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Monday February 6th, 2023

Sri Lanka President knew revenues will be lost, VAT cut to remain for 5-years: Jayasundera

ECONOMYNEXT – Sri Lanka’s President Gotabaya Rajapaksa knew revenue will be lost by tax cuts but he considered it an investment, and an 8 percent tax rate slashed from 15 percent, will remain unchanged for 5 -years, a top official said.

“The President promised this nation a new taxation strategy,” President’s Secretary P B Jayasundera said at a seminar titled Colombo Development Forum this month.

“He knew the revenue will be lost but he considers that lost revenue as an investment in the country.

“Therefore, outdated archaic taxes have been given up. Singe rate VAT has been introduced. New corporate structure has been introduced.”

Sri Lanka’s last administration came to power promising to simplify the tax system but got caught up in an International Monetary Fund drive to increase revenue to GDP to some arbitrary number and put more money in the hands of politicians and bureaucrats.

Illiberal Consolidation

The IMF’s ‘revenue based fiscal consolidation’ was unusually illiberal or statist in that it placed no emphasis on cutting spending, in a country where the public sector was already unaffordable to the working productive sectors.

The lack of emphasis on cutting spending anti-austerity style went against all principles of natural justice where the burden of fiscal consolidation has to be spread at least partly on the state workers and not only on the general public, in a full sellout to the anti-austerity brigade some critics say.

Under the illiberal ‘revenue based fiscal consolidation’ spending was ratcheted up from 17.3 percent of Gross Domestic Product in 2014 to 18.7 percent by 2018, reversing trend of steady contraction seen since the end of a civil-war in 2009 when spending was close to 24 percent.

Revenues were raised from 11.6 percent of GDP to 13.5 percent with a plethora of niggling withholding taxes and royalties added despite as the hten administration which promised to reduce total number of taxes and simplify the system watched on the sidelines.

Personal income tax which was a 15 percent proportionate tax was ratcheted up to progressive rate close to 30 percent in giving way to the left, with predictable results on the electorate.

Un-anchored Monetary Policy

What remained of rule based monetary policy was jettisoned with ‘flexibility’ being given priority under the IMF program.

Monetary instability worsened with a highly unstable peg labeled the ‘flexible’ exchange rate (no-credible external anchor) was combined with ‘flexible’ inflation targeting (no credible domestic anchor) leading to currency crises in 2015/16 and 2018, triggering output shocks.

Under flexible inflation targeting, inflation, the real effective exchange rate, the call money rate, the yield curve and an output gap was targeted with large volumes of excess liquidity injected. In 2018 buy/sell dollar rupee swaps were used to inject liquidity and pressure the peg.

Under flexible exchange rate and call money rate targeting, the administration was forced to firefight the external imbalances, imposing import controls Nixon shock style, and de-railing a plan by the then-administration to have freer trade.

RelatedSri Lanka controls imports in ‘Nixon-shock’ move to protect soft-pegged rupee

In December 2019, a new administration cut taxes without going to parliament. The taxes are expected to be legislated shortly.

2019 ended with spending to GDP rising to 19.4 percent of GDP and the deficit had worsened to 6.8 percent, with the IMF program already on hold.

In 2020 with tax cuts, a Coronavirus crises and more monetary instability, growth and tax revenues had taken another hit. The current administration is also focused on firefighting the balance of payments, with money printing worsened.

5 Year Tax Fix

The budget deficit is estimated to be in the double digits in 2020, though some spending has been cut by putting on hold state worker salary hikes proposed by the last administration.

However tens of thousands of under-educated workers and unemployable graduates are being hired.

Meanwhile Jayasundera said the value added tax cut from 15 to 8 percent will stay for another 5 years and income taxes will not be changed, but the deficit will be brought down to percent in the medium term with economic growth.

“We are assuring the tax regime that we have instituted will not change. For the next 5 years VAT is 8 percent,” Jayasundera said.

“Income tax is whatever the rate we have gazetted. No other taxes will be brought in. Custom base taxes will be rationalized. We need much more efficient, transparent, compliance, friendly, tax regime and that is given.”

“If you want raise the turnover, raise the volume, raise the GDP. That is what this is all about. The Treasury secretary is not allowed to make any changes in taxes.”

In the meantime revenue shortfalls are being covered with monetized debt (liquidity injections), leading to a steady run on forex reserves, despite sweeping import controls. (Colombo/Apr03/2021)

Sri Lanka’s banks may have to re-structure loans caught in progressive tax

ECONOMYNEXT – Sri Lanka’s banks should explore restructuring loans of salaried employees hit by progressive tax, Central Bank Governor Nandalal Weerasinghe said as progressive income taxes were imposed at lower thresholds amid high inflation following a sovereign default.

