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Monday April 22nd, 2024

Sri Lanka VAT increase is better than killing economic freedoms with income tax

REASONABLE TAXATION: While bringing down the spending to GDP ratio to 15-pct, dependent allowances and inflation adjusted slabs should be brought in

ECONOMYNEXT – Sri Lanka’s plan to hike value added tax to 18 percent to help maintain a large public sector and military is a better option that raising income tax which will kill consumption (killing a recovery), kill investment (killing long term growth).

A hike in value added tax still leaves money in the hands of wage earners and others giving them the freedom to make economic decisions and spend.

A 3 percent hike in VAT to 18 percent is less damaging on the people than a 5 percent inflation tax, which the country’s inflationist central bank imposes on the people at a minimum.

It must be remembered that the central bank’s 5 percent inflation tax or currency depreciation through flexible exchange rate is imposed to on the very poor through higher food prices while foods are exempted from VAT.

Indirect value added taxes are collected after an economic transaction is made. Income and wealth taxes prevent a gainful economic decision from being made.

Value added tax however is somewhat complex for businesses to operate.

Thought retail businesses operate on cash, businesses that operate on credit will have to borrow 18 percent of revenue to pay the tax on the 20th of the next month.

Businesses operating on credit therefore will have to borrow to pay VAT encouraging false accounting or raising costs.

This may not be a problem in countries with legally controlled central banks with tight inflation targets, sound money and low interest rates, but it is problem in flexible inflation targeting countries where inflation and interest rates are high.

Giving Power to Rulers to Decide Through Income Tax

Capital consumption taxes like income taxes and wealth taxes transfers economic decisions to bureaucrats and the political class, and tends to mis-direct the economy.

The US, which is heavily focused on income tax has no VAT and small state level final sales taxes are found.

The IMF, perhaps due it US progressive (read socialist) or New Dealer origins may favour income tax like most socialists.

However, in Sri Lanka people are whacked with both income and value added tax.

All capital consumption taxes destroy investible resources which are then frittered away in bureaucratic current spending.

The very sudden tax hike, involving a low threshold, and no deductions, is also contributing to brain drain.

However, the heavily socialist thinking behind income tax – tax the rich – does not help anyone.

High progressive taxes were a feature of Roosevelts New Deal interventions – which delayed a recovery from the depression, as well as Hitlers program. The Social Market economy architects cut the marginal tax rate.

Post 1980 IMF programs which do not stabilize the currency unlike before the Second Amendment when the agency was less vilified but attempts other reforms, are supposedly based on Thatcher era reforms.

But Thatcher not only stabilized the currency (in parallel US also raised rates strengthening the dollar), reducing fuel and energy prices, helping public acceptance of the power sector privatization (but hurting coal miners).

Giving Freedom for People to Choose through VAT

A key reform was raising VAT while cutting income tax.

Unlike in Sri Lanka, Thatcher campaigned on cutting high progressive taxes and giving freedom for people to choose after they came to power.

This is how Thatcher’s finance minister, Geoffrey Howe boldly gave choice to the people on the street and a boost to economic decisions of the community vs the bureaucrats, hiking VAT and cutting income tax.

“We made it clear in our manifesto that we intended to switch some of the tax burden from taxes on earnings to taxes on spending,” Howe said in his budget speech in 1979, where the clarity of thought, reason and interconnected logic was worthy of any 19th century classical liberal.

“This is the only way that we can restore incentives and make it more worthwhile to work and, at the same time, increase the freedom of choice of the individual. We must make a start now.”

In the late 1970s the UK was also in the same position as Sri Lanka. High income taxes were hitting skilled workers.

In fact the ‘brain drain’ originally started in the UK during its period of monetary instability.
“The upper rates no longer affect only those on very high incomes,” Howe said.

“They apply – and Labour Members may find this surprising – not only to senior executives and middle managers in industry but increasingly to skilled workers, as well as to professional people and the proprietors of small businesses.

“These are the people upon whom so many of our hopes for initiative, greater enterprise and national prosperity must depend.

“Our long-term aim should surely be to reduce the basic rate of income tax to no more than 25 per cent.”
The basic rate is now 20 percent.

