Part 6: Overcoming Stagnant GDP—Reforming Subsidies, Energy, and Taxes, A candid study and an action plan Economic and social development for Sri Lanka
Posted on May 29th, 2023

by Professor Sunil J.  Wimalawansa

Tariff and taxation

Most of the Sri Lankan government’s revenue is derived from customs duties and Value-Added-Taxes (VAT).  This contrasts with most other countries where customs act as a border protection force to prevent the smuggling of counter-banned, incoming illegal items such as narcotics and to prevent dumping from protecting local industry.  In addition, when customs duties are charged in Sri Lanka at airports, aviation levy & BTT add about 25% to the CIF Value, which also passes on to the consumers.  This is not the way for a government to collect funds at the expense of the public.  Instead, it should focus on preventing the recently discovered massive VAT scandals prohibiting funds from coming to the treasury.  

Most countries use VAT only when value is added to a product, but in Sri Lanka, the retail sales function adds VAT up to 20%, even when no value is added to a product or consumer.  These taxes are in addition to the CIF and governmental stamp duties.  Besides the lack of digitization, Custom’s collections are open bribes.  Why it is not reformed is a puzzle.  Customs taxation adds an extra third to commodities consumers use. These are passed over to consumers—the poor and middle class bear the brunt.  So where is justice?

Only a tiny percentage of the adult population in Sri Lanka pays personal taxes.  The current tax-exempt earning capacity is Rs 25,000 per month.  However, thousands of Sri Lankans earn much more than this and do not pay income tax.  This is partly due to inefficiencies of the inland revenue department (and favouritisms) and loopholes in the current tax laws.  This should be rectified by paying a fair share of taxes for the services they receive.  Improving the efficiency of the Inland Revenue Department and eliminating inherent corruption is critical for improving the government’s revenue collection.  

Establishing a mandatory auditing and reporting mechanism from all cash banks to the Inland Revenue Department of all high-value transactions and regular deposits by cash-only businesses can be minimized by working with the banking sector.  To collect payroll and debit taxes, Customes and other revenue, the government must establish an efficient and fool-proof electronic mechanism.  Ironically, many in the upper middle class and big businesses avoid paying taxes, as most politicians do.  As a percentage of their income, the lower middle class pay a higher rate of taxes via consumer goods.  Thus, while people experiencing poverty are not paying income tax, they are taxed by the government indirectly via commodities.

Reduction of energy consumption and importation of not dependent on crude oil

Satirically, the Sri Lankan government hinders free trade by enforcing import tariffs.  Gasoline (petrol) is a classic example.  The high cost of gasoline, currently about Rs 450 ($4.50) per gallon (~Rs 90 per litre), is due mainly to governmental taxes.  Despite excessive taxes, it does not deter gasoline consumption by individuals.  At the same time, there is no restriction or program to prevent waste from an estimated one million government vehicles, including the police and military—again paid by the taxpayers.  

Due to the lack of accountability, they continue to abuse this pre-paid” petrol and diesel, including routinely using these vehicles for personal use (e.g., taking their children daily to schools, shopping for spouses, etc.).  Although never discussed, these add a significant financial burden to governmental expenses, ultimately paid by consumers.  Because of the ongoing bribery, irregularity, and routine unlawful actions, the consumer price index increased; they are paying higher prices for everything, even though people with low incomes cannot afford to pay.

Another scandal is that across-the-board subsidies, such as provided to diesel fuel.  This incentivized the rich to use high-consumption luxury vehicles but pay less at the pump. It is estimated that over 90% of this is used by gas-gobbling, governments, NGOs, and companies that own high-consumption vehicles.  The government must act to stop importing and increasing consumption tax on these high-consumption luxury vehicles.  The government need to develop a scheme to phase these out by stopping their importation (except for construction, transportation, military vehicles, and ambulances) and allowing replacing them with low-consumption vehicles (or using alternative energy) to lower the running cost. 

Subsidies harm the development

Gasoline prices have been increasing over the past 20 years, affecting inflation and the cost of living. Rising taxes and tariffs are counter-productive to the country’s economic growth in this situation.  The government must gradually decrease and remove most subsiding on consumer goods, whether diesel, fertiliser, or high-end goods or commodities.  Introduction and raising government subsidies before each election is a political gimmick to attract votes.  Most subsidies are unsustainable and unnecessary and negatively affect the budget.  Moreover, most of the population does not benefit from such sector-based offerings.

