COLOMBO (EconomyNext) – Sri Lanka should raise the retirement age as people get older and the state should cut sweeping subsidies and tax holidays should be ended to get more revenues, the Central Bank said.
"With regard to government expenditure, government welfare measures such as subsidies provided to several sectors in a blanket manner remain a fiscal burden that should be immediately revisited," the Central Bank said in its newly released 2014 annual report.
The report did not elaborate on the subsidies.
The new administration made two additional sectors in the economy, tea and rubber smallholders, who were earlier not a burden to their fellow men in society but were standing on their own feet, bite the dust and become a tax-eating-crony sectors through a guaranteed price subsidy scheme.
Sri Lanka’s paddy farming and dairy sectors as well as onion and potatoes are already tax-eating-crony sectors which are preying on the poor and hungry and especially children suffering from malnutrition, through price support and import duty protection.
The new administration also sharply raised the salaries of state workers, increasing their burden on the rest of society, and pushing up the total non-productive recurrent spending by the rulers from tax collected from hard working sections of society.
The Central Bank said Sri Lanka’s government revenue fell from a share of 27.4 percent of gross domestic product in in 1978 to 16.8 percent in 2000 and 12.2 percent in 2014.
"As this is increasingly challenging the performance of the fiscal sector, decisive measures are necessary to address this issue through a medium term framework," the Central Bank claimed.
"Some areas that need attention in this regard are further simplification of the tax system, broadening the tax base by improving direct taxation and minimising tax exemptions, and strengthening tax administration."
Other economists have however pointed out that fixing budget deficits by raising revenues instead of cutting taxes is well known fiscal myth propagated by statists on a generous citizenry who do not have time to reason out their own interests and liberties.
Sri Lanka had high levels of poverty and low levels of employment when tax to revenue ratios were close to 20 percent and the way to fix budget problems are not to extract more taxes from the population but to reduce the state.
Top Indian economist B R Shenoy (who also worked in the IMF) in a report in the 1960s to Sri Lanka’s then administration pointed out that a revenue to GDP ratio at 22 percent at the time was too high to allow for private citizens to grow business.
"Taxation in Ceylon is too high and needs to be scaled down," Shenoy wrote in his report, ‘The Economic Situation and Trends in Ceylon – A program for Reform."
"Currently revenues appropriate about 22 percent of GDP which is double the average in India and well above the average in Germany, Italy and the US."
In West Germany at the time, revenue to GDP was 13.7 percent and Japan 13.9 percent the document said.
The best way of fixing budget problems are to bring down recurrent spending of the government, which the last administration had done to some extent.
Sri Lanka’s budget deficit reduction, especially after the end of the war in 2009 came with cutting down current expenditure, along with the reduction in the tax-to-GDP ratio, reducing the total tax burden on the people.
In 2009 total state expenditure was 24.9 percent revenue was 14.9 percent of GDP. By 2013 total state spending was brought down to 19.2 percent, and current spending was cut to 13.9 percent of GDP from 18.2 percent in 2009, bringing a high quality fiscal correction.
The overall deficit was brought down to 5.9 percent of GDP in 2013 from 9.9 percent in 2009. The revenue to GDP ratio was brought down from 14.5 percent to 13.1 percent, reducing the overall burden of the state on the people.
In 2014 however current spending deteriorated to 13.5 percent of GDP and overall deficit rose to 6.0 percent. But in 2015 current spending is budgeted to deteriorate further to 13.7 percent.
"Those people who are properly worried about the deficit unfortunately offer an unacceptable solution: increasing taxes," US economist Murray Rothbard once wrote.
"Curing deficits by raising taxes is equivalent to curing someone’s bronchitis by shooting him. The "cure" is far worse than the disease."
"No, the only sound cure for deficits is a simple but virtually unmentioned one: cut the federal budget."
The new administration has taken steps to reduce tax frauds in the alcohol sector. Analysts say eliminating tax holidays would improve rule of law and justice.
Another key benefit of ending tax holidays will be that the state will not be able to intervene in the economy and mis-direct investments with incentives based on the whims of politicians and bureaucrats.
As a result private capital will flow in to the most productive areas where there are the highest profits.
Direct taxes destroy investible capital, turning them to consumption in the hands of the political class, reducing future employment opportunities for ordinary people.
Partly due to high direct taxes at home which have reduced jobs, as well as currency depreciation due to loose central bank policy which have destroyed real wages, analysts say millions of South Asian workers are working in Middle Eastern countries which have mostly indirect taxes and strong currencies.
Such countries with little or non-existent direct taxes have workforces exceeding their own population.
Currency depreciation also destroys investible capital, in addition to transferring real income to business owners from their workers.
Sri Lanka is also facing the problem of an ageing population, reducing the number of workers available to produce output to sustain themselves and taxes to sustain a high spending state.
"Reviewing the current stipulated age of retirement is also necessary, following the examples of other countries that have experienced the issue of population aging," the Central Bank said.
More girls should also be put into the workforce, the Central Bank report said.
"To attract females into the labour market, flexible work hours, improving work conditions, increasing the availability of short-term and part time employment opportunities, and legislative reforms are necessary, while ensuring equal employment opportunities for female," the report said.