This column said before the IMF program started that Sri Lanka should go for 20 percent VAT and eventually 15 percent corporate income tax eventually (The Yellen Tax). If 15 percent tax is given for new companies the IMF cannot object since that is official US policy.

However spending must be brought down.

READ MOREWhat Sri Lanka’s IMF program should look like

Thatcher also raised the slabs to account for inflation. A five percent inflation target should lead broadening tax slabs.

Eliminate the Social Security Contribution Levy

In the next tax reform, the cascading social security levy should be eliminated and the VAT raised to 20 percent.

The SSCL should be eliminated simultaneously with the raising of VAT so that market prices will remain the same and the government will recoup some of the money lost from the cascading tax.

Charge VAT on Fuel and Electricity

Value added tax should also be charged on electricity and the turnover taxes the excise taxes on diesel and coal should be removed or reduced.

Fuel taxes are in the nature of road taxes and should not be charged from electricity. Import duties on fuel should not be passed on to exporters. Zero rating and charging VAT will eliminate the problem.

This will allow exporters to reclaim VAT on energy, making the country competitive.

As a result, industries will not have to be given a different electricity tariff.

Vat should not be charged on electricity while excise taxes on diesel remains. Import duties on coal should be converted to VAT.

Brain Drain and Dependents

Sri Lankan politicians and politicians look at East Asia with envy, but does not follow their policies either on central bank control, or taxes.

Countries in East Asia that have good monetary regimes and do not go to the IMF regularly tend to have low value added taxes (about 10 percent) and corporate tax rates (about 20 percent).

Anecdotal evidence show that professionals are migrating because they are unable to pay school fees and medical expenses in addition to being unable to make mortgage and lease payments.

In social media there are posts of migrating families seeking good homes for pets.

Though politician claim that people are taxed for education and health, income tax payers end up sending their children to private schools and they go to private hospital.

One way out is to give tax credits for dependents and housing mortages like in East Asian countries, whose policies IMF countries do not follow.

The state should be limited to 20-pct VAT

World Bank and IMF claims that 20 percent spending to GDP is not a problem should be rejected.

Sri Lankans know how the state was bloated due to giving jobs to unemployed graduates by both the JVP ideology and the Rajapaksa regimes which put them to practice.

After raising VAT to 20 percent and with income tax at 20 percent, the rulers will take about 40 percent of a persons’ income.

That should be enough for the rulers and state workers to survive.

The state should be limited to the taxes than people can pay.

The government should also impose a 2 percent inflation target on the central bank. Putting on inflation tax on top of VAT increases is an invitation to disaster.

The 5 percent inflation tax is to be imposed on the people every year. An annual 5 percent inflation tax is worse than a one time VAT hike.

However unless the central bank is restrained printing money for growth, preferably with an exchange rate target as it is simple and transparent, no other reform in taxes will either stop the out-migration nor investment driven growth. (Colombo/Nov08/2023 – Update IV)

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Sri Lanka motor racing crash claims 7 lives, 4 critical

ECONOMYNEXT – A deadly accident at motor Race Sri Lanka’s hill country town of Diyathalawa has claimed at least 7 lives police said, after a racing vehicle, in the seasonal Fox Hill Super Cross ploughed in to spectators after running off the track.

Another 21 spectators were injured Sunday, and hospitalized and at least four were critical, police said.

Thousands of people come to watch the Fox Hill Super Cross race, which is usually held in April, as large numbers of people head to the cooler climes in the hills.

According to footage taken by spectators one car overturned on the side of the track.

Sri Lanka’s Newsfirst television said Marshalls were waving flags to caution other vehicles, when another car went off the track and crashed into spectators. (Colombo/April21/2024)

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Widespread support for Sri Lanka debt workout, reform progress at IMF/WB meet: Minister

ECONOMYNEXT – There was widespread support for Sri Lanka’s debt restructuring and acknowledgement of progress made under an International Monetary Fund program, at meeting of the fund and World Bank, State Minister for Finance Shehan Semasinghe said.

“The strides made in our economic recovery and financial stability have been acknowledged as significant advancements towards our country’s prosperity by our stakeholders and international partners,” Minister Semasinghe said in an (twitter) post after attending the meetings.

