Sri Lanka is showing signs of recovery and stabilisation following the crisis. However, along with rebuilding the economy, addressing income inequality to ensure that growth benefits all citizens remains a challenge.

In an interview with The Sunday Morning Business, University of Ruhuna Department of Economics Senior Lecturer Dr. C. Gunasinghe discussed the country’s fiscal policies and their impact on growth equality. 

He noted the Government’s efforts to balance economic reforms with the needs of vulnerable populations and highlighted the reforms required to achieve a more inclusive economy.

Following are excerpts: 

How has Sri Lanka’s fiscal policy impacted income inequality concerns and what progress can be observed? 

With Sri Lanka having faced one of the worst economic crises in its history, today, the economy shows signs of stabilisation, especially according to data from the World Bank, the Central Bank of Sri Lanka (CBSL), and the Department of Census and Statistics (DCS). We are seeing a return to normalcy.

The overall rate of inflation as measured by the Colombo Consumer Price Index (CCPI) on a year-on-year basis has fallen sharply from its peak of 70% in 2022 to around –0.3% in July 2025. The economy has rebounded from its worst growth rate of –3.5% in 2002 to a significant positive growth of 5% in 2024. We have also seen progress with debt restructuring and an increase in foreign reserves. 

While these figures are positive, a more serious challenge remains, being that of income inequality.

More than 24% of Sri Lanka’s population lives below the poverty line of $ 3.65 per day. This means that a quarter of the population is struggling to maintain a minimum standard of living. 

The burden of the economic adjustments proposed by the International Monetary Fund (IMF) has fallen hardest on low-income families. Fortunately, the Government seems to understand that fiscal policy must go beyond simply balancing accounts.

As far as I can tell, the Government has recognised that balance also requires fairness. Stabilisation is only the first step; shared recovery is the real goal. I believe the Government understands that the true test is not just meeting IMF targets, but ensuring that reforms protect the vulnerable, restore public trust, and create opportunities for everyone.

To achieve this shared goal, the Government has taken difficult but necessary steps. It has worked to broaden the tax base while protecting low-income earners, such as by raising the tax-free monthly income threshold from Rs. 100,000 to Rs. 150,000. This is a protective measure. At the same time, the tax system has been made more progressive, with higher earners paying a larger percentage.

Restructuring State-Owned Enterprises (SOEs), which have historically been a burden on the Treasury, is another measure the Government has taken. It has also taken steps to curb financial leakages by legalising and digitalising public finance. Financial technology (fintech) is being used in the Government’s payment system with the support of Government and private banks to ensure transparency and reduce inefficiency. 

Additionally, it has introduced better targeting of assistance for vulnerable populations. While a cost-reflective pricing mechanism for utility services like electricity and water has been implemented as per IMF guidelines, support systems have been put in place to help disadvantaged communities. This is a difficult balancing act for the country as far as its challenges are concerned, involving meeting economic requirements while protecting vulnerable segments of society.

Poverty has increased from about 15% before the crisis to 24% today. The target is to reduce this figure to 22% by 2026, which will be a challenge. The tax-to-Gross Domestic Product (GDP) ratio, which fell to a low of around 8.3–8.9% in 2021, increased to around 13.7% in 2024, indicating a reversal of the prior trend and a significant increase in Government revenue. 

While this is a positive development, most of the tax income comes from a regressive indirect tax system (around 80% of total tax income), which has major implications on income inequality. The proportion of taxes paid from income is much higher for low-income individuals than for the wealthy, which directly affects the poor. 

Although the Government has provided some subsidies and safety nets, I don’t believe they are sufficient. It is necessary to increase the direct tax proportion of the Government’s total tax income.

What is the progress of Sri Lanka’s Gini coefficient from 2019 to 2025? Has the distribution of income improved since the crisis?

