the need for the upcoming budget to concentrate on increasing government revenue while cutting down on expenditure. Impact of tax concessions Senior economist and former CBSL Deputy Governor Dr. W.A. Wijewardena told The Sunday Morning that a crucial step to take would be to reintroduce the tax system that was in place prior to December 2019. “The most important thing the Government must do with the upcoming budget is to abolish the tax concessions granted to income taxpayers and value-added taxpayers, and revert to the tax system we had before 2019. “As the Government is already very badly hit by an income loss of Rs. 500-600 billion, which caused it to buy (money) from the CBSL and would destabilise the entire finance economy (if it continues), Cabraal said he wants to maintain a proper balance between fiscal policy and monetary policy. “What he means is that the Government will have to generate its own revenue instead of depending on the money being printed by the CBSL – failing which, they will be digging their own graves, because how can the Government run without income?” Dr. Wijewardena questioned. He pointed out that tax reforms were essential, particularly for direct taxes, as the wealth gap was growing exponentially and indirect taxes were bleeding the low-income population dry. Speaking on the income distribution in Sri Lanka, he estimated: “Nearly 50% of income is earned by the top 20% of income earners, and the lowest 20% earns only 5%. If you consider Sri Lanka’s total GDP (gross domestic product) of (approximately) Rs. 16 trillion (as of 2020), it would mean the top 20% were earning about Rs. 8 trillion per annum. If the Government imposes a 20% tax on them, it can earn Rs. 1.6 trillion at least in additional tax income. “It is not the poor people who should be taxed; however, it is they who are paying through these indirect taxes. Income tax is not collected from the wealthy,” he alleged. Dr. Wijewardena said the next step would be to curtail state expenditure through the budget. “Resources will have to be allocated to improve productivity, namely through education, health, and research and development. State sector enterprises will have to be made viable in order to be run as business enterprises rather than branches of a political party,” he said. Dr. Wijewardena also said that he expected the Minister of Finance to take a “painful” decision on reducing state expenditure by at least 25%, adding that while these are all painful methods in the short term, the situation will worsen in the long term if this is not done. “What happens whenever there is a budget deficit is that the government cuts capital expenditure and expands current expenditure, and as a result, long-term economic growth is hindered,” he added. While noting that the vehicle import ban would continue for another year at least, Dr. Wijewardena opined that the import restrictions would be possibly lifted sooner rather than later. “Even though prices of vehicles will increase due to these restrictions, there are enough stocks of vehicles in the country. However, the Government is losing out on import duty, which is on average about 200-300%. As such, this might gradually be lifted. “However, as far as the other items such as food are concerned, (CBSL) Governor Cabraal very clearly said that he will lift the restrictions in phases without causing further negative impacts to the economy,” he added. Advocata Institute Chief Operating Officer (COO) Dhananath Fernando was also critical of the import restrictions, particularly for its supposed purpose of helping develop local industries. “Our imports have been declining since 1990. In that backdrop, in the last 30 years, our local industries should have developed. However, that hasn’t happened, which proves that this is not the right strategy. In my view, if you really want to develop a business, there is no point hating your competition. You have to be positive and develop it better, rather than trying to restrict your competitor because ultimately, consumers will find ways to get the services even if you stop that particular import,” he explained. He pointed out that despite the import restrictions introduced earlier last year, the import numbers continued to increase. “The best example is of the imports in June-July 2021. Even after restricting imports, import numbers were at a 17-month high during that period. There are two reasons: One is that, of our import combination, only 20% is consumable goods, mainly medicines and essentials; of the remainder, about 60% is intermediate goods, while the balance 20% is capital goods. There is nothing luxurious that we are importing at the moment. For the last 30 years, we have been cutting down on imports, and you can observe that when imports were curtailed, exports also declined,” he said. He charged that the reasoning behind imposing import restrictions to protect local industries was flawed, pointing out that the domestic ceramic industry had failed to compete in the global market despite being over 30 years old. “There is a perception that when you cut down on imports, you can develop local industries. However, unfortunately, data proves otherwise. In my view, it is when you