Instead of raising gasoline taxes, the government should invest in renewable energy [e.g., capturing energy from sea waves, expanding solar (e.g., countrywide on highways) and wind power].  In parallel, it should take actions to decrease energy consumption [e.g., introducing low energy consumption technologies (LED technology), energy-saving green-building constructions, incentives to decrease energy use, and out-of-the-box technologies], thus, preventing the need to increase (or reduce) the fossil fuel importation, to conserve foreign exchange.

In 2005 alone, the fuel subsidy to the Ceylon Petroleum Corporation was estimated to be about Rs. 22 billion, while the Ceylon Electricity Board lost approximately Rs.19 billion.  How can these two independent organizations lose so much money when they sell their products significantly higher than the estimated total cost of production?  These two alone amounted to about 3% of the GDP of Sri Lanka.  For these state-owned enterprises (SOEs) to lose money, there must be a massive structural failure—mismanagement, overpayment of employees, and/or large-scale pilferage.  When is the government going to audit these SOEs?

The losses mentioned above are equivalent to government spending on healthcare or education.  Allowing such mismanagement, year after year, without acting for structural changes makes no sense.  There has been no substantial ministerial effort to sort out these issues: perhaps they are part of the problem and involved in corruption.  The government must trim these waste and subsidies and use those savings on sustainable development programs to generate jobs, taxes, wealth for low-income people in rural areas, and prosperity.

Who should create jobs?

Government has no business in job creation.  Instead, it should facilitate the private sector by lessening regulations and non-interference for industries to thrive. When left alone, the private sector will create higher-paying, sustainable jobs.  The focus should be on large-scale, modernized agriculture, transportation, and infrastructure development, drastically updating school and university curricula, and educating youth in high-end skills (i.e., skills training programs as mentioned earlier, particularly in rural regions allowing them to diversify their income sources.

Sri Lanka’s government abandoned the automatic fuel price adjustments and adopted monetarization (to print money excessively—artificial currency not attached to gold reserves), equivalent to 3% of GDP from 2004.  This printed money subsidised various commodities, particularly crude oil (gasoline) and fertilizer.  This modified economic policy was another sham, presumably aimed at insulating the country from world market prices and opening doors for pilferage.  However, such short-sighted actions invariably increase inflation, commodity prices, and job losses, leading to a liquidity trap.  Therefore, it will end up with a lose: lose situation for Sri Lanka, adding misery to people and increasing debt.

Not surprisingly, excess borrowing and printing money accelerate inflation and the cost of goods.  As witnessed a few months ago, inflation rose to over 18%, plunging the country into a balance of payments crisis, and the banks were on high alert.  The government must resist the temptation of continuing monitorization.  The absence of a government, at least, wouldn’t cause that harm to the country!

Strangely, 75% of government subsidies benefit high-income earners, some of whom do not pay taxes.  Wouldn’t they be able to succeed without such contributions?  If the government policy is to give subsidies, which is erroneous, subventions should be provided directly to those who desperately need assistance rather than subsidising the rich.  Of subsidised commodities like diesel fuel, 70% are used by wealthy families, comprising 10% in Sri Lanka.  So, where is equity and justice?  This is not the way to help the poor and needy. 

Text Box:  The long-term effects of these inappropriate subsidies include providing wrong price signals and preventing conserving energy or seeking out alternative energy sources (e.g., generating energy from ethanol, wind power, biogas, desalination, and capturing energy from wea waves).  Perhaps, why not the government direct some wasteful subsidies as incentives to develop alternative energy sources mentioned above that would eventually reduce the demand for fossil fuels (coal and gasoline/crude oil) and invest in energy conservation?

For example, instead of losing over seven million rupees a day, the electricity board should divert some of these losses” (including reducing their bonuses) to embark on programs like selling fluorescence and LED light bulbs to consumers at subsidized prices to reduce energy consumption.  Government should only allow importing energy-efficient appliances like refrigerators, air conditioners, and large electrical equipment for industry and hospitals, and incentives to conserve energy and develop alternative energy. 