“Further, it was heartening to note the widespread appreciation and support for Sri Lanka’s debt restructuring process.

“We remain steadfast in our commitment to reaching the restructuring targets and confident of smooth progress in the continued good-faith engagements for a speedy debt resolution that will ensure debt sustainability and comparability of debt treatment.”

Sri Lanka ended a first round of talks with sovereign bondholders in March without striking a deal but some agreement on the basis for a deal.

An initial deal with bilateral creditors have been reached, but they may be awaiting a deal with private creditors to sign formal agreements.

International partners have appreciated reforms made under President Ranil Wickremesinghe, Minister Semasinghe said.

“It was great to engage in productive bilateral discussions with all of whom appreciated the recent economic developments, progress in debt restructuring, strengthening of tax administration, and ongoing governance reforms,” he said.

Sri Lanka’s rupee has been allowed to re-appreciate by the central bank amid deflationary monetary policy, bringing tangible benefits to people in the form of lower energy and food prices, unlike in past IMF programs.

Electricity prices were cut as a strengthening currency helped reduce the cost of coal imports.

Related Sri Lanka central bank mainly responsible for electricity price cut

The currency appreciation has also allowed losses to the Employment Provident Fund imposed to be partially recouped, helping old workers near retirement, as well as raising disposable incomes of current wage earners on fixed salaries.

Related Sri Lanka EPF gets US$1.85bn in value back as central bank strengthens rupee

The IMF, which was set up after World War II to end devaluations seen in the 1930s after the Fed’s policy rate infected other key central banks, started to actively encourage depreciation after a change to its founding articles in 1978 (the Second Amendment).

The usefulness of money as a store of value, or a denominator of current and future values then decline, leading to loss of real savings, real wages and increases in social unrest.

Before that, members who devalued more than 10 percent after printing money for growth or any other reason, faced the threat of suspension from the organization as punishment.

Sri Lanka’s rupee has appreciated to around 300 to the US dollar now from 370 after a surrender rule was lifted in March 2023.

But there is no transparency on the basis that economic bureaucrats are allowing the currency to gain against the US dollar (the intervention currency of the central bank).

The rupee is currently under pressure, despite broadly prudent monetary policy, due to an ‘oversold position’ in the market after recent appreciation made importers and banks to run negative open positions as the usefulness of the currency as a denominator of future value declined with sudden strenghtening. (Colombo/Apr21/2024)

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Sri Lanka choices recalled in Vietnam debate on monetary and fiscal options to target output

FIRST SIGNS: Fuel queues and shortages were developing in Vietnam in 2022 with a BOP deficit of $15.6bn in 3Q when rates were hiked to stop inflationary sterilization. Photo/

ECONOMYNEXT – Vietnam can grow 6.0 percent in 2024, with ‘policy support’ but there is a debate whether it should be done through fiscal (widening deficits/worsening debt or state spending) or monetary means, a top International Monetary Fund official said.

The IMF projects 6.0 percent growth for Vietnam in 2024 “as it rebounds from a challenging 2023,” Krishna Srinivasan, Director of the Asia and Pacific Department told reporters during the Spring Meetings in Washington.

Western Statism

“Now, in the case of Vietnam, I would say that there’s an issue about policy mix, whether you could get more support from the fiscal and rely less on monetary,” Srinivasan said.

“So there is an issue of policy mix which we’re talking, which we’ve been engaging the authorities with.

“I would say that policy support should be more favorable and that should, and along with external demand, help raise growth to 6 percent.”

Sri Lanka used both fiscal and monetary mix to boost growth from December 2019, triggering an external default two and a half years later.

Vietnam’s forex reserves fell below 3 months of imports in 2022 after the State Bank kept policy rates down by inflationary sterilization of forex market interventions.

The currency was then stabilized with rapid fire rate hikes and credit controls to dial back inflationary policy, just as long fuel ques started to form at petrol sheds, with angry riders already hit by rising prices due to Dong weakness. 
The return to market interest rates averted wider social unrest from being triggered by depreciation and further losses at state energy utility EVN, due to fixed prices amid soaring coal prices.

