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VAT hike will disproportionately affect the poor: Experts
View(s):By Tharushi Weerasinghe
The government’s decision to increase the Value-Added Added Tax from 15% to 18% in January will disproportionately affect the poor, dealing them yet another blow in the wake of recently increased personal income taxes and electricity tariffs, experts say.
“The VAT hike will increase the prices of VAT-applicable goods and services, and this will then cause a contraction in demand since some people simply won’t be able to afford the goods,” noted economist and Chief Executive Officer of Advocata, Dhananath Fernando, adding that the poorer sections of society often bear the brunt of policies like this.
Dhananath Fernando
He said that the 3% increase in food prices, while equally applicable to all, would not impact various income groups equitably. For instance, the increase in the price of essential items like dhal would affect both lower-income people who spend a larger proportion of their income on food and higher-income people who allocate a smaller portion of their income to food expenses. This effectively means that lower-income groups will have less to spend on other needs.
“The challenge, though, is that when you cause such distortions, there’s room for corruption,” Mr. Fernando warned. He highlighted the possibility of traders attempting to import taxed items under the HS (harmonised system) code of untaxed items, which could affect VAT revenue. “Usually, the more deviations exist, the more space for corruption,” he added.
The economist noted that the tax policies being brought in often failed to adhere to the four fundamental principles of taxation: simplicity, transparency, neutrality, and stability.
“The principle of simplicity in our tax system is deviated from because of the distortions in taxes, tariff lines, and various rates, the complexity of which makes it challenging for individuals to navigate and understand their tax obligations,” he said, adding that even transparency is compromised where taxpayers are not able to identify and understand their obligations due to the convoluted tariff structure at the border.
“Neutrality is another vital principle that we should uphold, but we’ve seen instances like the mansion tax and super gains tax in 2015, which targeted specific groups and discouraged them,” Mr. Fernando commented, adding that the converse with the tax exemptions for select individuals was also a problem. The IMF governance diagnostic report has also called for transparency in disclosing these tax exemptions, as there have been extensive exemptions and tax holidays granted over the years that undermine neutrality.
“Stability is crucial as well. Constant changes in the tax system only exacerbate complexity and confusion.” People are unlikely to remember the current VAT rate when it changes frequently over a short period, leading to widespread confusion.
Mr. Fernando noted that the decision to increase VAT was also taken as an attempt to meet IMF obligations. “IMF has referred to a 15% shortfall in the committed government revenue, which may be something the government is attempting to cover,” Mr. Fernando continued. However, the IMF has not stipulated how this income increase should happen. It only sets a target for earnings as a percentage of GDP.
He said that it was uncommon to increase both direct and indirect taxes simultaneously, given the intensity of the burden it places on consumers and the fact that very high rates discourage even the sincerest taxpayers. He noted that increasing revenue without cutting expenditure was like “trying to fill a bottomless pot”. While VAT was the easier tax to administer, he noted that the government might consider a salary hike or a revision of the PAYE taxes.
Mr. Fernando also raised concerns about the political motivations behind the tax increase, suggesting that it could be a means of gaining favour with government workers expecting a salary hike. “The upcoming tax increase announcement could have been announced at the budget, but instead they’ve announced it now, and when the budget comes along, they will most likely “victoriously declare” the salary increase.” He pointed out that such a move essentially charges the same people and gives it back to the same people for political gain.
Speaking to the media last Tuesday, Cabinet Spokesperson Bandula Gunawardena said President Ranil Wickremesinghe would be proposing a salary hike for government servants during the November 13 budget. These sentiments were echoed by President Wickremesinghe on Wednesday night at the National Industry Awards. He said the decision to raise the VAT was part of a policy that would put Sri Lanka’s practices in line with those of Pakistan and India.
He emphasised the critical need to maintain economic stability and noted that these difficult decisions were necessary despite the public criticism they have sparked.
However, the Ceylon Chamber of Commerce expressed concern about the government’s decision to increase the tax. “While recognising the government’s commitment to revenue enhancement in alignment with IMF obligations, it is imperative to evaluate the broader economic ramifications of such a decision,” the CCC said in a statement. It noted that the already contracting purchasing power of consumers, given the increase in personal income tax, electricity tariffs, and fuel prices, may be further crippled by an added increase in VAT.
The Chamber urged the government to consider alternative fiscal strategies, like optimising expenditures, insisting that by improving budgetary practices and reducing excessive borrowing, a more balanced and sustainable fiscal trajectory can be established.
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