Three years after the devastating tax policy changes in 2022, Human Rights Watch (HRW) recently levelled the criticism that these ‘ruinous’ tax failures had pushed millions into poverty, played a central role in the country’s 2022 economic collapse, and continue to deprive citizens of essential public services.
The Sunday Morning Business spoke to several experts regarding any progress made in reversing the impact of these tax failures thus far, especially concerning the vulnerable segments of the country.
Partial recovery
Speaking to The Sunday Morning Business, KPMG Sri Lanka Tax and Regulatory Division Principal Suresh R.I. Perera emphasised that the recent economic crisis, worsened by tax policy failures, had had a devastating impact on poverty and public services, as highlighted by the HRW report.
He explained that Sri Lanka had taken some positive steps to address the crisis’s fallout, including social protection, where the Government had expanded social protection measures, such as augmenting benefit amounts and broadening the coverage of direct transfers.
One such initiative is the ‘Aswesuma’ programme. ‘Aswesuma’ welfare benefit payments were directed to commence on 1 July 2023. The programme was approved by the Cabinet of Ministers in December 2022. These transfers may have played a role in mitigating the escalation of poverty.
On tax reforms, Perera explained that Sri Lanka’s tax system remained a key fault line in its post-crisis recovery, adding that while some progress had been made, the path to a more equitable and sustainable fiscal regime was still fraught with structural and political challenges.
Initial reforms were introduced from mid-2022 to mid-2023, including raising Personal Income Tax (PIT) rates and reinstating the Value-Added Tax (VAT). These measures have resulted in more revenue generation. However, he pointed out that the reversal of the impact of previous policy failures was only partial and faced major challenges.
“The poverty rate is gradually increasing. The gain in poverty reduction from cash transfers was almost entirely offset by the continued reliance on regressive indirect taxes, like the increased VAT, which imposes significant financial burdens on poor and vulnerable households.
“Public spending, particularly on education, remains chronically underfunded. For instance, education spending was around 1.5% of GDP in 2022, among the lowest in the world, down from 3-5% historically,” he said.
Perera believes that moving away from this regressive system is feasible in principle but faces several challenges such as political resistance, making tax hikes and base broadening unpopular, especially ahead of elections. These challenges also include administrative capacity, such as weak enforcement, outdated IT systems, and low taxpayer morale hindering reform; the informal economy, since a large informal sector makes income taxation difficult; and policy inconsistency, where frequent reversals and ad hoc exemptions reduce credibility.
Need for a higher tax-to-GDP ratio
Sri Lanka’s tax revenue was Rs. 2,721 billion in 2023 and Rs. 3,705 billion in 2024. In 2025, Sri Lanka expects to collect Rs. 4,590 billion, a 24% increase from 2024. Out of the projected 2025 tax revenue, Rs. 1,167 billion is expected from income tax, Rs. 2,772 billion from taxes on goods and services, and Rs. 651 billion from taxes on external trade.
Verité Research Lead Economist Raj Prabu Rajakulendran noted that the impact of the previous taxation scheme largely remained within the economy, especially with regard to the poor, considering that the VAT still remained at an all-time high.
“While the income tax threshold has increased, providing some relief, indirect taxes remain, affecting everyone. The poor are affected more given their low income, since a higher proportion is spent on taxes. In this sense, there is much more to be done. While the increase in the threshold remains the main tax change brought by the incumbent Government, hopefully, the new Budget will contain other tax changes,” he said.
In March 2022, Sri Lanka’s tax-to-GDP ratio was 7.4% of GDP, among the lowest in the world. A key requirement of the International Monetary Fund (IMF) programme is for the Government to achieve a minimum tax-to-GDP ratio of 15%.
Concerning Sri Lanka’s current tax-to-GDP ratio, Rajakulendran noted the need to target at least 20% to ensure sustainability, raising revenue well beyond just IMF targets. However, he believes this requires more than limiting the changes to easy fixes, suggesting that revenue should instead come through revenue administration, being strict on tax exemptions, and widening the tax base, as opposed to increasing rates.
Real relief for the poor yet to be seen
Economist and former Executive Director of the Centre for Poverty Analysis (CEPA) Dr. Herath Gunatilake noted that the Government had not done much work on the tax front yet, with the main change being the reduction of certain percentages and changing the tax threshold. While this has provided some relief, he noted that this mainly benefited the lower-middle-class segment, rather than the poorest of the poor.
