REIMAGINING THE TAX REGIME

Prashanthi Cooray analyses two contrasting sets of tax reform proposals

Sri Lanka’s economic turmoil can be traced back to mismanaged moves that snowballed into a debilitating crisis. To meet the 2019 election promises, a series of ill-advised tax decisions were introduced when state funds were already buckling under the weight of a failing economy.

The sweeping tax cuts drastically reduced government revenue, leading to fiscal deficits and an inability to service debt or fund essential public services.

In response to the burgeoning crisis, several corrective measures were introduced in 2022. The tax policies implemented under then president Ranil Wickremesinghe were characterised by austerity measures and a reliance on fore­ign loans, focussing on reducing the fiscal deficit through tax hikes.

Following the presidential election, the victorious National People’s Power (NPP) party is positioning itself as a champion of transformative tax reform.

With an economic landscape marred by the high cost of living, fiscal deficits, a low tax-to-GDP ratio and high levels of tax evasion, the NPP’s manifesto presents ambitious changes aimed at creating a fairer and more efficient tax regime – or so it claims.

Its proposals include adjusting corporate tax rates to promote local investment and offering tax relief and incentives to stimulate growth in various sectors. A fairer and more progressive personal income tax structure aims to reduce the burden on low and middle income individuals by raising the annual tax threshold from Rs. 1.2 million to 2.4 million rupees, and revising rates and brackets.

The NPP’s manifesto calls for a zero VAT rate on essential goods and services, including locally produced milk and eggs, drugs, school books, agricultural equipment, equipment for the disabled and IT related services.

Acknowledging the need to simplify the tax code, the NPP plans to reduce tax brackets and streamline regulations, thereby enhancing compliance and accessibility, and alleviating the administrative burden on both taxpayers and authorities.

The emphasis on enhancing the efficiency of tax administration and reducing corruption involves training and capacity development of officials at the Inland Revenue Department (IRD).

A unique digital identification code will be assigned to citizens for easier access to public services alongside measures to expedite the collection of tax arrears. And a dedicated tax policy unit is to be established with a special section for international transactions.

While the opposition force Samagi Jana Balawegaya (SJB) shares some common ground with the NPP on tax reform, their approaches diverge in philosophy and execution.

The SJB proposes cautious reforms aimed at improving compliance and efficiency within the existing tax framework rather than overhauling it.

It calls for reducing corporate tax rates by up to six percent from the present 30 percent on  profits on exports and introducing a 15 percent base erosion and profit shifting (BEPS) minimum alternate tax for multinationals.

The SJB’s personal income tax rate after the tax-free slab of Rs. 100,000 a month will start at one percent and increase up to 24 percent on income up to around half a million rupees a month. Thereafter, the current rates will apply to high income earners.

This will broaden the tax base rather than only raising rates for high income individuals, which has driven many professionals to seek employment abroad.

As Sri Lanka approaches the general election, these differing visions for the country’s tax regime will be critical in shaping economic policies and influencing voter sentiment.

The NPP’s tax proposals will resonate with a large segment of the population that is disillusioned with the status quo, and seeking reforms promoting social justice and economic equity. However, radical changes to the tax regime could undermine an already fragile economy.

As the nation navigates its path towards recovery, the implications of the proposed tax changes will be closely watched by citizens and policymakers alike.

The challenge lies in articulating a compelling vision and ensuring successful implementation in what is a complex political landscape.