Non-negotiable reforms for election manifestos

By Dhananath Fernando

Originally appeared on the Morning

The year 2024 will be an election year. The general flow of events is that each political party and candidate will launch a manifesto of a grand-scale and present their plans for the people and the country. Most of these promises will not be implemented or will only be half implemented. In certain cases, the opposite of what was promised will be implemented. 

Most manifestos are presented in general terms with a target of 20 years ahead with little data. Many manifestos across all party lines are wish lists with no action plans.

In my view, this time there is a slight difference. 

Regardless of the party formation or whoever the presidential candidate will be, there are few reforms that are non-negotiable. Ideally, across all manifestos, there are five basic ideas which have to be the common denominator.

Strengthening social safety nets 

Following the worst economic crisis in Sri Lanka’s history and high inflation, about four million people have fallen below the poverty line. That puts seven million people under poverty. The recent Household Income and Expenditure Survey carried out by LIRNEasia and the World Bank indicates significant poverty levels and aftereffects of poverty due to the economic crisis. As a conscientious society, we need to take care of our poor people with the social safety net. 

The social safety net is not just an allowance. It is a system and a process of targeting the right people, providing an exit route, and with proper administration. The current Aswesuma programme is making some progress with World Bank assistance, but regardless of the political leader who comes to power, it is a non-negotiable condition that social safety nets have to be strengthened and improved. 

The current process has too many loopholes which have to be addressed and improved. Simplifying the process, providing the exit route, and monitoring and depoliticising has to be a continuous effort from the new leadership of the country.

SOE reforms 

Thus far, mandatory SOE reforms have been painfully slow. Many parties with vested interests are trying to delay it until the election. However, the continuation of SOE reforms is a must. 

Colossal losses, interference in the private sector, intervening in markets, creating an unfair playing field, and inefficiencies are a few reasons why SOEs played a pivotal role in Sri Lanka’s economic crisis. SOEs are vehicles of corruption and have diluted entrepreneurship and Foreign Direct Investments significantly. Without reforming SOEs, the future of Sri Lanka appears to be bleak. 

The principles announced by the SOE Restructuring Unit are in the right direction, but the SOE Act and reforms of the Ceylon Electricity Board, Ceylon Petroleum Corporation, and many other networking industries are a must. 

Anti-corruption and governance reforms

Execution of anti-corruption laws and governance reforms is another area which has no room for negotiation. The International Monetary Fund (IMF) Governance Diagnostic and many other locally-developed reports on governance provide direction on what needs to be done. 

Strengthening our Judiciary system, transparency and accountability in our tax system, removing tax exemptions, and repealing the Special Commodity Levy and the Strategic Development Act too falls under governance and anti-corruption reforms, as those acts provide the legal opportunity for corruption. 

There is a strong sentiment from people on the contribution of corruption to the crisis, so taking long-term measures regarding corruption is a must. Anti-corruption and governance reforms go beyond going after corrupt politicians. Rather, it is a system and framework for minimising government influence. Some reforms are complementary and reforming SOEs is also a key component of anti-corruption and governance reforms, as these SOEs play a vital role in corruption.

Following the IMF programme and debt restructuring 

Given the international financial architecture, we have no option other than sticking to the IMF programme. We can negotiate some of the actions that we have promised, but overall indicative targets and reforms have to be maintained. Otherwise, it will be yet another incomplete IMF programme and the debt restructuring process will be in jeopardy. 

Debt restructuring and the continuation of the IMF programme are very much interconnected. At the moment, external stakeholders are concerned about political instability and in fact, the IMF’s first review identifies the political risks for the continuation of the IMF programme. A commitment from any political leader on sticking to the programme will help Sri Lanka in rebuilding relationships with the world.  

Trade reforms and joining global supply chains 

We have to grow our economy to emerge from this crisis. Tax revisions make it likely that growth will slow down and the only solution to grow small island nations like Sri Lanka is through global trade. Our problems regarding global trade are mainly the problems in our own regulations and systems. 

We have to remove our para-tariffs and simplify the tariff structure for a few tariff lines. Not only will this help trade, but consumers will also have a greater choice of goods and services as well as competitive prices. 

On the other hand, the Government can improve the revenue from Customs since at the moment, the high tariffs are a main reason for revenue leakage in the form of corruption. Trade reforms are about growth, minimising corruption, encouraging exports, and assuring reasonable prices. Even at present, after very high taxes, there are levies such as the Special Commodity Levy, Ports and Airports Development Levy, and a huge array of taxes which hinder the competitive nature of our economy.

These five policies, in my view, are non-negotiable. If any administration deviates from them, it is very likely that we will fall back a few miles behind where we started. 

