Increase income taxes to avert financial crisis - DEW


The very existence of the state and the day to day functioning of society depend on government revenue which keeps things going. In recent years, Sri Lanka has experienced a steady decline in tax revenues which now threatens to derail the provision of government services to the public. In this interview, The Island staffer C. A. Chandraprema speaks to former taxman turned politician minister D. E. W. Gunasekera as to what can be done to remedy the situation.

Q. In 2013, the total tax revenue of the government as a percentage of the GDP was 11.6%. The total debt service payments for the year 2012 amounted to 13.4% of the GDP. So the total tax revenue is not enough even to meet the government’s debt repayment obligations. Furthermore nearly 40% of the debt service payment is just accumulated interest. So how long do we have until we go belly up?

A. We cannot sustain this for long. Up to a point the government can create money through the Central Bank but there is a limit to that because it will cause inflation. They can get further loans and make adjustments. The system will not collapse. There are methods of making adjustments and carrying on. But my problem is how this situation will affect the people and the provision of services like education and health. All over the world, tax revenue as a percentage of the GDP of a country at our level of development ranges between 20-25%. In our case I say it has to be at least 18%.

Q. Referring to tax revenue as a percentage of the GDP can sometimes be misleading, because it all depends on what the country needs. There is no uniform percentage that seems to fit all countries. There can be wide disparities in tax revenue as a percentage of the GDP even between countries at a similar level of development. In France its 22% and Italy 23% but its higher in Norway at 27% and the UK at 26%. But it’s a low 10% in the USA and Japan. In countries closer to our level of development, in Malaysia it’s 16% and the Philippines 13%. If the latest figures reveal that our total tax revenue is 11.6% of the GDP and the Budget deficit amounts to 5.9% of the GDP, arithmetically as you say 18% would be quite enough for Sri Lanka. Now the question is how do you increase tax revenue? It goes without saying that we cannot even think of increasing indirect taxes which are levied on goods and services as that will increase the cost of living. So we can talk only in terms of income taxes. In Sri Lanka income tax makes up only 20% of total tax revenue but in developed countries like the UK, Netherlands, Canada and Australia, income taxes provide over 60% of total tax revenue. But if you increase income taxes in Sri Lanka, that may act as a dampener on saving and investment.

A. The income tax should be significant but reasonable. From the time of independence in 1947, never have tax revenues come down to 11% of the GDP. Never have rich people enjoyed tax concessions as they do today. We increased the tax free threshold for individuals to Rs.600,000 a year and at the same time reduced the maximum tax rate applicable to 24%. So this has resulted in a shortfall in tax revenues. The secretary to the Treasury P.B.Jayasundara told me that his first duty every morning is to find liquid cash for the day to day needs of the various departments – an increasingly difficult task.

Q. In many developed countries, there is a big difference between the corporate tax rate and the individual tax rate. In Australia the corporate tax rate is 30% while the individual tax rate is 45%. In the UK, its 21% and 45% respectively. But in countries like Malaysia the corporate rate is 25% and the Individual rate is 26%. In Singapore its 19% and 21% respectively. So in Sri Lanka we have a corporate tax rate of 28% and an individual income tax rate of 24%. Obviously the logic behind reducing the corporate tax rate is to give them more money to reinvest. But if we look at the higher rate of tax that individuals have to pay in certain developed countries, the government takes one third to nearly one half of your salary regardless of whether you have mortgages to pay or invalids to look after. In some Western countries, the state is the biggest exploiter of working people. Do we want that here?

A. The highest individual tax rate was 70% during N. M. Perera’s time. We are not asking for the individual tax rate to be increased from 24% to 70%. All we are saying is make the maximum rate 35% instead of the present 24%. You have to understand that these taxes are paid in a graduated scale. First there is the tax free segment of your income, then there are graduated slabs - the tax for the first slab would be two or three percent, and the rate for the next slab will be slightly higher. So at the end of the year you may be paying an income tax of only about Rs. 5,000-10,000 which is not excessive. You have to find the money to keep the government going. So long as Ronnie de Mel was the Finance minister from 1977 to 1987, tax revenues as a percentage of the GDP didn’t decline. He was very particular about collecting revenue to keep government services going. There is also the case that there has never been such a level of corruption in the Inland Revenue department as we see today. In the old days income tax assessors had immense discretionary powers. These have to be done away with because today, discretionary power has become a money making opportunity. If corruption can be minimised in the three income generating departments of the government the customs, excise, and inland revenue, there will be no need for an increase in taxes.

Q. Increasing the corporate and individual tax rates may not be feasible because countries like Malaysia also have low tax rates. This low tax regime is psychologically important for countries like ours. Is there a way forward other than by increasing the tax rates? The Inland Revenue Department is feared by the public. This has long been seen as an institution that ruins people’s lives. We have all heard horror stories about how income tax assessors make excessive presumptive assessments and offer to reduce the assessment if they are given a cut. Today, the tax rates have been reduced to a very reasonable amount. Furthermore the time bar has been reduced to 18 months so the inland revenue authorities cannot serve you with assessments going beyond 18 months. In such conditions, the number of those coming forward to pay their taxes should have increased but it has not. I would think that what is needed now is a ‘Api wenuwen api’ style public relations campaign (which increased recruitment into the armed forces at the start of the war) to persuade people to pay these reduced income taxes. The public should be educated as to the relief available to them through the new laws and convinced that the IRD is no longer the instrument of expropriation through terror that it once was. They should be informed as to the advantages of being tax payer which makes it easier for even self employed persons to obtain bank loans and the like. We have never seen a public relations campaign by the Inland Revenue Department to make it a more people-friendly institution. There was a young man whom I knew who started a boutique selling rice, curd and the like. Within a few weeks of having opened his boutique he got a letter from the Inland Revenue Department saying that he should disclose his income by such and such a date or the department would file action against him in courts! Such terror tactics make people creep into holes in the ground and refuse to come out. I am not suggesting a tax amnesty which applies only to whales and sharks. I am talking of an across the board PR campaign to convince the ordinary people that the Inland Revenue Department is not a punitive institution out to take everything you have and that they only want just a little bit of your money to keep the state services functioning. You yourself said that even if the top income tax rate is increased to 35%, people will finally pay only a small amount because of the graduated scale. But that is not the way the ordinary public looks at the income tax department. The priority should be to do away with the fear that any talk of ‘income tax’ generates in people. The payment of a small income tax should also be promoted as a civic duty and a sign that you are doing your bit for the country.

A. I agree with you on that point. There is a large middle class that is not paying tax. Even though the actual tax that people at that level have to pay would be very little, people are scared off by the mere sight of the tax form and the language used. So yes, the approach of the Inland Revenue authorities should change.

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