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Indirect Taxation in Sri Lanka the Development Challenge

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Indirect Taxation in Sri Lanka the Development Challenge Indirect Taxation in Sri Lanka The Development Challenge 1 Abstract distribution. Taxation, inter alia, can Kopalapillai Amirthalingam be used as a tool to ensure such Senior Lecturer, ri Lanka is seeking rapid income distribution across Department of Economics, economic growth targeting geographical demarcations and University of Colombo. S at doubling per capita income deciles. income by 2016. Nonetheless, inequality is at its historical In the past three decades, a highest and thus the development number of developing countries the country. This situation challenge is to ensure that rapid have experienced major episodes of necessitates comprehensive policy economic growth is achieved financial crisis that were brought measures either to reduce while better ensuring equitable about by unsustainable fiscal expenditure or to increase the income distribution. Since fiscal deficits. As in the case of a number revenue base of the country, so deficit is significantly high in of other developing countries, the that the government need not Sri Lanka, taxation is crucial in fiscal deficit in Sri Lanka too has depend overwhelmingly on debt. generating government revenue been high for a long period. Though However, given the security because of the harmful the fiscal deficit was at its peak at situation and the need for rapid macroeconomic repercussions of 23 per cent of GDP in 1980, it development of the country, other means. However, tax ratio averaged 13 per cent during 1977- expenditure cuts could be harmful is on the decline and the decline 1991 and 9 per cent during 1992- not only economically, but also is closely related to the decline 2009 (Central Bank of Sri Lanka). politically. of the indirect tax revenue. However, even a 9 per cent deficit Therefore, enhancement of could be a dangerous phenomenon Therefore, focusing on taxation is indirect taxation is vital. as it could act as a catalyst for crucial since alternative ways of Efficiency and productivity of financial instability in the country. financing government expenditure, VAT should be improved while For example, Brazil's financial such as, money creation, mandating taking measures to ensure equity. crisis in 1999 was closely related larger required reserves, domestic This will be an important to its high budget deficit, which was borrowing and foreign loans can development challenge to the 8.4 per cent of its GDP (Woo, 2003). have harmful macroeconomic country. When government revenue is repercussions. International insufficient to offset expenditure, empirical evidence on tax ratio Introduction the country is forced to depend on (total tax revenue as a percentage foreign and domestic sources to of GDP) has 40 per cent, 25 per cent Development can be defined as bridge the fiscal deficit. As a result, and 18 per cent as the average tax economic progress shared by all, government's debt as a percentage ratios for high-, middle- and low- and is particularly so if one focuses of GDP (Gross Domestic Product) income countries respectively on sustainable development. Sri rises. High levels of debt in turn (Gallagher, 2005). Nonetheless, tax Lanka is seeking a rapid economic will increase the pressure on the ratio in Sri Lanka has been growth after ending the thirty-year government's ability to meet its declining and remains well short of old civil war. The current target is other commitments. This is of the average rate of developing to double per capita income from particular concern when these countries. It is important to note the current level of USD 2053 to commitments involve essential and that the tax ratio has declined from USD 4106 by 2016. Inequality, as development-oriented expenditure. 21 per cent in 1979 to 12.8 per cent measured by the Gini coefficient Government borrowing also tends in 2009. Indirect tax as a however, is at its historical highest, to reduce the quantum of resources percentage of GDP has declined 0.49 in 2006/2007, compared to available to the private sector and from 15.7 per cent in 1980 to 9.9 0.43, 0.46 and 0.48 in 1978/79, results in higher interest rates in per cent in 2009. During the same 1986/87, and 1996/97 respectively. the domestic market. This will period, as a percentage of GDP, Thus, the development challenge is increase the cost of borrowing for direct tax has also declined to ensure that rapid economic the private sector, thereby crowding marginally, from 3.1 per cent to 2.9 growth is achieved while better out private investment, adversely percent (Central Bank of Sri Lanka). ensuring equitable income affecting the economic growth of Here, we can notice that the decline 11 — Economic Review: Oct./ Nov. 2010 of tax ratio has been closely related developing countries usually wish consumers by way of increasing the to the decline of indirect taxes as to increase development-oriented price of goods and services. The a percentage of