It is difficult to find recent data, but we can surmise that the Gini coefficient has improved from what it was during the economic crisis and the pandemic. In 2019, the Gini coefficient was around 0.46. This index ranges from zero (perfect income equality) to one (perfect income inequality).

While this is a moderate number for the South Asian region, it is not ideal compared to advanced countries. According to the CBSL, the top 20% of households by income hold more than 50% of the national income. In contrast, the poorest 20% of households hold only 4.8%, and the poorest 10% hold less than 2% of the national income. This is a serious issue that must be addressed as it has potential implications for poverty, social stability, and economic development.

This unequal distribution is likely driven by many factors, such as unequal access to education, infrastructure issues, and limited opportunities. We also observe a high level of income inequality between urban and rural areas, as well as within cities like Colombo.

Our post-crisis growth has been reported at around 3% in 2024. Has our growth, especially in 2024 and 2025, been inclusive? What does growth look like for 2025?

The economy is gradually recovering, but many issues still exist. The real wages of employees have fallen and remain below pre-crisis levels. This means many people are struggling to find employment opportunities that meet their financial needs. On top of that, we have also seen a large number of people migrating, which is also a serious issue.

This scenario, where per capita GDP has been increasing while income inequality has been rising, is actually quite natural in terms of economic theory that suggests that initial growth might disproportionately benefit those with existing wealth and access to opportunities, creating divergence as society develops. 

Hence, while per capita income has increased, the distribution of that income has not improved because returns to physical capital are higher than human capital. We are still in the early stages of this process, which Europe went through centuries ago. 

The different skills and opportunities available to various segments of society are contributing to income and wealth inequality. If this is not properly addressed, later stages of development will potentially see inequality hinder further growth.

Sri Lanka achieved a primary surplus in 2024. Has this fiscal consolidation created fiscal space to reduce inequality or has it limited social spending?

Achieving a primary surplus is a significant achievement. From 2000 to 2020, Sri Lanka’s GDP growth remained mostly positive, with a few exceptions like 2001 and a growth rate of –3.5% in 2022. 

Even when the economy was growing, the tax-to-GDP ratio was unfortunately falling, which is a very unusual situation compared to other countries in the South Asian region, where it typically increases in parallel with economic expansion. This is a serious instance of fiscal mismanagement while maintaining a substantial welfare economy. 

Tax-to-GDP ratio is a key indicator to measure a country’s fiscal health, and its continuous decline to around 8.3–8.9% in 2021 was a major factor for the 2022 crisis. This has now started to increase.

While there was a primary surplus in 2024, there remains limited fiscal space. A significant amount of Government revenue goes towards debt interest payments, and around or more than 60% of total revenue goes to finance debt. 

This leaves only about 40% or less revenue for other necessary Government expenditures, like salaries and capital investments. Until recently, half of the Government’s recurrent expenditures were financed by borrowing, including external loans and sovereign bonds.

With revenue targets set at 15% of GDP by 2025, what are the impacts of the current tax regime, the collection network, and the fact that we rely heavily on indirect taxation? How can Sri Lanka rebalance the tax structure to reduce the regressive impact on low-income households?

It is a challenge. We have seen tax revenue increase from around 9% of GDP in 2023 to 13% in 2024, mainly from increased taxes. The goal is to reach 15% of GDP to achieve stability. 

However, the heavy reliance on indirect taxation, which is regressive and widens income inequality, remains a problem. The real challenge is finding a way to broaden the tax base without harming the general population.

One view in economics is that achieving greater equality may come at the cost of reduced economic growth, creating a potential trade-off between these two goals. Redistribution through taxes and social spending, while essential for equity, may sometimes reduce incentives to work, save, or invest, especially if poorly designed. 

However, this trade-off is not inevitable. Examples include investment in education and health (equalising opportunity and improving productivity) as well as progressive taxation that funds infrastructure or social insurance. 

