The Economy: Chickens come home to roost
Posted on March 5th, 2016

Courtesy The Island

Last Friday, for the first time since the present government assumed office, a special cabinet meeting was held to discuss the economic situation and a proposal to increase taxes. No official statement has yet been given out about the decisions made at that cabinet meeting or whether a final decision was arrived at all. However news that has leaked out to the press indicates that the government intends increasing the Value Added Tax from the present 11% to 15%. Furthermore, VAT exemptions for telecommunications, private health and private education will be removed. The Nation Building Tax is supposed to remain at the present levels. It is assumed that the present level referred to is the 2% that is still being charged even though the NBT was increased to 4% in the 2016 budget. In addition to this a new tax that will be introduced is the capital gains tax which had been abolished some time ago.

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The capital gains tax was introduced along with the quasi-socialist reforms of the S.W.R.D.Bandaranaike government and abolished as the free market economic policy became the norm. Capital gains are the profits that an investor realizes when he sells the capital asset for a price that is higher than the purchase price and capital gains taxes are only triggered when an asset is realized, not while it is held by an investor. An investor can own shares that appreciate every year, but the investor does not incur a capital gains tax on the shares until they are sold. The government needs to demonstrate its ability to pay back the loans they expect to obtain from the IMF as well as on the open market – hence this increase in taxes. In the meantime the corporate income tax rate is also to be retained at the previous level of around 28% without being reduced to 15% as proposed in the Budget for 2016.

The large private business houses have been having a bad time since the present government came into power. Last year, all these conglomerates had to fork out amounts ranging from hundreds of millions to two or three billion rupees each depending on their profits for the past year – for no reason all except to keep the yahapalana government afloat. They had to pay this one off super gains tax over and above their usual tax commitments for that year. This amounts to the same kind of expropriation that was practiced by the 1970 SLFP led government of Mrs Sirima Bandaranaike. At that time whole businesses or estates were taken over by the government. The only difference this time is that the establishments themselves were not taken over, but huge amounts of money equivalent to the value of many smaller businesses have been taken by the government.

The business houses that were rattled by this unexpected expropriation would have been pacified somewhat when the corporate income tax rate was reduced to 15% in the 2015 budget (With a higher rate of 30% for the liquor, tobacco, gaming and banking industries). Now if this reduced rate is not implemented, the relief that the private sector expected would not be forthcoming. It is not clear whether the tax free threshold of 2.4 million a year for personal taxation will remain the same or will be retained at the 2015 level of Rs. 750,000. All these moves appear to have been taken in the backdrop of the Fitch ratings downgrade which now makes it more expensive for Sri Lanka to borrow on the open market and makes the bailout package from the IMF all the more important and the government now seems to be moving fast to implement certain recommendations that the IMF has been making since last year which had been highlighted in this column from time to time. Negotiations with the IMF are to commence after the second week of this month.

If one asks what all this economic distress is due to, the single most important factor is the salary hike of Rs. 10,000 a month for public servants who number around 1.3 million. Even if all those statistically categorized as public servants may not be eligible for this salary increase, still the government needs something like one billion USD every year just to pay that increase. Now the government has given the unions that supported them the undertaking that Rs.2,500 of this would be included in the basic salary of a public servant. When the salary of the lowest grade is increased by Rs. 2,500 the grades above them become entitled to multiples of two, three and four times that increase in the basic salary. In a situation where the lowest grades are in a minority in the public service, this new commitment may cost around 200 to 300 million USD per year to implement. These were insane commitments made to bribe voters. Another measure taken to bribe voters was to reduce taxes on fuel and certain other commodities. The government did manage to win votes as a result of these measures. But now the chickens are coming home to roost.

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