Taxation: Theory and the Sri Lankan

Experience

Dr K. Amirthalingam Senior Lecturer

Department of Economics University of Colombo

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Reducing fiscal deficit?

Considering the Sri Lankan Situation

Expenditure cuts seems to be impossible.

Sources of finance for public expenditure

Debt (domestic and foreign)

Money creation

Harmful repercussions?

2

Magnitude and Type of Public Debt (As a % of GDP)

0

20

40

60

80

100

1201

97

7

19

79

19

81

19

83

19

85

19

87

19

89

19

91

19

93

19

95

19

97

19

99

20

01

20

03

20

05

20

07

20

09

20

11

20

13

Foreign Debt Domestic Debt Total Debt Linear (Total Debt)3

Financial debt Social debt

• Interest payment 27 % of total expenditure

• Are we heading towards social debt?

4

Public Spending on Education (As a percent of GDP)

Cuba (2010) 12.8

Denmark (2009)

Ghana (2011)

8.7

8.1

South Africa (2012)

Argentina (2011)

6.6

6.3

UK (2012)

Jamaica (2012)

6.2

6.1

Senegal (2010) 5.6

United States (2012) 5.4

Nepal (2010) 4.7

Chile (2012) 4.5

India (2012) 3.4

Cambodia (2006) 2.6

Sri Lanka (2012)

Myanmar (2011)

1.7

0.8

Source: World Development Indicators Database.

Budgetary allocation for Some ministries (LKR Billion)

0

50

100

150

200

250

300

350

Def &Urbdev

Port &High

Fin andPlan.

Health Econ dev. Transport Education Higheredu

2010 2011 2012 2013 20146

Public Spending on Health in 2012 (As a percent of GDP)

Netherlands 9.9

Denmark

Ghana

9.6

3.0

South Africa

Argentina

4.2

5.9

UK

Jamaica

7.2

3.3

Senegal 2.8

United States 8.3

Nepal 2.2

Chile 3.5

India 1.3

Cambodia 1.3

Sri Lanka 1.3

South Sudan 1.0

Source: World Development Indicators Database.

So what next? We should focus on taxation

Purpose of Taxation

• Raise resources to finance government expenditure

• The way of taxation:

• Administratively feasible,

• Equitable and

• Efficient.

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• Administratively feasible: Simple to administer

• Equitable: Low burden on the poor

• Efficient: Higher revenue with lower economic distortions

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Good Tax Bases

• Drinking

• Driving

• Smoking

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• Taxation is important to raise domestic investment and government savings and to reduce debt

• Lewis (1984) argues that an increasing share of tax revenue as % GDP is an instrumental objective of economic development policy

• High-income countries : Rising shares of tax revenue and government expenditures as a % GDP as they became more economically advanced.

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• Developing countries need to increase expenditure on

• education.

• Health

• infrastructure

• Social development (social protection)

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• Developed countries depend mainly on direct taxes for revenue

• Developing countries depend on indirect taxes for revenue

• Sri Lanka relies excessively on indirect taxation.

• It has not been successful historically in raising much revenue through direct taxes. Why?

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• Musgrave (1969) Theory

• From Indirect taxation to direct taxation?

• First Stage?

• Second Stage?

• Sri Lanka?

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Types of Taxation

Direct Taxation

Indirect Taxation

Direct taxation

• Tax payer will be the final bearer of the burden of payment.

• Burden can not be shifted.

• Progressive.

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Indirect Taxation

• Tax payer will be the ultimate consumers

• Tax burden can be shifted.

• Regressive.

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• Revenue generating enterprises in the real economic sector play the most important role in our economic system.

• “Capital money” ?

• “Consumption money”?

• If any money spent is recovered through sale proceeds that is “capital” money

• When the money is spent on food, the money is gone and you can’t recover it. It is Consumption money

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• Taxation in Sri Lanka • Tax Ratio

Tax ratio is defined as total tax revenue as a percentage of GDP.

• Almost half a century ago, Kaldor (1963) argued that for a country to become “developed” it needed to collect taxes at 25-30 per cent of GDP.

• International empirical evidence in 2001 : Average tax ratio should be

• higher income countries : 40 per cent, • middle income countries :25 per cent and • low income countries: 18 per cent (Gallagher,

2005).

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Tax Ratio in Sri Lanka

R² = 0.7185

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11

12

13

14

15

16

17

18

19

20

Indirect and Direct tax revenue (As a % of GDP)

0

2

4

6

8

10

12

14

16

181

98

0

19

82

19

84

19

86

19

88

19

90

19

92

19

94

19

96

19

98

20

00

20

02

20

04

20

06

20

08

20

10

20

12

20

14

Indirect Tax Revenue Direct tax Revenue20

• Decline of tax ratio is closely associated with the decline of indirect tax revenue

• the decline of indirect taxes as a percentage of GDP is a necessary condition in tax theory

• But Sri Lanka could not expand direct tax revenue as a percentage of GDP to offset the decline of indirect tax revenue, in line with the theory

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Indirect and Direct Taxes (As a % of Total Tax Revenue)

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%1

98

0

19

82

19

84

19

86

19

88

19

90

19

92

19

94

19

96

19

98

20

00

20

02

20

04

20

06

20

08

20

10

20

12

20

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Indirect Taxes Direct Taxes22

• 80 Per cent from indirect taxes: Regressive

• 20 Per cent from direct taxes : Progressive

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Where we are?

• Compared with developed countries?

• Compared with our neighboring countries

• Compared with low income countries

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• Almost half a century ago, Kaldor (1963) argued that for a country to become “developed” it needed to collect taxes at 25-30 per cent of GDP.

