ECONOMYNEXT – Sri Lanka’s 2024 budget which did not contain the usual plethora of secretly hatched ‘black box’ taxes, also did not have a retrospective or ‘revenge tax’ on bonds to undermine rule of law as called for by some interventionists.

President Ranil Wickremesinghe himself told parliament that a new tax was being contemplated on bond buyers who prevented a freeze of a g-sec market like in Ghana, helping reduce money printing, though at high rates, since a deliberate default on rupee bonds was feared.

“Any tax measure of that nature would have to be retrospective in basis,” Advisor to the Finance Ministry Deshal de Mel told a post-budget seminar organized by the central bank.

“We have to make a change to the taxability of an instrument that at the time of transaction was a different tax regime.

“Our track record in terms of retrospective taxes has not been ideal. We have the surcharge on corporate income tax from 2022, and then before that you had the super gains tax.”

Sri Lanka imposed several revenge or punitive taxes in a 2015 budget called a ‘super gains tax’ supposedly on ‘ill gotten gains’ and followed up with a similar one later, despite the country trying to attract private investment.

In 2023 several urban intellectuals called for a ‘revenge tax’ on primary dealers and other bond buyers who stood to make large profits later, from buying bonds at high yields in an uncertain environment.

Some critics say the call for revenge taxes on bond buyers show that Sri Lanka’s post-independence decline, lack of policy stability, nationalism and bad governance is largely due to an illiberal urban intelligentsia which is egging on politicians to unleash the coercive power of the state upon unarmed citizens through ad hoc, arbitrary action.

High yields of around 20 percent were seen in bonds in previous currency crises. But in previous currency crises triggered by mis-targeted rates, banks were large buyers of bonds.

When rates fell, the capital gains helped off-set some of the losses from bad loans of banks in previous currency crises.

However, this time, banks also stayed off the bond market, with some also staying off bills, pushing up yields leaving only some insurance companies, non-bank primary dealers and their clients as buyers.

Pension fund managers also have ethical constraints on buying bonds which are destined to default.

“In general, I think any kind of retrospective measure is detrimental to the investment environment,” de Mel explained.

“Certainty and clarity is important in any investment decision. So any measure that is retrospective is contrary to those principles.

“I think that was one of the reasons why there was reluctance to go down that road.”

The International Monetary Fund in a governance diagnostic report also warned against retrospective taxes shortly before the budget saying they reduced the “predictability of the tax system with detrimental effects on long-term investment.”

The Rule of Law

Retrospective taxes and ad hoc tax changes of any kind undermines rule of law and governance.

“Nothing distinguishes more clearly conditions in a free country from those in a country under arbitrary government than the observance in the former of the great principles known as the Rule of Law,” explains economist and philosopher Friedrich Hayek.

“Stripped of all technicalities this means that government in all its actions is bound by rules fixed and announced beforehand – rules which make it possible to foresee with fair certainty how the authority will use its coercive powers in given circumstances, and to plan one’s individual affairs on the basis of this knowledge.

“Although this ideal can never be perfectly achieved, since legislators as well as those to whom the administration of the law is entrusted are fallible men, the essential point, that the discretion left to the executive organs wielding coercive power should be reduced as much as possible, is clear enough.

“While every law restricts individual freedom to some extent by altering the means which people may use in the pursuit of their aims, under the Rule of Law the government is prevented from stultifying individual efforts by ad hoc action.”

Rule of law “means, in the first place, the absolute supremacy or predominance of regular law as opposed to the influence of arbitrary power, and excludes the existence of arbitrariness, of prerogative, or even of wide discretionary authority on the part of government,” explains British constitutional theorist A V Dicey.

The IMF said both retrospective taxes and repeated tax amnesties undermined the system.

“Policy makers have introduced repeated tax amnesties while imposing additional tax, sometimes retrospectively, on compliant taxpayers,” the IMF said in a governance diagnostic report.

“Such a system undermines the trust of taxpayers, reduces predictability of the tax system with detrimental effects on long-term investment, distorts decisions, and complicates administration.”

Primary dealers are already taxed at 30 percent on all business income. (Colombo/Nov15/2023)