• Are pricing formulas a good move? 
• How can authorities implement formulas amidst a crisis?

By Tanya Shan Pricing mechanisms and tax hikes are some of the moves by the Government to resolve the economic crisis, which are further adding fuel to the people’s burning issues amidst soaring inflation. However, according to economists, price mechanisms are not ideal tools for a free market economy. Advocata Institute Chief Operating Officer (COO) Dhananath Fernando told The Sunday Morning that pricing mechanisms were not good solutions for a market and what should happen instead was permitting new and sufficient players in the market so that consumers could decide the prices based on supply and demand.  “It is consumers who should decide the prices. For this to happen, there should be a sufficient number of players in the market. But Sri Lanka is a small country, and we have a small market. Players might not benefit much from a small market. This is where global integration comes into play. The players should be allowed to operate freely and trade internationally as well,” Fernando stated. He added that the implementation of pricing mechanisms should not even be among the first two solutions to address the inflation-related impact on businesses as the priority solutions should be allowing more players in the market and the Government staying away from doing business.  “The Government should release the petroleum business and ask the private sector to run it; the private sector will depend on the global market changes and revise prices accordingly. But now the Government is coming up with all these pricing mechanisms because it has a stake in all the businesses,” Fernando stated. According to him, as a result, the Government has to increase the prices of fuel based on a fuel pricing formula as it cannot sell fuel at a lower price, thereby causing losses to the Ceylon Petroleum Corporation (CPC). “The interim measure to avoid causing losses is indeed increasing prices; if not, the Government will print money to fund the CPC, which will depreciate the currency, thereby causing inflation once again. This is a vicious cycle,” he added. University of Colombo Department of Economics Senior Professor Sirimal Abeyratne told The Sunday Morning that it was ‘wrong’ to implement pricing mechanisms in the first place.  “Everything has gone wrong but now we are letting the market decide the prices. We should have done this way earlier and stopped the Government manipulating the prices. The country is used to depending on the Government for cost hikes, and pricing mechanisms are a breakthrough in our thinking pattern but this is the worst time to do that,” Prof. Abeyratne stated.  Tax hikes and complications Moving on to the tax hikes and why Sri Lanka’s tax system was more complicated and less targeted, he stated that as far as direct taxes were concerned, Sri Lanka was an outlier among neighbouring countries because direct tax collection in Sri Lanka was too small.  In Sri Lanka, direct taxes include Personal Income Tax (PIT), Corporate Income Tax, Advance Personal Income Tax (APIT), Withholding Tax (WHT), and tax on interest. According to data published by the Central Bank of Sri Lanka (CBSL), revenue from direct taxes increased by 12% YoY in 2021 to Rs. 302.1 billion. Prof. Abeyratne stated that the reason behind comparatively less direct taxes was that the Government did not have information or did not want to have information on personal income and wealth because then many people would have a problem exposing and explaining their income.  “That is one thing we need to do if we are to get out of the crisis – have an efficient information system about people’s wealth and income. Then the Government will know what to tax, whom to tax, and who should be given subsidies and so on.” Prof. Abeyratne noted: “The direct and indirect tax composition of Sri Lanka is not consistent with our state of development. Currently, direct taxes account for only around 20-25% of our tax revenue. In my view, the share of direct taxes in Government tax revenue should go up to around 40-50%. This doesn’t require an increase in our tax rates; instead, it is sufficient to widen our tax base in order to achieve this target. Secondly, I recommend introducing a wealth tax on property. However, all our former governments up to now have shown a reluctance to put things in order and improve the efficiency of direct tax revenue collection.”  He further stated that improving revenue generated through direct taxes was the most effective approach available to the Government in improving its revenue and that obtaining further revenue from indirect taxes would be unlikely and counterproductive. “The situation of Sri Lanka’s indirect taxes is quite complicated and it has a negative impact on our production and exports. On one hand, we have multiple taxes on commodities, and on the other hand, our taxes on international trade are remarkably high in comparison to other countries in the Asian region. In fact, our taxes on international trade are comparable to the tax rates levied in African countries. In 2019, prior to the imposition of the current import controls, the tax share from taxes levied on import trade amounted to 18% of the Government tax revenue, whereas in India it was only 4.5%. So you can understand that even before the Covid pandemic we were not functioning as an open economy in practice. Therefore, I do not see much room for increasing Government tax revenue through indirect taxes,” he opined. Immediate revamp impractical Economist and Advocata Institute Associate Rehana Thowfeek told The Sunday Morning that it was somewhat difficult to revamp the tax administration immediately. “At the moment we have to sort of go back to the things we are used to and the things we are aware of. The system is reverting to 2019 but there are some issues that need to be addressed. The Ministry of Finance has indicated that it will be looking at tax exemptions and rationalising all of that; I think we can see a more suitable tax structure. The goal should be to widen the tax base,” she added. The Government two weeks ago made a U-turn, returning to 2019 tax levels. In a press release, the Prime Minister’s office said that the Value Added Tax (VAT) and the Telecommunication Levy were proposed to be increased with immediate effect, with the overall estimated annual tax revenue from all the said changes amounting to approximately Rs. 220 billion. The statement said that the VAT was proposed to be increased to 12% from 8%, through a gazette notification, subject to Parliamentary approval. It further said that the Telecommunication Levy was proposed to be increased to 15% from 11.5%, issued via a letter from the Telecommunications Regulatory Commission of Sri Lanka, subject to the approval of the Act’s Amendment. The statement noted that the estimated additional revenue for 2022 from these two immediate measures was Rs. 94 billion.  The proposed Amendment to the Inland Revenue Act are due to come into effect from 1 October 2022 and will reduce the personal income tax relief from Rs. 3 million to Rs. 1.8 million and reduce tax slabs on taxable income from Rs. 3 million to Rs. 1.2 million, while imposing tax rates of 4% to 32% on each slab.  It will also make Withholding Tax (WHT) on employment income tax mandatory, consider WHT on interest and dividends as final payments, and reintroduce a relief on interest income of Rs. 1.5 million for senior citizens. Furthermore, it will impose WHT on service payments exceeding Rs. 100,000 per month made to individuals such as professionals and increase Corporate Income Tax to 30% and concessionary tax rate to 15%.  Speaking on the 2019 taxes, Advocata Institute Chief Operating Officer Dhananath Fernando stated that the context in 2019 was different whereas now we were in the middle of an economic crisis while highlighting the fact that Sri Lanka’s tax system was somewhat complicated. “The more you earn, the more you pay tax. They are not incentivising people to earn more. That is a problem. You cannot have a complicated tax system that discourages people and makes them earn less or show less income,” he stated.