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Tax ratio (In Selected Countries)

Country 2009 2010 2011 2012 2013 2014

Denmark 34.3 33.6 33.7 34.1

Jamaica 27.2 26.5 25.7 27.1

UK 25.6 26.4 27.1 26.9

France 19.8 21.3 21.2 22.0

Australia 22.1 20.6 20.5 21.4

Kenya 18.7 19.4 19.5 19.9

Ukraine 16.4 15.5 18.5 18.2

Brazil 14.8 14.6 15.7 15.4

Nepal 11.8 13.4 13.3 13.9 15.3

Sri Lanka 12.8 12.9 12.4 12.0 11.3 10.7

Ethiopia 6.7 8.3 9.4 26

• Musgrave (1969) points out that economic development of developing countries will increase the share of direct taxes in total tax revenue.

• Sri Lankan Situation.

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GDP per capita US$)

Country

19

90

19

94

19

98

20

02

20

06

20

10

20

12

Canada 21,302 19,786 20,875 23,995 40,245 47,465 52,409

USA 23,955 27,776 32,949 38,175 46,444 48,358 51,755

Korea 6,642 10,275 8,134 12,789 20,917 22,151 24,454

Malaysia 2,417 3,686 3,229 4,131 6,180 8,754 10,432

Thailand 1,508 2,467 1,837 1,989 3,143 4,803 5,480

Sri Lanka 472 655 841 904 1,423 2,400 2,922

India 376 355 425 487 830 1,417 1,503

Pakistan 360 420 453 487 853 1,023 1,255

Kenya 366 268 475 398 612 793 933

Uganda 245 199 289 238 335 472 551 Source: World Development Indicators

Revenue from direct taxes (% of Total Taxes) Taxes on Income(Direct tax revenue) (% of Total Taxes)

Country

19

90

19

92

19

94

19

96

19

98

20

00

20

02

20

04

20

06

20

08

20

10

20

12

USA 90 92 93 92 92

Canada 72 71 71 73 74 76 72 74 77 .. 77 77

Malaysia 43 47 44 46 60 55 62 .. .. .. 67 71

India 19 23 29 30 32 36 38 43 47 52 55 52

Kenya .. 29 33 40 38 33 33 36 39 42 44 46

Thailand .. .. .. .. .. .. .. 39 44 48 42 45

Korea 40 40 39 37 41 38 37 41 44 .. 42 ..

Pakistan 13 18 21 20 29 28 31 28 28 37 36 37

Uganda .. .. .. .. 15 16 21 25 27 27 31 36

Sri Lanka 12 14 15 16 14 15 17 15 19 21 19 19 Source: World Development Indicators

• Why Tax ratio is very low in Sri Lanka 1. Tax exemptions: To reduce the burden caused by indirect

taxes on the poor, government usually exempts necessities. 2. Tax exemptions to attract FDI 2. Tax avoidance and evasion: This year(2014) more than 4,000

private companies and individuals failed to pay their taxes amounting to Rs. 139 billion (Sunday Times: October 5,2014)

3. Inefficiencies of tax administration (Complex tax law, large number of taxes, cumbersome processes etc)

4. Reduction of trade related taxes in the post liberalization period (WTO agreement)

5. Over estimation of GDP and the sources of growth such as increased public sector wages, large infrastructure investment and construction which are not generating taxable incomes

6. Agriculture sector: Still agricultural sector play an important role in terms of both in terms of contribution to total output and to employment.

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7. Existence of a large informal economy led to tax evasion and avoidance:

Sri Lanka’s shadow economy to be around 45 % of GDP on average during 1999-2006.

8. The inability to change the mindset of public and corporate sector towards paying taxes (SL progressing towards upper middle income category??)

9. Increasing trend of cross boarder shopping (online purchases)

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10. Unplanned and ad hoc fiscal measures :tax amnesties and tax concessions;

11. Complexity in tax legislation,

12. Low revenue from tax on salary: There are 1,289,151 employees in the public sector and 3,466,194 employees in the private sector in 2012 (CBSL, 2013)

• Only 868,031 public and private sector employees have registered under PAYE scheme but PAYE deducted only from 268,651 employees in 2013 (IRD, 2013)

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• To enhance tax revenue in Sri Lanka, several measures should be implemented. Possible tax reforms should include

broadening the tax base targeting direct taxation

simplifying the tax rates

simplifying the tax laws

reducing the numbers of taxes

facilitating voluntary compliance

improving tax administration with the usage of modern information technology

strengthening investigation, audit and enforcement capacity

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• To enhance tax revenue in Sri Lanka, several measures should be implemented. Possible tax reforms should have following features

Broad tax base targeting direct taxation

Moderate rates of taxes,

Simple and clearly-worded tax laws

reducing the numbers of taxes

Low compliance costs

improving tax administration with the usage of modern information technology

strengthening investigation, audit and enforcement capacity

Fair and impartial dispute resolution mechanism

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Cont………….. Exemptions to be revisited to recognize the necessity for

such exemptions Concessions also needed to revisited to reaffirm whether

concessions are inline with current priories Levying much higher taxes on items of consumption by

those deriving undeclared incomes. These incomes can only be taxed through expenditure taxes on their investment and expenditures

avoiding politically motivated tax amnesties and tax concessions,

reducing corruption by introducing severe penalty system targeting tax evaders and corrupt officials,

providing incentives to genuine tax payers and tax officials, and

avoiding political interference and influence on tax administration.

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• Government: better tax system should be put in place: Tax commission report?

• Sufficient power should be given tax officials

• All three revenue generating institutions should be brought under one umbrella.

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Budget 2016

• Composition of direct and indirect taxes

• Public sentiment

• Investment climate

• Role of FDI

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