Wednesday, October 21, 2009

Taxation Policy – a more equitable route to raise revenue for Government

Way back in ancient history, when I was an undergraduate at the University of Bristol, I did a treatise on the most equitable tax policy that a country should adopt. Sadly in the case of Sri Lanka our taxes are highly regressive (it means that the least well off share a disproportionate tax burden) A committee of notables have been appointed by the President of Sri Lanka to advise him on how best to restructure our taxation system to achieve the revenue targets. The Country is woefully short of the current targets, so much so that they seem to be prepared by wishful thinkers and not professionals. (I mean the targets!)

I presume these new appointees’ brief is to present a more equitable, progressive and workable proposal. This should however not discourage private investment that is an essential engine for growth. I have my doubts that the committee has the will, the intellectual mastery of the complexity of taxation law, or the understanding of their brief, let alone the commitment in time, to avail themselves of this opportunity to put their stamp on the future growth of this country.

A good taxation structure is essential for accelerated growth of an economy like Sri Lanka, as well as for raising funds for Government Expenditure in a more equitable fashion. It must be simple to enact, understand, implement and enforce in order to minimize avoidance and ensure compliance across income streams.

To quote an example from my studies, I came out with a flat tax, on all forms of income (excluding sin taxes that are easy to collect) at a rate of 15%, which would have raised the necessary funds. This rate was considered low enough to reduce evasion, and ensure compliance and collection, increasing the net while eliminating distortions, but collecting the necessary revenue for the government.

The current very complex structure is full of loopholes and tax holidays, with a large proportion of the very wealthy simply outside its catchment, making a mockery of the whole system. With no capital gains taxes, wealth taxes or inheritance taxes Sri Lanka can rightfully claim to be a tax haven for the wealthy.

There are the sin taxes such as on Tobacco, Alcohol and Gaming which are generally easy to collect and yield the greatest revenue, but are extremely regressive, and then there are the import duties mainly on food and fuel that raise another huge chunk for the government. This again is also very regressive in a country addicted to imported food. Import duties on cars have suddenly ground to a halt due to the oversupply in the local market affecting Govt. coffers.
The level of corporate taxation is very unreasonable as there is a two tier tax structure where small companies are taxed at 15% and the moment taxable profits increase to Rs5M the rate increases to 35% creating effective tax rates of over 1000% at the margin.(5M tax 750K, 5.1M tax 1785K effective rate on additional 100K profit is 1035%) or over 10 times the extra profit!! This tax is easy to collect. The banks are highly taxed, a means of gaining more revenue for the government, but this has effectively been as a result of a high discrepancy in borrowing and lending rates. So this tax has been paid by the borrower, and not the bank. You could argue the lender to the bank, the depositor also is effectively taxed by the same logic. It is a no brainer to reduce bank tax rates to the same as other corporate and force them to reduce the margin between lending and borrowing to no more than 200 basis points or 2%. This fact alone should stimulate investment by borrowing by the Private Sector and encourage Savings by individuals.

It is the individuals that are hard to track, document and collect. There are many individuals especially in the provinces that are outside the tax radar. They live in large houses, have a fleet of cars and own numerous unincorporated businesses with hardware stores and tipper lorries. They appear to be very profitable. These individuals have few records that are auditable for taxation purposes.

Including these people with few records but noticeable increases in wealth annually, is going to be a challenge. They generate the money to send their kids to international schools educate them overseas, and remain without a tax file. How can this income get into the tax net to make the system equitable? Government servants should be netted as they are not taxed and vehicle duty concessions for them withdrawn. There should be no incentive other than income to encourage people to join government service. Other fringe benefits, like inefficiency and early retirement at 55 are all benefits that do not need to be made more inefficient by giving duty concessions for their personal vehicles and tax free income.

There is enough fodder for the committee to look at in my analysis above. I go for an across the board corporate and income tax rate of 15% on income both earned and unearned like interest income. As long as everyone is included in the net with an individual allowance be it for a company, single person, married or family of the first Rs500,000, the tax yield will be double what the government currently gets from Income and Corporate taxes at present. I suggest a flat rate of 10% on all non food and medicine sales in the form or a type of VAT as is now implemented.

So guys please brain storm, think outside the box and have the courage to come up with a revolutionary proposal. I am waiting!!


Jack Point said...

A rational tax policy is not possible until there is a rational policy on government spending.

If spending keeps growing by leaps and bounds, taxes must grow by similar amounts. Since relatively few people pay income tax, the burden on them is disproportionate which is why regressive, sales based taxes are better in these circumstances.

Proposals to collect back taxes going back upto 1932 (with another presidential committee to determine which tax payers are dead or alive) have been made within the last year and give an indication of things to come.

Dulan said...

I've read of the case for a flat tax in the Economist as well. If such a thing can be achieved in this paradise isle is another issue altogether. :)

Like Jack Point said, the lack of rational policy is what stymies growth in Sri Lanka. If we are to deal with policy that plays to the gallery, then we are in very big trouble.

I remember not so long ago reading of a suggestion that the unemployed graduates in the country be taken in by the Inland Revenue Department as Tax collectors. The case was made that the excess tax funds from the individuals thus netted could be used to pay them.