The State Bank of Vietnam later cut rates and relaxed credit controls as the BOP shifted to a surplus.

The government has since cut value added taxes. Public sector salaries are set to rise further this year, possibly as much as 30 percent, after earlier wage restraint. (Related Link: Public employee’s salaries to increase by 30 per cent from July 1: Minister)

State Driven Growth Options

The IMF also said in an Article IV consultation report released in October 2023, that fiscal metrics should be effectively undermined for ‘growth’ but more through income redistribution, and possible support for a fallout from a weak property sector.

Some Vietnamese property companies are reeling from expansion during earlier low rates and Covid-linked construction delays, which could also hit banks.

“Building on successful fiscal consolidation in recent years, there is fiscal space to provide further support,” an IMF Article IV consultation report released in October 2023 said.

“The government could scale up social safety nets that would boost growth and protect the most vulnerable households.

“Given the slowdown and the constraints faced by monetary policy, going forward, fiscal policy can take a leading role in supporting aggregate demand.

“For instance, the government could scale up social safety nets—and consider cash transfers to provide swift relief to poorer households.

“If the current turmoil proves more damaging to the economy and the financial sector, targeted support could be considered, including to help real estate developers restructure.”

Dong on thin ice

In 2023, Vietnam’s balance of payments was only marginally in surplus by 1 to 3 billion dollars a quarter, indicating that credit was still resilient after a successful ‘soft-landing’, and any further shocks from macro-economists can destabilize the external sector easily.

In the fourth quarter of 2024, Vietnam’s BOP was only 2.4 billion dollars in surplus.

Any extra spending or tax cuts which boosts the deficit due to attempts to engage in ‘macro-economic policy’ and expand government borrowings would lead to money printing under a fixed policy rate, reversing gains made by the State Bank over 2023, and pushing the Dong down, analysts say.

Western macro-economists believe that expanding government action (through the Treasury or central banks) to tinker with ‘aggregate demand’ can boost growth numbers instead of giving a chance for people and businesses to engage in real production of goods and services by providing monetary stability.

Collapsing currencies and external imbalances are then blamed on ‘current account deficits’ and ‘structural deficiencies’.

Such Keynesian and post-Keynesian beliefs have worsened since quantitative easing was normalized in the US after the Great Recession and ‘stimulus’ re-captured Western media attention despite the hard lessons of the 1960s and 1970s, critics say.

In Sri Lanka, the IMF taught a central bank that had already busted the currency from 4.70 to 131 to the dollar to calculate ‘potential output’ just as the country was barely recovering from a 30-year civil war.

Sri Lanka defaulted within 7 years of ‘data driven monetary policy’ (flexible inflation targeting with output gap targeting) and three currency crises later in peacetime amid increasingly aggressive macro-economic policy as consecutive stabilization programs reduced growth numbers.

Aggressive Macro-economic Policy

After using higher deficits and inflationary rate cuts in 2015 amid low inflation, inflationary rate cuts despite tax hikes in 2018 (fiscal policy is tight therefore monetary has to be loose mantra), macro-economists took a proverbial Keynesian bull by the horns and cut both taxes and rates from December 2019 saying there was a ‘persistent output gap’.

Related Sri Lanka fiscal stimulus to close output gap

Analysts say there is no real choice between monetary or fiscal deterioration to achieve macroeconomic policy desires of interventionists, in a country with a bureaucratic interest rate.

A policy rate, unless hiked, will automatically result in inflationary monetary operations as domestic credit picks up, irrespective of whether it is driven by private or state credit.

Any so-called ‘fiscal support’ can only be given without harming the exchange rate in a country that has a reserve collecting central bank with a policy rate, by liquidating any sovereign wealth funds or borrowing abroad and pushing up net external debt, analysts say.

By worsening external net debt levels, desires of macro-economists can be satisfied without harming monetary stability and the living standards of the population in general or nutrition of the children of the poorest sections of society by so-called exchange rate flexibility or debasement.

In Sri Lanka, potential output is now written into a brand new IMF-backed monetary law even before the first default workout is complete. Potential output is mentioned in every monetary policy statement, not stability. (Colombo/Apr20/2024)

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