VAT: The good, the bad and the solutions

By Dhananath Fernando

Originally appeared on the Morning

The Value Added Tax (VAT) increase from 15% to 18% and the removal of about 95 items from the VAT exempted list to a VAT applicable list has raised concern among politicians and people alike. 

When taxes change too often, public confusion and erosion of tax revenue both have to be expected. VAT was once 8% in Sri Lanka and then revised to 12%. It was again increased to 15% and finally now to 18%. The VAT threshold was once at Rs. 12 million and later increased to Rs. 300 million. Currently it is at Rs. 80 million and expected to be reduced to Rs. 60 million. 

When the VAT threshold was increased to Rs. 300 million from Rs. 12 million, the number of individuals registered for VAT dropped to 8,000 from 28,000. Our policymakers are discussing expanding the tax base after diluting our tax base through our own inconsistent policies. 

One of the key principles of taxation is stability, according to the Tax Foundation. The other principles are simplicity, transparency, and neutrality. When tax rates and thresholds are changed often, thIMFe markets and individuals react and tax revenue will erode. 

A complicated context 

Sri Lanka’s context is sadly more complicated than many other cases. We have given a commitment to the International Monetary Fund (IMF) on increasing our tax revenue because our interest costs are extremely high. Most of the interest is inherited due to bad financial management over the years and there is very little meaning in blaming each other. 

On one hand, the Government has no other option but to increase revenue through taxation. However, on the other hand, when taxes are increased the economy will contract. Growth, which is also a key requirement for us to emerge from the crisis, will be affected due to the lowered purchasing power of the people. When the economy contracts, tax revenue will also start to decline.  

Given the perennial weaknesses in our tax administration, the Government has selected the most convenient option of VAT to be increased, since it can be collected easily compared to other taxes. VAT is considered to be better compared to other taxes such as the Nation Building TAX (NBT) or the Social Security Levy (SSL), which are considered to be cascading taxes, where throughout the economic process one tax is applied on top of the other. 

This leads to a situation where the effective tax rate becomes very high, but with VAT, tax will only be applicable for the value added throughout the supply chain. Also, high income earners generally contribute a higher VAT in total as VAT is a consumption tax. People with higher incomes tend to consume more, so the more they spend, the more taxes the Government can recoup. 

The negative impact of VAT can be witnessed when it is applied to food items. The poorest of society gets adversely impacted, since their percentage of expenditure on food is very high compared to people who fall into higher income brackets. 

There will be considerable impact on the overall prices for the common people with the new VAT revisions. The price of petrol and diesel is expected to increase by about Rs. 50-60 (provided the other taxes are not changed and global fuel prices remain the same). LP Gas (12.5 kg cylinder) will increase by about Rs. 500-600. 

Prices of solar panels, electronic items, laptops, and mobile phones are expected to rise. This will also have an impact on inflation as well, but we need to keep in mind that inflation is always a monetary phenomenon. With high prices, people may consider cheaper alternatives and supply and demand will readjust, provided we keep our monetary policy right. 

Solutions 

A key solution to bringing down prices of food items is to remove the Special Commodity Levy (SCL) applied to these items. The SCL not only increases prices, but the provisions provided to the minister to impose and remove the SCL overnight opens significant room for corruption. The recent increase of the SCL on sugar to Rs. 50 from 25 cents is a good example of how an overnight gazette creates room for corruption and passes the burden to the people. 

Other taxes on food items including CESS, Ports and Airport Development Levy (PAL), and many other para-tariffs should be removed. There is a myth that productivity can be improved by imposing tariffs on domestic food items. If that is the case, our industries for milk, yoghurt, cheese, and many other food items have to be extremely productive and efficient. Instead of domestic product growth, we see the same producers ask the Government for further protection. 

Tax competitiveness as a framework 

 Moving forward, Sri Lanka has to look at tax competitiveness as a framework for thinking about taxes. In the global context, everything is about competitiveness, including the tax system. As an example, if corporate tax is 25% in competing markets in the region, we cannot increase the corporate tax to 30%, only considering the revenue requirement of the Government. 

At the same time, we cannot compromise our healthcare and education systems, which help to develop better skills through taxpayer money, by bringing taxes unnecessarily down and compromising our tax revenue. In a market system, competition and prices play a key role, and the same is applicable for taxes, FDIs, and many other variables. 

We have to first take the basic steps of improving tax administration. We then have to rationalise our expenditure and spend where we need to spend, thereafter raising revenue by being competitive. A VAT increase to increase Government revenue alone will not solve our macro instability. We have to ensure macro stability by being competitive in all aspects of the economy.