King Parakramabahu & UNP’s tax policy
Posted on April 12th, 2019

C.A.Chandraprema Courtesy The Island


Former Central Bank Governor Ajith Nivard Cabraal 

In this interview, former Central Bank Governor Ajith Nivard Cabraal speaks to C.A.Chandraprema about the tax policy of the UNP government since 2015 and the Budget for 2019.

Q. You were a private sector person for the better part of your career. How is the Sri Lankan private sector taking the Prime Minister’s comment that even King Parakramabahu charged VAT and that the paddy cultivators of that era were taxed twice or thrice because they had so much money? 

A. Sadly, our Prime Minister has now become a comedian who makes funny comments. Many people do not take him seriously today. Parakramabahu the Great was a king who ensured that the farmers of Sri Lanka were motivated and supported. As a result, King Parakramabahu was able to make Sri Lanka the “Granary of the East” through the efforts of the farmers. Today, our economy is stagnant. The Government’s agricultural policies are openly hostile towards the farmers, and overall, Sri Lanka is experiencing a huge recession, although the Government is cooking up figures to show otherwise. In the past four years, the GDP has officially grown by only about 7% in US dollar terms, while in the previous nine years, it grew by over 207%. Even the present dismal growth is quite dubious, and if not for the disgraceful “massaging” of figures by the Census Department, it will be much less! The taxes imposed by this Government have however doubled during the last four year period, and this contradictory situation is clearly not sustainable. There is no way the private sector could now make ends meet, and it’s only a matter of time before some irreversible and permanent damage is caused to a majority of the economic stakeholders, and not just the farmers only. While all this damage is being inflicted on the economy, the Prime Minister and a few of his ministers make silly jokes and pretend the economy is flourishing. The people and the private sector however are not amused or deceived, and are suffering tremendously in silence.

Q. You were with the UNP many years ago in the JRJ era. How do you see the UNP tax policy then and now? 

A. The UNP was generally considered to be a Political Party with an economic policy that assists and encourages the private sector. However, when Ranil Wickremesinghe came into power in 2015, the UNP Government started off with a draconian “super gains tax” and several other debilitating taxes which crippled the private sector and de-motivated entrepreneurs. The UNP’s “economic czars” were also hell bent on increasing government revenue, and kept on chanting the “mantra” that their Government was going to quickly increase the tax income up to the levels of developed countries. That, they did brilliantly well by taxing the people and businesses mercilessly. This foolhardy and blind approach of increasing government revenue at any cost without considering the consequences has driven the private sector to the wall, and today, we see all economic stakeholders reeling under this terrible tax onslaught. There is no capital formation, no incentive to foster growth, and the number employed is falling drastically. But, the government is unmoved, pretends all is well, and continues to collect even more taxes, which will ultimately drive this country’s economy to collapse.

Q. Is there anything called a quintessentially UNP tax policy and a quintessentially SLFP/SLPP tax policy?

A. After the 1970-77 pro-left “closed” era, the SLFP was generally known as the Party that was not too friendly towards the private sector. Thereafter, the economy was liberalized in 1977 by J R Jayewardene, and thereby the pro-right UNP was identified as a more private sector friendly Party. However, after the centre-left Mahinda Rajapaksa led SLFP administration from 2006 to 2014, that perception changed completely. The Rajapaksa administration, through its pragmatic policy mix, was able to expand the economy at a phenomenal average growth rate of over 6% per annum, from USD 24 billion to over USD 79 billion, while local and foreign investments flowed to all sectors of the economy. Poverty reduced dramatically and infrastructure across the country improved visibly. People and Businesses enjoyed stable interest rates and exchange rates for the first time in the post-liberalization history. Most tax rates were reduced, although the total tax income increased as a result of the fast growth of the economy and better compliance. Instead of continuing with that successful tax policy, this Government, in its haste to collect even more taxes, disturbed that equilibrium, but only managed to kill the goose that laid the golden eggs. Today, there are no golden eggs and no golden goose.   

Q. Every government depends on a few perennial favourites to raise tax revenue. The import tax on vehicles, tobacco and liquor feature very prominently in that list. Today, we hear loud complaints that vehicles have been taxed out of reach of the local buyers. The tax on the Suzuki Wagon R is said to have been doubled since the present government came into power. What are the market dynamics when taxes are raised on vehicles? 