have made it competitive that you have built your global company. “I understand the argument that when you have an infant industry, you need to protect it till it gets on its feet, but in the modern world, how it works, in my view, is you identify a better value proposition of a global industry and you try to pitch it to that. “Meanwhile, I understand that we are in a foreign exchange crisis, so we may need to consider some import controls in the short term, but the reality is, if you push the restrictions with the purpose of developing local industries, it would set a wrong example because ultimately, they will have to face the competition if they want to expand the business beyond the local market,” he added. With regard to the vehicle import ban, Fernando said that it not only curtailed state revenue through reduced taxes, but also eroded the aspirations of the professionals of the country, even pushing them towards migrating elsewhere. “Vehicles are aspirational goods, especially for the middle class, and many Sri Lankans associate prestige and success with a vehicle. So, the aspirational Sri Lankan is getting hit. Their quality of life is deteriorating,” he said. Fernando then proposed that the upcoming budget must address both the health crisis as well as debt sustainability. “The Government must get the fundamentals right with the next budget. Unfortunately, the health crisis and debt sustainability were not considered in the last budget. I think even the business community failed to see the importance of these aspects at the time. “My second proposal is that we reduce government recruitment and expenditure. There has been a lot of talk of increasing taxes and government revenue, but without a significant effort to cut down on government expenditure, the people will not digest a tax increase in a positive way. It will make the Government unpopular and have an impact on political stability,” he further noted. Touching on taxation, he too acknowledged reforms were needed, adding: “A proper tax infrastructure must be set up and the tax base must be increased with a proper system.” ‘Reduced imports not the answer’ Meanwhile, Samagi Jana Balawegaya (SJB) MP Eran Wickramaratne said the key areas to look at were exports and revenue. “It is essential to first focus on macro stabilisation before looking at specific sectors; to build a production economy, given our twin (budget and current account) deficits, we need to increase revenue and exports so that we have the funding,” he explained. Adding that the Government should prioritise food security and human capital development, he said: “Given the limited resources, we will have to decide on our priorities. I believe that soft infrastructure, i.e. human capital, will have to be prioritised over hard infrastructure such as roads and highways. The ‘haves and have-nots’ gap in education and training has increased with the pandemic. In addition to ensuring food security, agricultural productivity must also be prioritised.” Meanwhile, SJB MP and economist Dr. Harsha de Silva said the reduction of imports was not the answer to the forex crisis, but rather the boosting of exports was the solution. However, he said this will be a challenge, as the country’s exports are stagnating. Criticising the tax cuts of late 2019, Dr. de Silva charged that this loss of revenue must be regained if the Government was to stabilise the economy and see growth. “The Government’s budget and its deficit is a function of revenue and expenditure. As they can’t cut expenditure anymore, a revenue-enhancing mechanism is needed. Taxes have to be increased in some way,” he noted. He then went on to say that the only other form of earning revenue, apart from taxes, was through the sale of state assets to private companies, adding: “Those who said they were not going to sell an inch of land have sold 40% of our power plant to a foreign company without the Cabinet having discussed it. I don’t know how many others they’re going to sell like that, but how much can you sell?” Nevertheless, the Government does not seem to have decided on increasing taxes or reducing spending yet. When queried about curtailing state expenses, State Minister of Finance Semasinghe said that only non-essential expenses would be reduced. “We have put in controls on non-essential expenditure. However, welfare expenditure as well as salaries and wages given to the government service won’t be touched. We have passed the most difficult period. By the end of November, many will be fully vaccinated. Once the vaccination programme progresses, the impact of Covid will be very less, and so our main focus would be to revive the economy,” he stated. Pertaining to tax increments, he said no decision was taken in this regard. “We have not decided on tax reforms as such, but there are different proposals put forward to the Finance Minister. This will be a budget to overcome the negative impact of Covid in the last two years, and it will also lend an ear to the public and every industry. We don’t intend to increase taxes, but periodically, service tax on goods and services will be used to protect local producers,” he added.


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