- Verite Research’s Sri Lanka Economic Policy Group offers three policy options, which will help increase tax collection, without making changes to existing tax rates
As the government urgently needs to increase its revenue to GDP ratio by 3-4% over the next two years, an effort that is mandatory to improve debt sustainability dynamics, the Sri Lanka Economic Policy Group of Verite Research pointed out that the goal can be achieved by opting for “simple” policy options, which would offer immediate and significant progress.
In the preliminary assessment by the core group of four leading economists, the policy brief highlighted the need to focus on reversing current methods of tax collection. The document called for the restoration of effective tax collection methods that were dismantled in 2020.
In January 2020, President Gotabaya Rajapaksa announced major tax policy changes, which led to a reduction in tax revenue from 11.6% of GDP in 2019 to 8.1% of GDP in 2020. This reduction in revenue has led to a fiscal situation that made debt servicing unsustainable and a credit rating downgrade. Overall, this decision shut Sri Lanka out of global financial markets.
The political group presented three policy options that authorities can choose from, which will help increase tax collection, without making changes to existing tax rates.
Necessary will be to restore methods that improve the efficiency of tax collection.
The proposed options are: (1) restore PAYE to current tax rates and thresholds, (2) restore WHT to 5% on interest, fees, and other income, and (3) restore WHT to 10% on interest, fees and other income.
With policy options one and two, Sri Lanka can improve tax collection by 40.9 billion rupees from June to December 2022 and 101.5 billion rupees in 2023.
While with policy options one and three, Sri Lanka can improve tax collection by Rs 75.4 billion from June to December 2022 and Rs 184.2 billion in 2023. The first combination of options will contribute increase revenue by 0.4% of GDP in 2023, while the second mix will help increase revenue by 0.7% of GDP in 2023.
The recommendation comes from a core group of economists including Professor Dileni Gunewardena, Professor Mick Moore, Dr Nishan de Mel and Professor Shantayanan Devarajan.
The Economic Policy Group of Sri Lanka attempted to isolate and identify how much of the decline in income tax revenue was due to the removal of the PAYE collection method and how much was due to the change taxable income threshold and tax rate.
The effort was made assuming the scenario where the PAYE method had not been abolished but revisions to the taxable income threshold and income tax rates had still taken place.
In addition, using data from the 2019 Labor Force Survey (LFS), the “expected” tax revenues for each year were calculated. For the purpose of this exercise, it has been assumed that the pattern of income distribution of the employed population in Sri Lanka has not changed between 2019 and 2021 and is similar between the formal and informal sectors.