A.  The underlying principle of a successful system of taxation is that the system must be convenient, affordable and yield the required results. From a convenience point of view, many governments impose taxes on vehicles, tobacco and liquor because those are easy to impose, administer and collect. However, there is always an optimum level beyond which it is not feasible to collect taxes from whatever source. In the case of imported vehicles, taxes increase the cost of the vehicle while the currency depreciation too adds heavily to the cost. It is therefore not surprising that some of the popular vehicles have recently doubled in price, which has, in turn, made it impossible for middle class citizens to afford such vehicles. Another aspect that needs to be considered is whether the tax rate has increased to a level where the consequent fall in demand for the vehicles has led to a lower amount of taxes being collected. In such a situation, the government will end up having less revenue that they originally intended to collect.

 Q. When taxes on liquor and tobacco are raised, some see it as a positive thing because it will discourage the use of such products. Should tax policy get mixed up with promoting morality?

 A. Some persons resort to promoting a moral angle when they cannot find an economic justification to their economic policies. However, almost always, everyone sees through those shallow stories, and do not believe such pathetic claims.

 Q. If we take the Sri Lankan economy, can the government survive without liquor and tobacco taxes?

 A. Liquor and tobacco taxes contribute significant amounts to government revenue. Such taxes are quite helpful in meeting government expenditure. In a crunch situation, the government may of course survive without liquor and tobacco taxes, but that would mean the resulting shortfall in taxes would have to be re-couped by increasing taxes elsewhere.

 Q. The present over dependence on indirect taxation is because the proportion of direct taxation is so low. When you were in the government, why is it that you were unable to increase the proportion of direct taxation?

 A. Whether it is direct or indirect, the burden of tax is ultimately upon the taxpayer – be it as a producer or as a consumer. Let’s take the example of a person who has avoided or evaded the direct taxes due from him. If however, he buys a new car, he will pay a huge tax amount by way of custom duties. If he celebrates his daughter’s wedding at five star hotel, he will pay a substantial tax amount as VAT. If he buys a bottle of whiskey he will pay another significant indirect tax as an excise duty. Finally, in some form or another, his income will get taxed via indirect taxes, each time he consumes. So, overall, there are merits and de-merits of the different methods of taxation. The challenge for a government is to choose the most appropriate and practical mix of direct and indirect taxes at the different levels of GDP and per capita incomes, in a reasonably equitable manner. During the previous regime, the Government’s approach to taxing the public was practical with a sensible mix of indirect and indirect taxes. That system was carefully designed to yield the desired results, while encouraging the private sector. That is why a steady stream of investments continued to flow from the private sector, which contributed to the healthy macro-fundamentals in the nine years, 2006 to 2014.

 Q. As these questions are being formulated, a private bus strike has been announced to protest against the increase in fines for traffic violations. For some offences the fine could be as high as Rs. 25,000 or multiples of that. Is there some benchmark where fines and charges should match the average income of the relevant country?

A. In any country, the charges for services as well as fines for offences must be proportionate to its general levels of income. Just because a heart surgeon in UK charges UK Pounds 15,000 for a heart by-pass operation in that country, it would not be feasible or reasonable for a surgeon in Sri Lanka to charge the equivalent Rs.3.6 million for a similar operation in Sri Lanka. Just like professional fees and/or taxes, fines must be proportionate to the country’s levels of development and incomes. If not, huge imperfections and hardships may be caused to the people. The current Government has however showed that it is not at all sensitive to the people’s needs, and therefore I won’t be surprised if they increase the current Rs.25,000 fines to Rs.100,000 in a few months time, just like how they increased the fines of Rs.2,000 to Rs.25,000 overnight.    

Q. How would you respond to the charge that the Rajapaksa government gave out too many tax exemptions which resulted in the shortfall in govt. revenue?

