Tax cuts aim to spur economic growth

Markets in Sri Lanka surged after a long spell and people were delighted by the new tax breaks announced by the government but the move worried economic experts owing to a drop in tax revenue and cash inflows.

The government has taken radical measures to spur economic growth lifting business sentiment with a simple tax system with low rates and a wider tax net easing the burden on the present taxpayers, experts explained.

Eminent economist and former Deputy Governor of the Central Bank (CB) W. A. Wijewardena told the Business Times that these concessions will result in a loss in revenue of about Rs. 650 billion to Rs. 700 billion or about a third of the government revenue while the adjustment should lead to a compensatory cut in government spending.

“But since it cannot be done, the other alternative is to borrow from the market immediately; that would involve allowing interest rates to go up and since it’s not the government’s intention, the most likely source would be to borrow from the Central Bank by issuing Treasury bills after increasing the Treasury bill limit through Parliament,” he pointed out.

“However it would involve compromising future inflation rate and if the CB wants to stick to the present inflation target of 4-6 per cent, it has to sell those Treasury bills at a higher interest rate; hence, an increase in interest rates is inevitable,” he added.

This is an unconventional stimulus package by using tax cuts to increase cash holdings with individuals and businesses; the caveat there is that individuals increase consumption of imported goods and foreign travel putting pressure on the exchange rate to depreciate, he emphasised. It has to be avoided by resorting to exchange controls or import controls; whether companies reinvest those moneys will depend on their own reading of market prospects, he opined.

In the short to medium term, the government has to recoup the lost revenue by roping in more people into the tax net; it would automatically happen since abolition of PAYE and withholding taxes on interest income.

Prof. Sirimal Abeyratne, Professor of Economics, Colombo University told the Business Times that there should be fiscal implications due to a reduction in one third of the tax revenue following the tax cuts.

But the government’s financial management authorities may have alternate means to attract private investment worldwide and create more employment opportunities, he said.

LOSS TO REVENUE OF ABOUT RS. 700 BN

Sri Lanka has an underdeveloped tax system with high tax rates and people are heavily taxed at present, Prof. Abeyratne pointed out adding that the country should move towards a low tax regime and wider tax base.

Therefore the government has taken the bold step towards this end and it is too early to predict the outcome of the tax relief package introduced this week, he added.

The reduction of VAT from 15 per cent to 8 per cent and the removal of 2 per cent Nation Building Tax (NBT) will pave the way towards an economic resurgence and the lowering of taxes will increase consumer demand on goods and services, a senior tax specialist said.

However he noted that "the psychology of pricing is such that, traders would not reduce prices just because taxes are removed".

Under this set up the Finance Ministry should devise a mechanism to pass the benefits of the tax reductions to consumers by traders, he emphasised.

Tax concessions to attract investments in the long term would not augur well for the economy as it would reduce revenue to the government coffers; he said adding that the loss in revenue by introducing new tax relief package will be around Rs. 500 billion according to provisional estimates.

It is essential to find alternate revenue measures to offset the losses caused by the removal of several of derivative taxes and reduce existing tax rates, he suggested.

N. R. Gajendran, senior partner at Gajma and Co and tax specialist, told the Business Times that it is essential to present an amendment bill and enact it in parliament to introduce new income tax revisions and other tax measures and removal of eight other taxes.

VAT rate change could be handled by the government by issuing a gazette notification under the signature of the Finance Minister. He saw no difficulty in making these changes.