Sri Lanka has recently been urged to maintain its reform momentum, a key message emphasised during the recent visit by the International Monetary Fund (IMF). While this emphasis highlights the need for commitment, it also suggests that there is limited scope for tax revisions, particularly reductions, in the current year.
Discussing the implications of this on the economy, experts agree that, despite the challenges, it is essential for Sri Lanka to adhere to its current tax policy path and more importantly, revenue targets, while working towards improving the country’s overall tax revenue and fiscal position.
During her visit, IMF First Deputy Managing Director Gita Gopinath, while commending Sri Lanka’s progress, emphasised the need to sustain the reform momentum and adhere to the established reform programme.
Her speech also highlighted the Government’s adjustments and the significant increase in tax revenues, which have grown by more than two-thirds as a share of Gross Domestic Product (GDP). In light of this, the Central Bank of Sri Lanka has also stated the importance of continuing the current reform agenda.
A necessary but challenging path
Speaking to The Sunday Morning, KPMG Sri Lanka Tax and Regulatory Division Principal Suresh R.I. Perera noted that maintaining current tax levels without reducing them was crucial for fiscal consolidation, macro-economic consolidation, gaining investor confidence, and debt restructuring credibility.
“The IMF and creditors view consistent revenue generation as a sign of reform discipline. Increased tax revenues directly contribute to improving the Government’s fiscal position, reducing the need for borrowing, and making debt more sustainable in the long term. This is a core objective of the IMF programme and progress here is essential to avoid a repeat of the 2022 crisis,” Perera said.
He added that higher taxes, while necessary for fiscal health, could place a burden on households and businesses, potentially impacting disposable income and business profitability in the short term. He noted that the operations of Small and Medium-sized Enterprises (SMEs) were highly strained in a high-tax environment, which could lead to public discontent and “reform fatigue,” as Gopinath cautioned.
Perera also pointed to the need to be mindful that high tax rates could sometimes incentivise informal economic activity, making tax collection more challenging. Policies, such as discouraging cash transactions, can play a role in this aspect.
“If tax reforms disproportionately affect lower-income households, such as through regressive indirect taxes, it could worsen poverty and inequality, even as the overall economy improves. Gopinath highlighted the need for inclusive policymaking and engaging all segments of society, and improving the targeting and adequacy of social safety nets is crucial to mitigate this,” he pointed out.
Moreover, according to Perera, while the goal is to increase revenue, poorly designed tax policies can discourage investment, entrepreneurship, and formal sector growth. He observed that the IMF emphasised that reforms to boost tax compliance were important in order to deliver revenue gains without resorting to additional tax measures. Further, the fund notes that the tax exemption framework should be well designed to reduce fiscal costs and corruption risks while enabling growth.
Hence, he explained that continuous tax increases without visible improvements in public services or a perceived reduction in corruption could lead to significant public fatigue and opposition. Accordingly, this could undermine the political will to continue reforms and potentially lead to social instability.
In this light, Perera added that the IMF’s stance on maintaining reform momentum, particularly on tax revenues, was a necessary but challenging path for Sri Lanka.
“It aims to build a sustainable economic foundation, reduce debt vulnerability, and promote long-term growth. The key to avoiding counter-productive implications lies in transparent and inclusive policymaking, effective communication with the public, strong social safety nets to protect the vulnerable, and a continued strong commitment to good governance and anti-corruption measures,” he said.
Need to sustain tax rates, higher tax revenue
Addressing economic implications and macroeconomic consequences of the inability to reduce taxes, University of Peradeniya (UOP) Department of Economics and Statistics Professor Wasantha Athukorala stated that price reductions were unlikely this year, primarily due to the high tax rate imposed on goods and services. Hence, a significant reduction in the cost of living also seems improbable, according to him.
“Sri Lanka’s tax revenue is not positioned to adequately cover the country’s expenditure. With Sri Lanka expecting Rs. 4,590 billion from tax revenue in 2025, almost Rs. 3,000 billion needs to be allocated solely to pay interest on debt. Hence, there is no fiscal space for the Government to reduce tax revenue. The Government aims to increase tax coverage and it is essential that it works towards increasing the overall tax revenue within the country,” Prof. Athukorala noted.
Discussing the implications of this, he also highlighted that it was unlikely that any inflationary pressures arising this year would be attributed to tax changes. However, he noted that such pressures could stem from other factors, such as global uncertainties.
Adding to this, he also observed that tax revenue was projected to increase in 2025. This year, the Government revised certain tax rates, including reducing Pay As You Earn (PAYE) Tax. Prof. Athukorala noted that these revisions had positive implications for consumers, although they would reduce Government tax revenue to a certain extent.
Nevertheless, he noted that the estimated revenue amounts had already factored in this change. Adding more reasons for this expected increase, he noted that the Government was also working towards tackling tax-related issues such as tax avoidance within the country and reducing corruption.
