Trouble at our borders

In this weekly column on The Sunday Morning Business titled “The Coordination Problem”, the scholars and fellows associated with Advocata attempt to explore issues around economics, public policy, the institutions that govern them and their impact on our lives and society.

Originally appeared on The Morning

By Erandi de Silva

Sri Lanka’s long-standing system of “para tariffs” is a regressive institution that is fairly unknown to the everyday Sri Lankan. A para tariff refers to a type of tariff that is levied on top of the regular Customs Duty that all our imports are subjected to. It is surprising to learn that most of our imports endure not only the regular Customs Duty, but also the Port and Airport Development Levy, “CESS” (Export Development Board levy), and VAT (Value-Added Tax).

Effects of our current tariff system

These taxes stem from revenue concerns and protectionist motives to protect specific local businesses and reduce imports. However, the unsavoury reality is that it deters international trade while making imported goods incredibly expensive for all Sri Lankans. Despite the Customs Duty that already amounts to 30%, once the para tariffs come in, the total tax on most goods – from food to personal care items – can increase anywhere from 50% up to 100%. This severely limits our ability to choose the products we want to consume and puts even basic items almost out of reach in terms of the price point for most people.

Another primary issue with the prevalence of para tariffs is the lack of transparency for the general public. While most are simply unaware of the complexity of these taxes and their effect on the cost of our goods, the current system makes it exceptionally tedious and confusing for ordinary citizens who wish to access and understand our tariffs, as the method used to calculate the total tariff of a good is unclear.

Moreover, as this convoluted system is incredibly difficult to grasp and manoeuvre, locals who attempt to ship in products or factor inputs for their own businesses or personal needs will be slapped with massive fees that they did not anticipate for their shipments. This increases their costs, making growth unlikely for local businesses that need imported inputs as well. This is highlighted in a 2019 study by Asian Development Bank (ABD), which reports that local exporters cited inadequate access to imported inputs at competitive prices as one of their top challenges.

Local producers who are not import-dependent also lack the incentive to improve their products and lower their prices as they have no foreign competition; they can price higher as imported products are artificially more expensive. This means our local products remain internationally uncompetitive and our imports are unnecessarily expensive, while producers increasingly rely on the Government to protect their profits. In short, this system is counterproductive – it both hinders affordable imports and the growth of many local businesses.

Guides for positive reform

If the Government truly cares about the quality of life of Sri Lankans, it would take steps to increase consumer choice and affordability as well as improve our local businesses. Trade liberalisation is by far one of the most effective methods of achieving these outcomes. Replacing our confusing system with a uniform tariff rate could be the first important step in this journey.

Given the issues elaborated above, it is clear that our current reliance on the overcomplicated para tariff system is detrimental to the country’s economic interests and future growth. It is time for a different approach, and to some extent, the Government has come to this conclusion. The National Policy Framework includes the point “reducing import taxes on raw materials and intermediate goods to promote domestic production” under its macroeconomic policy framework. While tariff reform has to be much broader for the country to reap real economic benefits, this is one component.

Chile, which is often championed for its move towards trade liberalisation after a long history of protectionism, experienced significant growth subsequent to the introduction of a flat tariff for imports. This reform to simplify border tariffs led to a better allocation of local resources as it prevented preferential treatment of particular industries and local producers. Therefore, the market evolved to be more competitive and local businesses found it easier to access the necessary imported inputs they needed. This helped steer growth in the export sector as well, causing the volume of total exports to rise at an annual rate of 8.1% from 1990 to 2003. Despite the initial flat tariff rate being relatively high, the implementation of a uniform rate itself stirred positive effects while also inspiring further liberalisation. The rate of the flat tariff was gradually reduced over time up until the year 2003, and Chile now boasts a uniform tariff as low as 6% along with multiple free trade agreements (FTA) that completely eliminate tariffs for the countries involved.

Even though Sri Lanka’s case may not be identical, it is evident that simplifying and integrating tariffs will reduce confusion, increase transparency, and remove red tape that stands in the way of better trade, which in turn bring more opportunities for economic growth. Although it is not necessarily the desired endpoint, if Sri Lanka wants to maintain its tariffs at a relatively high level, the Government could still eliminate the para tariff system and impose a single, uniform rate that encompasses the same level of protection for all local industries.

At the very least, this could still facilitate much better exchange at the border by bringing more clarity to the system and eliminating the current uncertainty about the total tariff value for a product. This reform could then improve our local businesses and export sector by increasing accessibility to imported inputs for local companies, as it did in Chile. In the long run, however, a uniform tariff will not single-handedly improve much if the rate of tax is still incredibly high; Sri Lanka would also have to gradually reduce the overall tariff rate and engage in other strategies to ease trade for the benefits of a more comprehensible tariff system to truly materialise.

If the Government takes the right actions, this could be the beginning of a positive trajectory towards a more functional and effective tariff system. The question is: “Are we ready to break down some walls?”