 A. What is important to a Government is not how much it is taxing the private sector or whether the Government has the stomach to tax the people until they collapse. The Government must be smart and sensible enough to collect revenue that is only sufficient to run the government machinery and to pay its dues. While taxing, the Government must also ensure that sufficient funds remain with the people and private sector so that they could make adequate investments and ensure the growth of the economy. In that regard, the Rajapaksa government did well, because it was able to simultaneously generate strong economic growth, bring down the fiscal deficit, and reduce the debt to GDP levels. Even after giving various tax exemptions which served as incentives to the private sector, the Rajapaksa Government had sufficient funds to undertake a massive quantum of public investment, the likes of which had not been seen before or after that era. Unfortunately, this Government has a narrow focus of only increasing revenue, and within that policy framework, they have cancelled many tax incentives and increased tax rates, little realizing that by doing so, they have seriously compromised private investment and growth. Today, the entire economy as well as the people is suffering, businesses are crashing, banks are foreclosing on private assets, and livelihood opportunities are being lost in hundreds of thousands. 

 Q. If your side if re-elected to office at the end of this year, the biggest challenge you will have to face is raising enough revenue to meet the expenditure of the government. How do you intend meeting that challenge?

 A. There is no use raising revenue by taxing the stakeholders with high tax rates and a plethora of taxes, if the economy is contracting as a result. That is what this Government has achieved. We will not follow that foolish path taken by this Government. We will take a practical and pragmatic approach, and will actually reduce the tax rates as well as do away with certain obnoxious levies which hinder and hamper the growth of businesses. We are confident that many businesses will then be re-vitalized, and that will lead to quicker and higher growth, which in turn, will lead to higher tax revenues, thereby compensating the reduction in taxes due to the lower rates. That would mean we will still have the necessary funds for the government expenditure and investment. At the same time, as a result of our pragmatic and business-friendly policies, the economy will experience a stable Rupee and an overall decline in interest rates, where the biggest beneficiary will be the Government. In the last four years, due to the foolish and corrupt practices of the leaders of the current government, the government securities’ interest rates increased by a massive 4% thereby imposing a huge burden on the government coffers by way of a higher debt servicing costs. The average stock of Government Securities in the four years 2015 to 2018 amounted to approximately Rs.4,500 billion, and accordingly, this 4% increase in the interest rates would have caused an additional expenditure of about Rs.180 billion to the Government each year, which is only slightly less than what the Rajapaksa Government would have spent to construct two 900 Mw Norochcholai Power Plants!

 Q. There is now unrest among senior government servants over proposed increases in the salaries of judicial officers. Others holding equivalent rank are now demanding an equal pay hike. How feasible is that economically?

 A. The adjustment and/or revision of the emoluments of senior government servants is a very sensitive issue which has to be implemented after careful study and recommendations of knowledgeable experts. Up to 2015, the revision of public servants’ emoluments was tackled in that manner by highly respected and senior public servants, and not by corrupt politicians with dubious agendas. When blatantly corrupt politicians who themselves are under a cloud for masterminding corrupt scams, take ad hoc decisions pertaining to the adjustment of top public servants’ salaries, it naturally leads to doubt, disquiet and unrest amongst the top echelons of the public service.       

 Q. Would you agree with the statement that the economy was in much better shape when you assumed power in November 2005 than it is today?

 A. The Sri Lankan economy was in shambles in November 2005 when we assumed office. The country was suffering from low growth, declining employment, stagnant per capita income, low foreign reserves, low investment, rapidly depreciating currency, high interest rates, unsustainable fiscal deficits, high inflation, low business confidence and a falling stock exchange. In the nine years that we were in office, we improved every one of the country’s macro-fundamentals to reach levels where Sri Lanka could boast of having the best macro-fundamentals in South Asia, while also occupying a leading position in the entire Asian Region. In fact, many global investors categorized Sri Lanka as a “breakout nation”, and as a leading and fast-growing emerging economy of the world! Today, after four years of this hotch-potch Yahapalanaya, Sri Lanka’s macro-fundamentals are once again in shambles, and can be described in almost exactly the same terms as in November 2005. In fact, the current situation is worse than in November 2005 because that at time, the economy had the greater challenge to grapple with the internal conflict, which resulted in the sapping up of a lot of resources. But that is not the case now, which suggests that the present downturn is entirely due to the mismanagement of the Government’s economic team.

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