Stagnant GDPImportance of promoting the agricultural base

Although South Asia is home to one-fifth of the world’s population, the region accounts for only six percent of global GDP and five percent of international trade.  Sri Lanka’s most dynamic current sectors include food processing, textiles and apparel, food and beverages, telecommunications, insurance, and banking.  Exports of plantation crops comprised 90% in 1970, compared to only 15% in 2003, while textiles and garments accounted for 63%.  Since the textile quota system was abolished in 2005, the market has been flooded (e.g., bale clothing) with cheap clothing from countries like China and Taiwan.  

In the long run, exports of only the high-end brand-named finished product will survive due to fierce competition from China.  The apparel industry must prepare for this shrinking market with diversification and finding new markets.  While the percentage of GDP generated from textiles and garments will decrease, the Sri Lankan government must focus on finding other potentially lucrative areas such as tourism, marketing high-end products, assembling and exporting, and communication centres, as described above. 

With trade liberalization, the incoming flow of goods into the region is increasing steadily.  That would not help the budget deficit, solve the potential debt crisis, economic growth or relieve poverty.  Global trade liberalization benefited the industrial sectors but has left the cottage industries and agriculture lagging.  Agriculture is the livelihood for around seventy percent of South Asia families, including Sri Lankan.  It accounts for a quarter of the GDP in South Asian countries, higher than other developing nations.  Agriculture in Sri Lanka currently accounts for 20 percent of GDP and 18 percent of exports.

Since the economy was liberalized in 1977, the contribution from agriculture (assisted by irrigation) to the national economy of Sri Lanka has declined.  However, the agriculture sector was expected to increase significantly with the accelerated Mahaweli project (the last, larger project in Sri Lanka).  Out of the total population of 19 million, nearly 72% live in rural areas.  The number of small farmers employed in the sector is about 75%, and the industry is protected with average tariffs of around 28%.  Expansion and modernization of agriculture are crucial for increasing food supply, profits for farmers’ and overall economic growth and stability, reducing unemployment and poverty, and providing food security.  Instead of fostering them, these have been neglected.  Political interference from provincial councils, removal of tariffs, and mediocre infrastructure facilities, including cold storage and refrigerated transportation of food, have hampered the agricultural sector from developing.

What prevents economic advancement in Sri Lanka

The severe shortage of dedicated, honest, uncorrupt, strong and patriotic leadership with long-term vision has been a significant problem in Sri Lanka for several decades.  Unfortunately, this has also been an essential issue in all developing counties.  However, if a leadership team with impeccable character emerges, there is no doubt that Sri Lanka can beat the Singaporean and Shanghai economies within a decade.

Sri Lanka has the necessary natural resources, educated human resources—skilled labour, access to ports, etc.  However, it lacks the vision, willpower, and credible people to implement it.  Prime Minister Lee Kuan Yu of Singapore borrowed the unimplemented Colombo-Plan” in 1950 from Sri Lanka, which Sri Lankan refused to implement!  He had the wisdom and vision to implement it in Singapore four decades ago.  He and his team embarked on an open market philosophy while keeping corruption at bay, which paved the path for outstanding economic success in Singapore.

Even after 35 years of stagnation, it is not too late for Sri Lanka to embrace a market-driven economic approach with appropriate adjustments to the prevailing democratic political system.  However, this must be implemented without interfering with Sri Lanka’s 2,500-year unique Hela culture, heritage and Buddhism, environment, society’s values, personal freedom, and democratic ideals.  One of the major obstacles is the 1977 constitution with an executive presidency and the enacting of terrible amendments.  It allowed corruption and pilferage of funds and resources, and the executive presidency eroded the independence of the judiciary.  It also opened the door for future dictatorship when a power-hungry, corrupt executive president sustains a two-thirds majority in the parliament.

It is time to consider firm legislation and implement existing laws with punitive punishments for lawbreakers.  It should provide resources, guidance, and incentives for firms and local governments to implement environmental protection and uphold laws.  The consequences of not implementing these laws—the opportunity costs—are enormous. Examples include increasing sickness and premature deaths (higher morbidity and mortality) thus, increased healthcare costs, the spread of infectious and environmental-related” disorders like chronic kidney disease of unknown origin, deterioration of infrastructure, decreased productivity and output from factories, construction and agriculture sectors, and the eventual spiral of economic downturn.  Can Sri Lanka afford these?

Part seven is the last section of this series of articles.  It summarises the type of leadership the country desperately needs, key components the Sri Lankan government needs to address to overcome the financial difficulties, and the path to success and prosperity for Sri Lankans.

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