Sugath Kulatunga

The ripple effect of the increase in the VAT rate from 15 to 18 percent has led to another hike in the cost of living causing wide spread agitation against the measure and has rattled the government. It has given another opportunity to traders to inflict one more exorbitant hike in the price of goods. The government expects the people to believe that it was forced by the IMF. The restoration of VAT from the absurd level of 8 % to 12% was an IMF condition. What the IMF insisted was to increase the revenue but did not suggest the last increase in the VAT rate from 15 to 18. On the contrary IMF recommended the broadening of the tax base and  ensure larger contributions from high-income earners while avoiding overburdening the poor who are already suffering.   

IMF Staff emphasised the need for broadening the tax base citing the experience of Indonesia, Thailand and Vietnam – While Sri Lanka’s VAT rate is now below the average across Asian emerging market and developing economies of around 12 percent, the low standard rate alone cannot explain the low level of VAT revenues. As a share of GDP, VAT revenues in Indonesia, Thailand and Vietnam have exceeded that in Sri Lanka, despite relatively low standard VAT rates.” (IMF Staff Report March 6 2023)

In the Letter of Intent summitted by the President and the Governor of of the Central Bank to the IMF they said The adverse distributional impacts of the VAT rate hikes were mitigated by maintaining VAT exemptions on basic food items. To bring the tax to GDP ratio to at least 14 percent by 2025.The authorities commit to revamping the VAT system before 2024, by removing almost all product-specific VAT exemptions.”

Article-6.

We aim to raise the ratio to at least 14 percent by 2026, by implementing a sequenced package of tax measures including contributions from high-income earners while avoiding overburdening the poor.

Article 46.

One important priority of the program is to protect the vulnerable from the impact of crisis and policy adjustments. The authorities are committed to strengthen SSN by ensuring minimum SSN spending and improving the coverage and targeting of the SSN. The tax reform package under the program are also designed to be progressive and promote equity.

Ms. Kristalina Georgieva, Managing Director, IMF in her statement following the Executive Board discussion on Sri Lanka said:,

In this regard, the momentum of ongoing progressive tax reforms should be maintained, and social safety nets should be strengthened and better targeted to the poor.”

At the IMF Press Briefing on the EFF Program after the first review, Peter Breuer, Senior Mission Chief and  Masahiro Nozaki mission chief for Sri Lanka said that Tax reforms under the program are designed to be progressive ensuring greater contributions from higher income earners. Efforts to increase tax revenues should be pursued in a growth friendly manner while protecting the poor and most vulnerable.

It is important that those who can afford it make commensurate contributions to the financing of necessary government expenditures.”

The message from the IMF which was repeated by every level of the agency is unequivocal that the tax policy must be progressive and the high income earners must make a greater contribution to government revenue. They did not demand an increase in VAT rate beyond 15% instead they proposed the broadening of the Tax base. In the letter of Intent Sri Lanka the target for a VAT rate was only 14 % and that too designed to be progressive and promote equity.

The million-dollar question is why has the government on their own ‘Suo moto’ implemented the current regressive tax, increasing the cost of even essential food items and all services making life unbearable to the vast majority of the people. When President Gotabaya reduced the VAT rate, he expected the high-income earners to increase investments. It did not happen. The speculation is that RW spared the rich ,expecting their contributions of funds for the forthcoming elections. Gota paid for his mistake. Will RW suffer the same fate?

Meanwhile the VAT increase has resulted in a DAT increase for doctors. That in turn has made other health workers demand the same allowance which demand is now joined by teachers. Nobody will believe that they are not aware that DAT is a specific allowance based on special services and they are not entitled to it and no government can afford such bounty. In the old villages there was a belief that when a big ‘pideni” is offered to the ‘Riri Yaka” the Mahasona and Gara yaka’ will demand the same or more. The ripple could well end up in a Tsunami.

Sugath Kulatunga