Sri Lanka’s tax system has a design problem that its administrators have chosen, consistently, to treat as a revenue problem. The present architecture leans heavily on indirect taxation. Value-Added Tax (VAT), the Social Security Contribution Levy, excise duties, cess – these are levies embedded in the price of goods and services that every person in the country pays regardless of income, wealth, or economic circumstance.
The salaried employee who has already had Pay-As-You-Earn (PAYE) tax deducted at source, reducing the income before it arrives in the account, then spends what remains on groceries, utilities, fuel, and medicine, each carrying indirect taxes that make no distinction between the person buying them and the person who cannot afford to buy enough of them. The indirect tax does not ask what you earn. It does not ask what you owe. It asks only that you consume, which is not optional, and it charges accordingly. The result is a system that is, by construction, regressive, one in which the tax burden as a proportion of usable income falls more heavily on those with less of it, which is the inverse of what an equitable tax architecture is supposed to produce.
The salaried worker’s particular predicament illustrates the compounding effect with uncomfortable precision. PAYE tax is deducted monthly, automatically, before the income reaches the individual, an efficient collection mechanism that Sri Lanka has correctly implemented and which ensures that this category of taxpayer contributes with a reliability that no other category matches.
What remains after PAYE tax then passes through the indirect tax system on every transaction. If the individual manages, through discipline or sacrifice, to set aside some portion of the residual, the interest earned on those savings is subject to a 10% Advance Income Tax. Money taxed on arrival, taxed again on every purchase, and taxed a third time on the modest return it generates while sitting in a bank account. The compounding is not metaphorical. It is arithmetic, and the arithmetic is applied to the segment of the population that already contributes most reliably and has the least capacity to structure its affairs to avoid the liability.
The wealthy are in a different position, and the tax system has been insufficiently interested in closing the distance between them. High-net-worth individuals with income derived from business ownership, investment returns, capital appreciation, and property, sources that do not pass through a PAYE tax payroll and are considerably harder to monitor than a salary slip, contribute to Government revenue in ways that the Inland Revenue Department has neither the enforcement infrastructure nor, historically, the political mandate to verify with any rigour. The tax-to-GDP ratio has hovered in the low teens for years, against a regional average closer to 20%, and the gap between what the system should collect from those with the capacity to pay and what it actually collects is a function of that enforcement failure, not of insufficient indirect taxes on the people who are already paying.
What drives the public’s deteriorating relationship with taxation is not the fact of taxation itself. It is the specific combination of visible, unavoidable indirect levies; an interest tax on the savings of people who have very little to save; a PAYE tax system that extracts from salaried workers with mechanical efficiency; and public services, roads, hospitals, and schools that do not reflect the cumulative weight of what has been collected. A country that taxes its middle comprehensively and its wealthy selectively, and then delivers infrastructure and services that suggest the revenue disappeared somewhere between collection and delivery, has a legitimacy problem that no broadening of the indirect tax base will resolve. It will only deepen it.
The conversation Sri Lanka needs to have is about whether the people and entities with the greatest capacity to contribute are being reached with anything approaching the efficiency with which the salary of a junior executive is reached every month. They are not, and the reason is a collection system that finds compliance easier to enforce against those who cannot avoid it than against those who can. Fixing that is harder than adding a levy. It is also the only version of tax reform that does not further erode the confidence of the people being asked, again, to pay.