ECONOMYNEXT – Sri Lanka’s policy makers who advised ex-Sri Lanka President Gotabaya Rajapaksa, the cabinet and legislators who approved tax cuts made in December 2019 were responsible for severe revenue losses tax officers said responding to a speech by a former minister in parliament.

“The people who raised their hands when these policies were made are now blaming us,” H A L Udayasiri, the Secretary of the Inland Revenue Service Union told newly appointed State Minister for Finance Ranjith Siymbalapitiya during a visit to the agency.

Ex-Agriculture Minister Mahindandna Aluthgamage in September slammed low collections and the sharply lower tax payers in a wide-ranging speech in parliament.

The responsibility to the current situation should be taken by the officials who were there back then, including the President’s secretary, Finance Secretary and the cabinet, he said.

“We refuse to take the blame for that,” Udayasiri said. “Do not let these people blame the department taking the advantage of being a parliament MP. Because the department is still operating at least on this level is due to these officers.”

Sri Lanka had brought a new income tax law with support of the International Monetary Fund which had raised tax collections from in 2019 to 1,025 billion rupees, Udayasiri said.

He said the revenue union had some problems with the tax law but they had suggested changes and it was passed in parliament.

“Just when the results were to continue in 2020, taxes were cut,” Udayasiri said. “Many changes were done. The threshold for VAT was increased to 300 million and the income tax was increased to 3 million.

“Due to these reforms in 2020 tax income decreased by 600 billion rupees compared to 2019. And in 2021, the revenue decreased by another 700 billion rupees.”

Meanwhile the President of the, Commissioners Union, Sarath Abeyratna said the PAYE files which were 11 million rupees in 2009 had fallen to 39,000.

“When a policy decision was made to a volunteer based PAYE tax from a mandatory PAYE tax, the files that collected 1.1 million payee tax was reduced to 39,000 how can there be an income from that,” Abeyratne asked.

PAEY tax was abolished in the reform but was brought back as a voluntary tax following appeals by salaried workers who wanted the convenience of monthly deduction instead of filing a year end return.

There was a no broad culture in Sri Lanka of voluntary payments, Abeyratne said.

Udayasiri said Inland revenue officers had to work ‘with their hands tied behind their backs’ with instructions from the top that they were not to make site inspections or demand other data.

Post-Keynesian economists who advised President Rajapaksa had cut taxes to target an output gap also known as ‘stimulus’ after growth fell in the wake of two earlier currency crises from also output gap targeting style exercise in 2015/16 and 2018.

The IMF, which helped with the income tax law however alsogave technical assistance to the central bank to calculate an output gap, and encouraged ‘flexible inflation targeting’ despite the agency operating a reserve collecting peg.

Liquidity injected for flexible inflation targeting (to enforce rate cuts as domestic credit recovers) or outright stimulus (yield curve targeting, buffer strategy, overnight or term reverse repo injections/Soros style swaps) leads to balance of payments deficits and the currency collapses.

As a result there was a currency crisis in 2018 despite budget deficits being brought down and fuel market priced. In 2018 the rupee fell from 151 to 182 despite improvements in tax collections due money printed to target an output gap. When currency crises take place growth falls.

After low growth in 2017 and 2019, post-Keynesian advocated more tax cuts and money printing saying there was a ‘persistent output gap’.

The UK Finance Minister Kwasi Kwarteng’s also tried a similar tactic in this month, leading to bond market turmoil. UK’s Conservative government in 1972-72 tried a similar tactic known as the Barber-Boom.

However Keynesianism is widely taught in universities around the world as ‘macro-economics’ and when put into practice inflation and eventual output shocks are the result.

Tax cuts cannot boost economic activity or create inflation or balance of payments troubel, unless there is a central bank to print money and keep rate down. Tax cuts automatically leads to higher domestic borrowings and higher interest rates in the absence of central bank accommodation.

In the UK bond yields soared even before tax cuts took effect and the Bank of England bought bonds to keep rates down.

Classical economists and analysts have called for a currency board or hard peg to be set up to block the ability of the central bank to support stimulus or engage or mis-target interest rates to violate the impossible trinity for any other purpose. (Colombo/Oct 1/2022)