GDP. services such as education and most important single fact about training, agricultural extension and indirect taxes in developing Thus there is a need, as well as research. Thus, government economies is the dominant role room to increase the tax ratio in revenue may need to grow at a rate that they play in the revenue Sri Lanka because increasing tax that exceeds the growth of national system of almost every country. revenue as a percentage of GDP is income to provide resources for Historically, indirect taxes have vital for the economic development. recurrent government expenditure. been an important element in Lewis (1984) argues that an As a result, countries are stabilisation tax packages that aim increasing share of tax revenue in constantly trying to formulate a at raising revenue in the short run national income or in GDP is an better tax policy and frequently in many countries. instrumental objective of economic reforming their tax structure with development policy. High-income a view to increasing tax revenue. Musgrave (1969) divided the period countries have had rising shares of of economic development into two: tax revenue and government Though the main target of a country the early period when an economy expenditures to income as they is to increase total tax revenue, is relatively underdeveloped and have become more indirect and direct taxes play the later period when the economy economically advanced. Similarly, different roles in developing and is developed. During the early comparison among countries at developed countries. Developing period, there is limited scope for different levels of per capita income countries tend to rely on indirect the use of direct taxes because the generally show higher shares of taxation as a revenue source, since majority of the populace resides in government expenditure and such taxes are easier to administer rural areas and is engaged in tax revenue in national income of in countries that have poorer subsistence agriculture, and higher-income countries than in income and asset recording therefore their incomes are difficult poor countries. There appears to be systems. High direct taxes are also to be estimated. Therefore, indirect a relative increase in the demand thought to discourage taxes play an important role during for government services as per entrepreneurship and effort, and the early stage of economic capita income increases. At very hence lower direct tax rates are development. The difference in low levels of per capita income, the proposed in a bid for greater direct and indirect tax shares in principal needs are for "private" economic growth. Thus clearly, the developed and developing countries goods, such as food, clothing and growth in tax revenue has to be confirms Musgrave's theory. He shelter. The income elasticity of largely through the expansion of further states that the ratio of demand for those products falls as indirect taxation. However, since indirect taxes to total taxes is per capita income increases, and indirect taxes act as regressive related inversely to per capita there is an increased demand for taxes in which the tax burden may income, because the economic "public" goods at higher levels of fall on everyone equally, regardless structure of low-income economies income. The increased demand is of their income (or ability to pay), is not suited to the imposition of for government services in the areas further enhancement of the direct taxes. The following Table of transportation, communication indirect taxes might aggravate the clearly shows the difference and general government equity concerns encompassed in between Sri Lanka and some administration, to deal with the development objective. This developed countries, such as, increased complexities. Further, necessitates indirect tax reforms to Canada, New Zealand and Australia the demands for certain welfare be sensitive both to equity and and even some other developing services and transfer payments to growth objectives in the country. countries with regard to the various poorer sections of the capacity for raising tax revenue population are felt much more Defining Indirect Taxation through direct taxes (Taxes on strongly at higher levels of per income, profits and capital gains). capita income than at lower ones. Indirect taxation is defined as All these pressures to increase the taxation that may be imposed upon Table 1, shows that Sri Lanka has level of government expenditures the persons other than those who raised less revenue from direct and transfer payments generate a are intended to bear the final taxes (taxes on income, profits and need to increase tax revenue to burden. Unlike direct taxes, capital gains). This indicates that release real resources for the indirect taxes are the same for all, even in contrast to Thailand, provision of these government irrespective of the income level of Malaysia, India and Kenya, Sri services. In addition to the consumer and are therefore Lanka has relied excessively on general government consumption regressive.
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