“The largest tax burden for the poor comes through indirect taxation and this system must be changed to provide real relief. This is yet to take place, and I hope the Government will attend to this soon,” he said.
Dr. Gunatilake also stated that with a larger percentage of Sri Lanka’s tax revenue driven by indirect taxes, the poor segments of the country paid proportionately more taxes when considering their income relative to taxes paid. This, he highlighted, was one major tax failure with a substantial direct impact on poverty.
He noted that strengthening the tax collection system was essential, thus fixing governance issues and augmenting the tax base, since Sri Lanka had only a small number of registered taxpayers. He stressed the need to fix these, highlighting that rectification would allow for more spending on development projects and poverty alleviation.
With tax revenue largely used to provide subsidies and other welfare to enable relief for the poor, he further noted the requirement for augmenting tax revenue by eliminating governance and corruption issues in the system.
Dr. Gunatilake also pointed to the general misuse of tax revenue by governments, especially in budget allocations. In the past, he noted that while budget statements were made regarding allocations to each sector, the actual utilisation and spending of the money largely remained a mystery. He described the lack of such revelations as yet another failure of the system.
Need to increase spending
Meanwhile, University of Peradeniya (UOP) Department of Economics and Statistics Professor Ananda Jayawickreme noted that the impact on the poor remained, with indirect tax policies still in action, especially given that the main taxes that burdened the poor were VAT and other taxes on commodities. He added that the current heavy reliance on indirect taxes was concerning.
Budget 2025 expects a 23% increase in total revenue, which includes a 24% tax revenue increase, from Rs. 3,705 billion in 2024 to Rs. 4,590 billion in 2025. Moreover, a 17% increase in total Government expenditure is also expected.
Sri Lanka’s spending on several sectors declined due to taxation challenges, with the country’s education spending dropping to 1.5% of GDP in 2022, when the international benchmark remained at 4–6%. In 2022, the cost of tax exemptions reached 56% of revenue, nearly three times the education budget, representing the broader deprioritisation of social spending. While the incumbent Government has increased spending on education in Budget 2025, HRW highlights the need to reach the international benchmark.
Meanwhile, Prof. Jayawickreme noted that only around 25% of the allocated capital expenditure in the Budget had been spent. He emphasised the need to spend the money in order to ensure economic benefits and circulate the money to expand economic activities, adding that the inability to do so would lead to a stagnant economy.
He also stated that due to the high inflationary rates that resulted in commodity prices almost tripling, the current economic state included taxes on taxes.
“It is important to note that even the income taxes have an indirect impact on the poor, as these will be passed down by those who provide services. It is necessary to reduce the reliance on indirect taxes, reduce the prices of essential commodities, and spend the revenue collected from taxes to expand the economy and improve productivity. We are yet to see progress in reducing poverty and solving the issues of lower-income individuals,” he added.
Real tax reforms
Meanwhile, Arutha Executive Director Yolani Fernando highlighted two key issues concerning taxation.
“For decades, Sri Lanka has been heavily reliant on indirect taxes, leading to a higher burden falling on the poor, whereas a higher focus on direct taxation is required for a fairer taxation system, such as income tax.
“Sri Lanka has continued to have low income tax and massive tax exemptions on Corporate Income Tax (CIT). Pre-crisis, the tax ratio was around 80:20 (80% being indirect). We are currently moving away from this and have improved in terms of this ratio, although it is difficult to do so immediately,” she stated.
Given the relatively stable current condition, Sri Lanka can move forward from this point onwards. However, Fernando noted that the changes were mainly driven by changing rates, thresholds, etc. rather than real tax reforms, highlighting the need to move beyond these marginal steps to ensure further progress.
“What can take Sri Lanka beyond the current position are more sustained reforms in tax administration – which is complicated, and requires investment and human capital development – and capacity building in tax institutions like the Inland Revenue Department, which has been largely neglected for decades.
“While it is good that the Government is not looking at any new taxes, we hope that this means it will focus on improving tax administration, making the process of tax payment easier and tackling tax evasion,” she added.
Further, she noted that this was a long-term process, highlighting the need to move away from para-tariffs and focusing instead on protecting citizens rather than vested interests moving forward.