There have been complaints mainly by picketing state enterprise executives and also other workers of such agencies such Sri Lanka Port Authority that high progressive taxes were putting their bank accounts into overdraft after loan installments were cut.

“Yes, they have mentioned that,” Governor Weerasinghe said responding to questions from reporters.

“We have told the banks earlier as well. Because the interest rates are high and their business being reduced, the SME sector, the repaying capability has reduced.

“We have told them to explore their repaying capabilities and restructure their loans in order to safe guard both sides. At this time also we are asking the banks to do that.”

In the case of some state enterprises, the Pay-As-You-Earn tax, through which income tax is deducted from salaried employees in the past was not paid by the employee but the SOE.

Bad loans of the banking system overall had risen after the rupee collapsed, reducing the spending power in the economy, while rates also went up as money printing was scaled back, foreign funding stopped and the budget deficit widened.

The rate hike has prevented possible hyperinflation and a bigger implosion of the economy by stabilizing the external sector in the wake of previous mis-targeting of interest rates.

In the current currency crisis a delay in an IMF program due to China not giving debt assurances as well as fears of domestic debt re-structure has kept interest rates elevated.

Sri Lanka’s economic bureaucrats in 2020 cut taxes and also printed money, in a classic ‘Barber Boom’ style tactic implemented by UK economists and Chancellor Anthony Barber in 1971 to boost growth and employment.

The ‘Barber Boom’ ended in a currency crisis (at the time the UK did not have a floating rate and the Bretton Woods system was just starting to collapse under policies of Fed economists) and inflation of around 25 percent in the UK.

The UK implemented a three-day working week to conserve energy after stimulus while Sri Lanka saw widespread power cuts as forex shortages hit.

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Anthony Barber budget of 1971

Anthony Barber budget of 1972

Similar policies saw a worldwide revival as the US Fed economists injected money during the Covid crisis mis-using monetary policy to counter a real economic shock and boost employment while the government gave stimulus checques.

Now the world is facing an output shock as a hangover the Covid pandemic recedes.

The re-introduction of progressive tax at a maximum rate of 36 percent while tax brackets high jumped with the rupee collapsing from 200 to 360 to the US dollar had reduced disposable incomes further.

Salaries employees were encouraged to get loans in 2020 with the central bank mandating a 7 percent ceiling rate for five years.

However, any borrower who got loans on floating rates long before the scheme are now facing higher rates. (Colombo/Feb06/2023)

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Sri Lanka to address SME tax problems at first opportunity: State Minister

ECONOMYNEXT – Problems faced by Sri Lanka’s small and medium enterprises from recent tax changes will be addressed at the first opportunity, State Minister for Finance Ranjith Siyambalapitiya said.

Business chambers had raised questions about hikes in Value Added Tax, Corporate Income Tax and the Social Security Contribution Levy (SSCL) that’s been imposed.

It should be explored on how to amend the Inland Revenue Act, Siyamabalapitiya said, adding that the future months should be considered as a period where the country is being stabilized.

Both the VAT and SSCL are effectively paid by customers, but the SSCL is a cascading tax that makes running businesses difficult.

In Sri Lanka SMEs make up a large part of the economy, accounting for 80 per cent of all businesses according to according to the island’s National Human Resources and Employment Policy.

(Colombo/ Feb 05/2023)

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Sri Lanka revenues Rs158.7bn in Jan 2023 up 51-pct

ECONOMYNEXT – Sri Lanka’s government revenues were 158.7 billion rupees in January 2023 but expenditure and debt service remained high, Cabinet spokesman Minister Bandula Gunawardana said.

In January 2022 total revenues were Rs104.5 billion according to central bank data.

Sri Lanka’s tax revenues have risen sharply amid an inflationary blow off which had boosted nominal GDP while President Ranil Wickremesinghe has also raised taxes.

Departing from a previous strategy advocated by the IMF expanding the state and not cutting expenses, called revenue based fiscal consolidation, he is attempting to do classical fiscal consolidation with spending restraint.

President Ranil Wickremesinghe has presented a note to cabinet requesting state expenditure to be controlled, Gunawardana told reporters.

State Salaries cost 87.4 billion rupees.

Pensions and income supplements (Samurdhi program) were29.5 billion rupees.

Other expenses were 10.8 billion rupees.

Capital spending was   21 billion rupees.

Debt service was 377.6 billion rupees for January which has to be done with borrowings from Treasury bills, bonds and a central bank provisional advance of 100 billion rupees, Gunawardana said.

Interest costs were not separately given. (Colombo/Feb05/2023)

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