In 2022, there was notably low tax revenue, and in 2023, Sri Lanka revised certain tax policies to improve tax revenue, with the current Government also having made specific revisions.
Prof. Athukorala noted that while Sri Lanka’s tax revenue had increased rapidly, this increase remained insufficient to cover the country’s total expenditure. One significant expense he pointed out was the payment that needed to be allocated for the interest bill, at a substantially high amount of Rs. 2,950 billion, constituting a large percentage of the total expenditure.
Meanwhile, as per Budget 2025, capital expenditure and net lending stands at Rs. 1,304 billion, subsidies and transfers at Rs. 1,290 billion, salaries and wages at Rs. 1,230 billion, and other goods and services at Rs. 416 billion.
Prof. Athukorala noted that this clearly highlighted that overall expenditure remained very high, despite the tax revenue not demonstrating a sufficiently rapid pace of increase to match this.
Moreover, Sri Lanka’s tax revenue was Rs. 2,752 billion in 2023 and Rs. 3,705 billion in 2024. In 2025, Sri Lanka expects to collect Rs. 4,590 billion, representing a 24% increase from 2024. Out of the projected 2025 tax revenue, the country anticipates Rs. 1,167 billion from income tax, Rs. 2,772 billion from taxes on goods and services, and Rs. 651 billion from taxes on external trade.
Prof. Athukorala observed that this data demonstrated Sri Lanka’s inability to progress without a gradual increase in tax revenue. At the same time, the number of taxpayers in the country also remains low. He noted that Sri Lanka had 4.7 million wage employees, yet out of them, only 5% paid income tax and that the total number of taxpayers in the country by 2024 had amounted to only around 1.6 million, indicating that tax coverage remained very limited.
Some main conditions set by the IMF pertain to the country’s tax policy and Sri Lanka’s need to achieve its planned tax income levels, indicating a lack of room for revisions.
Moreover, University of Kelaniya Department of Economics Professor W.M. Semasinghe also pointed out that while taxes admittedly affected economic activities and free economy policies within the country, given the present situation, the Government had no other viable options to increase Government revenue as per the IMF targets or to manage the crisis.
Explaining the aspects that would be impacted due to this limitation, Prof. Semasinghe noted its repercussions on the living conditions of wage employees, domestic producers, and the broader production and export sectors. However, he emphasised that it was a path that the Government had to undertake.
Tax revenue targets as the main concern
Speaking to The Sunday Morning, Verité Research Lead Economist Raj Prabu Rajakulendran emphasised that the IMF was primarily concerned with revenue targets. Hence, according to Rajakulendran, if the Government adopts a pragmatic approach, there could still be scope for tax reductions for the general public, provided these are offset by compensatory measures elsewhere.
For instance, he suggested that Value-Added Tax (VAT) could potentially be reduced while simultaneously increasing tobacco taxes, collecting tax defaults, or securing sufficient tax contributions from high-net-worth individuals to compensate for the reduction.
Although the IMF’s stance on this matter is often communicated as a firm ‘no tax cuts,’ Rajakulendran indicated that he would not consider such a possibility entirely off the table if a strong case for compensatory revenue measures could be presented, suggesting it might not face restrictions.
However, in terms of the overall economic impact, he observed a persistent revenue collection problem that Sri Lanka had perennially faced, even prior to the recent tax cuts and the economic crisis. Sri Lanka’s tax rates have historically been comparable to those of its South Asian peers, but the collection process has not been effectively executed.
“Hence, our focus should be – and I think even the IMF is alluding to it – on governance reforms and public finance management reforms, including aspects such as revenue administration and digitalisation. This is because, at this point, Sri Lanka can no longer afford either tax rate increases or significant rate reductions. Rates have stabilised to a fair extent, but the actual revenue collected must be increased,” he said.
Sri Lanka recently reported a 4.8% economic growth for the first quarter. Its economy expanded by 4.8% year-on-year in the first quarter of 2025, easing from a 5.4% growth rate in the previous quarter.
In this light, in terms of macroeconomic growth, Rajakulendran noted that drastic reductions in growth were unlikely in the coming quarters, anticipating that Sri Lanka would continue to perform well in terms of economic growth and meeting revenue targets.
Nevertheless, Rajakulendran pointed out that questions of equity and standards also came into play. He emphasised that there was still a possibility of making the tax system more equitable. He also stressed that unless the Government reversed ongoing reforms, counterproductive implications were unlikely to materialise.
“With Sri Lanka currently being in a recovery phase, sustaining this momentum into the future is of importance. To achieve this, it is crucial to make use of the current reform momentum and begin addressing long-standing structural issues, thereby ensuring that Sri Lanka remains on an upward path,” he noted.