Evidence suggests that high levels of inequality can themselves undermine long-term growth by weakening social cohesion, reducing opportunities for human capital development, and weakening domestic demand. Hence, this challenge is especially urgent in the Sri Lankan context. 

Fiscal policy has placed a disproportionate burden on low- and middle-income households through an over-reliance on indirect taxation for even decades. Sri Lanka must rebalance its tax structure now in order to build a more inclusive and resilient economy and this requires a shift towards broad-based, progressive direct taxation, including income, wealth, and property taxes, while reducing the dependence on indirect taxes that disproportionately affect the poor at the same time. 

This would improve fiscal sustainability and ensure that the burden of adjustment does not fall unfairly on the most vulnerable.

Hence the key policy challenge is not choosing between growth and equality, but designing a tax and spending system that promotes both. A fairer tax system with progressive principles can be a powerful tool to reduce inequality, mobilise public revenue, and promote inclusive growth.

Social protection schemes are often criticised for weak targeting. What are the structural reforms needed to improve redistribution efficiency?

With the current poverty rate, these households lack adequate income to meet their minimum standard of living, including basic food requirements. This leads to food insecurity and malnutrition, issues that need to be resolved promptly. 

We don’t just need fiscal space, we need fiscal justice. To achieve this, we should expand targeted cash transfer programmes for a certain period while empowering such households to reduce their dependence on transfers in the long run. 

Around 1.8 million people are currently receiving assistance through the ‘Aswesuma’ programme. However, it is important to empower people with skills and opportunities, not just make them dependent on cash handouts. Nutritional subsidies and protecting health and education spending are also crucial.

Fiscal justice is required for this. I am glad that the Government seems to understand this and is giving it high priority. For instance, several programmes have been implemented to ensure that pregnant women and children receive adequate nutritional support. 

I am also aware that many activities are being planned to be implemented from the ground up, specifically targeting those in need. The focus is on an inclusive work process and a participatory development process where everyone is involved and no one is left behind.

The Government is also planning to introduce a universal pension. This would help people cope with economic shocks and crises.

What measures are required to ensure income equality in the long run?

Our income targets and statistics are often dependent on external factors. At the same time, it is prepared for unexpected events, like the recent US reciprocal tariff policy. 

Sri Lanka’s over-reliance on remittances and tourism leaves it open to vulnerability, and this became evident during the Covid-19 pandemic, especially with restrictions in global travel and decreases in migrant incomes, where the country experienced a drop in foreign exchange inflows. 

In order to build better economic resilience and long-term sustainability, it is essential to diversify the economy beyond these traditional sectors. A promising area in this regard is the education sector, with the potential to generate export earnings (through international students, edtech, and academic partnerships), improve the country’s human capital base, support innovation, and raise productivity across multiple industries. 

Investing in education, skills development, and research can help Sri Lanka reposition itself as a knowledge-based economy, reduce its external vulnerabilities, and create more inclusive and future-ready growth. The goal should be to move away from dependence on volatile sectors and towards a more balanced and self-reliant development model.

There is a serious need to match what the education system produces with the needs of the labour market, both locally and globally. This is essential not only to meet the country’s development needs, but also to tackle income, wealth, and intergenerational inequality. 

An important but often overlooked issue of Sri Lanka’s investment climate is the deliberate negative framing by certain media and key figures within the political Opposition, which can increase a sense of instability or insecurity. 

While media freedom and political pluralism are essential and are at the foundation of democracy, continuous alarmist or strategically exaggerated narratives, especially on economic and governance matters, can distort public perception and weaken investor confidence. When international stakeholders view Sri Lanka as a risky/unstable destination, it directly impacts capital inflows, tourism, and foreign direct investment. 

This does not call for suppression of dissent or political debate, but for the promotion of responsible, fact-based communication, especially on issues that affect the national economy and social cohesion. The goal should not be to silence critique but to promote a more constructive and accountable information environment that supports recovery, rebuilds investor trust, and strengthens democratic resilience.