TAX SPIRAL EXPLAINED | Daily News

TAX SPIRAL EXPLAINED

The new Inland Revenue Act replaces the existing income tax law and comes into effect from April 1, 2018. It’s stated aim is to simplify and modernise the existing code and it does take some steps towards this.

Sources of income have been consolidated and some exemptions removed but it also introduces new complexities with regard to deduction of certain business expenses including interest and repairs. It aims to reduce tax holidays, which is positive; tax holidays go against the principle of equal treatment but the aim to increase direct taxes is questionable. Indirect taxes affect consumption and spending but direct taxes affect savings and investment.

Nevertheless the Government is expected to collect more tax with the burden falling heavily on businesses and higher income earners.

This column will focus mainly on the larger issues from a macro perspective rather than a detailed analysis of tax rates.

Taxation is required to fund government spending but the system must based on sound principles: simplicity, certainty and stability. Simplification reduces costs of administration and brings greater clarity. The government’s pressing need for revenue means that taxes should focus primarily on this aspect; using taxes to regulate activity (eg. bank lending, leases etc.) should be avoided.

Tax transactions

Taxes designed purely to raise revenue are more likely to be simple, as the only design constraints are neutrality and efficiency. The number of taxes and the number of tax rules should be minimised.

Uncertainty can arise at any stage – when identifying tax transactions, valuing them and applying tax law to them. (eg. conflicts between the Inland Revenue and Foreign Exchange Act, uncertainty over application of capital gains tax to old apartments). For this reason it is preferable to alter rates on existing taxes rather than introducing new taxes or changing the basis of application. Ad-hoc tinkering outside the annual budget should be avoided. Retrospective legislation is particularly devastating and its use should be discontinued.

Stability is connected to certainty. ‘Certainty’ is knowing the answer to a given question; stability is about whether the current answer will still be correct in few years’ time. For taxpayers, stability enables better planning and efficient compliance.

People can budget household income more accurately and businesses can make long term investment decisions in confidence. Businesses would far prefer to operate in a slightly more imperfect system than in one where incremental improvements are made every year. Stability also enables more efficient administration; changes in returns, processes or mechanisms of collection create difficulties for the Inland Revenue.

A stable tax system requires greater predictability in expenditure. Unfortunately too much spending is driven by short-term expediency and is often disconnected from policy making, planning and budgets. A medium term expenditure framework incorporating fiscal sustainability and space is essential.

Inflation and currency depreciation

Fiscal Sustainability considers the fiscal balance, evolution of public debt, capacity of the government to finance its budget (borrowing etc.) requirements, refinance maturing debt and fiscal risks. Fiscal Space refers to additional expenditure needed to promote development or stimulate growth.

While taxes are important, it is government spending rather than taxation that ultimately determines the total burden of government activity on the private sector. Although spending may also be financed by borrowing or printing money, all government spending is ultimately a call on resources that have alternative uses or involves transfers from one group in society to another. If a government borrows money, this has to be financed at the time of borrowing and then serviced by future generations of taxpayers with interest. Money printing causes inflation and currency depreciation.

Thus far the Government has focused on achieving fiscal consolidation through revenue enhancing measures. This must change, the level and composition of public expenditure must be reviewed for efficiency. Between 2005-17 total spending quadrupled (from Rs. 584,783 m to Rs. 2,645,300 m). This level of growth in expenditure is difficult to sustain and threatens macroeconomic stability, which is necessary for growth.

The Government needs to conduct a comprehensive review of spending, evaluating the quality and efficiency with a view to reducing waste, inefficiency and improving outcomes. Expenditure needs to be prioritised within a frame of a medium term expenditure plan. There is much scope for further simplification and rationalisation of the overall tax system including para tariffs and excise duties.

People are worried that the rates of tax may increase-quite understandably so. They must pose the next logical question: What does the government do with the money that they collect? Is the public getting value for the money being spent-does the much vaunted public health and education system deliver value? If so why do so many go to private hospitals or fee-paying schools. For the richer sections, lead by the ministers themselves, even the local private hospitals and schools are not good enough - they must go overseas. Why?

Unless the public holds the government accountable for its expenditure we will see a never ending spiral of spending and taxes.

(The writer is a fellow of the Advocata Institute, a free-market think tank based in Colombo.)

 


 

There are 2 Comments

The writer does not seem to understand the inequitable nature of indirect tax, which is a regressive tax unlike direct tax. Although it is easy to collect, indirect taxes such as VAT makes poor pay a larger percentage of their income as tax than rich. In Sri Lanka, 80% of tax revenue comes from indirect tax and 20% from direct tax. Ideally it should be 40% from indirect tax and 60% from direct tax. The government is trying increase direct taxes gradually and hopefully reduce the indirect tax to share tax burden fairly.

All agree Govt need revenue. If the Govt reduces the ministries and deputy ministries millions of rupees can be solved. Do we need so many ministries in Sri Lanka. What do they do actually? Most ministries are unnecessary and unproductive. They are created to serve politics, but not to benefits the public. What these politicians simply do always is " Apiwa Gonata Andawanawa.

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