SL’s tariff regime

Originally appeared on The Morning

By Dhananath Fernando

The Minister of Finance mentioned that “many surprises” would be contained in the Annual Budget for 2024. In economics, surprises are something we would want to avoid; the more surprises we get, the lower stability is. Frequent surprises are a sure way to push away investors and the business community. One surprise measure mentioned recently in Parliament was a tax on primary dealers in the bond markets as they were left out in the Domestic Debt Restructuring (DDR) process.

Just a few weeks ago, this column speculated about the likelihood of selective taxes, such as super gains tax or wealth tax, in the Annual Budget for 2024. If the reason to impose a special tax on primary dealers is the high profits they made as a result of being left out of the restructuring process, does this mean the Government is admitting it made a mistake by leaving them out of the debt restructuring processes? If so, we cannot correct it by imposing a tax, since two wrongs do not make a right.

A special tax on selected groups or industries is the opposite of tax holidays. The way we select industries or business categories for special taxes is the same way we select industries for tax holidays. Both are two sides of the same coin.

It is true that Government revenue is low compared to the size of our economy, but it is definitely not the fault of the businesses which made profits, unless their profits are exempted from taxes.

Sri Lanka’s corporate tax of 30% is a reasonably high rate. Even the UK increased its corporate tax to 25% in 2023 from 19%. Tax competitiveness is already low due to unreasonably high taxes and an unstable economic and political environment. Therefore, what is the rationale for charging a higher tax on a selected industry or a group if they already pay a corporate tax of 30%?

The unfortunate reality is that we cannot increase tax revenue simply by imposing selected taxes or by spontaneously increasing rates. This would bring the same consequences as our tariff structure.

The issue with the tariff structure in Sri Lanka is that we have imposed different taxes for different HS codes, making it very complicated. Some HS codes are charged a CESS and others are charged para-tariffs, creating considerable doubt as to which taxes are applicable when importing anything. This complexity in the tariff structure has resulted in a high level of corruption.

It is argued that bringing the tariff rates down and making it simple will improve tariff revenue. The same logic is applied for income tax and corporate taxes. The more complicated and more targeted special segments are, the more likely tax evasion is, and will eventually lead to our overall tax revenue further deteriorating.

In 2015 and 2021, a similar attempt was made to impose a singular super gains tax on companies earning over Rs. 2 billion. There were many instances where special taxes were imposed on the financial sector without any detailed analysis or impact analysis on overall tax principles.

Has it made our tax revenue better? The answer is an obvious no. Therefore, special taxes which may come as surprises for selected industries may not lead to the expected outcome. Instead, they will create more confusion in the market.

It is likely that the Government is targeting primary dealers due to the controversy that arose during the bond scam in 2015 and similar incidents, with suspicions of insider trading taking place afterwards.

If the reason for super profits is insider trading, the answer is a forensic audit and bringing the related parties to justice. The Government can start the process by releasing the full forensic audit report on the investigation of the presidential commission appointed for the bond scam.

Imposing a special tax to correct the super profits of insider trading may start a vicious cycle of unethical trading and business operations.

Investors will consider the occurrence of a similar circumstance if they make better profits – that they too will be liable for a special tax in addition to the corporate tax they pay.

More importantly, it dilutes the principles of an aspirational society. Assuming that someone should pay a higher tax simply because they made a profit is discriminatory and acts as a disincentive for generating wealth and profit. Those who made a higher profit are already paying a higher tax proportionately, compared to those who made less profit, at a rate of 30%.

Taxes have to be imposed based on principles of simplicity, transparency, neutrality, and stability. These are referred to as ‘principles’ because there is a rationale behind it. Statistics without principles and principles without statistics are both dangerous.