Sri Lanka’s economic recovery from recent problems depends largely on the continued reform of the ineffective tax system and specific measures for revenue assurance. The country has struggled for decades to increase its tax revenue as a share of GDP, with the figure steadily falling to a record low of 6.7% in 2022. This is well below the World Bank’s recommended minimum rate of 15% to ensure long-term taxation.
The International Monetary Fund (IMF) recognized the importance of tax reform to revive Sri Lanka’s economy and proposed a $3 billion bailout package in 2023, conditional on increased tax revenues. The IMF’s program focuses on improving revenue collection methods, introducing new taxes, and raising existing tax rates to address large budget deficits caused by large expenditures and limited revenues.
5 Key Takeaways
- Tax Reform Dependency: Sri Lanka’s economic recovery is heavily dependent on tax reform to increase tax revenue, which has fallen to a record low of 6.7% of GDP in 2022.
- IMF Bailout: The International Monetary Fund (IMF) has proposed a $3 billion bailout package conditional on increased tax revenues.
- Tax Collection Issues and COTS Solution: The country’s tax collection issues stem from corruption, an ineffective tax system, and non-compliance. The inefficiency of tax collection methods, particularly the Ramis tax software, is hindering Sri Lanka’s ability to collect taxes effectively. Implementing a proven Commercial Off-The-Shelf (COTS) solution could significantly enhance revenue assurance and address these issues.
- Revenue Arrears: The collection of revenue arrears, totaling LKR741bn, needs urgent attention, with only 22% identified as recoverable.
- Investment in Public Services: Investing newly collected funds in public services and infrastructure can improve the quality of life and promote economic growth.
Tax Collection Issue at Its Core
Historically, Sri Lanka has had problems in tax collection due to various factors such as corruption, ineffectiveness of the tax system and non-compliance. Influential people in the tax field recognized the need for reform to increase revenue and accelerate economic growth. These individuals advocated for softer tax policies, stronger enforcement mechanisms, and greater transparency to improve tax regulations and generate needed revenues for public spending. Furthermore, proponents of tax reform argue that increased tax revenue is needed to finance essential public services, infrastructure development and poverty reduction programs. They believe that a more efficient and fair tax system creates a stable revenue base for the government and promotes sustainable economic growth in the long term.
As an illustration, by diversifying the tax base, reducing tax evasion, and implementing progressive tax policies, Sri Lanka can create a more favorable environment for business investment and economic prosperity. Critics of tax reform express concern about the potential negative effects on poor people, small businesses, and the economy as a whole. They argue that raising taxes can stifle consumption, reduce per-unit income, and discourage entrepreneurship, slowing economic growth and job creation. In addition, there are concerns about the government’s ability to effectively implement and monitor the new tax policy, especially in a country with a history of corruption and weak governance.
Going forward, the future of Sri Lanka’s economic recovery is closely tied to the success of tax reform. There is a need for the government to strike a balance between raising revenue and minimizing the burden on taxpayers, especially those who are already vulnerable. By carefully designing a fair, efficient, and transparent tax policy, Sri Lanka can chart a path for sustainable economic development and poverty reduction.
Sri Lanka’s Economic Recovery: Inefficiency of Tax Collection
The inefficiency of tax collection methods in Sri Lanka is a pressing issue that needs to be addressed urgently. The problems plaguing the Ramis tax software used by the Inland Revenue Department are hindering the country’s ability to collect taxes effectively. Despite the significant investment made in the system, it continues to suffer from functionality issues that are preventing the department from carrying out its duties efficiently.
It is concerning that the Committee on Public Accounts has revealed that the Ramis system has consumed over 10 billion Sri Lankan rupees (USD1 = LKR302), especially given that it has not lived up to expectations. The inability of the system to function as intended has led to a massive pile-up of tax arrears and penalty interest income, totaling over LKR904 billion as of 2022. This staggering amount represents a substantial loss of revenue for the government, which could have been used to fund important public services and infrastructure projects.
The auditor general’s report for 2022 underscores the severity of the situation, highlighting the urgent need for reform in tax collection methods. It is clear that the current systems in place are failing to fulfil their purpose, resulting in significant financial losses for the government. The Inland Revenue Department must take immediate action to address these issues and improve its collection processes to avoid further losses.
Possible solution
Investing in the upgrade of the Ramis tax software or adopting a proven, more efficient, and effective technological solution could be one possible solution to this problem. Training staff members to use the system properly and implementing stricter monitoring measures could also help improve tax collection efforts. Additionally, introducing incentives for taxpayers to pay their dues on time and penalties for those who fail to do so could encourage compliance and reduce the amount of outstanding arrears.
New Legislation Needed
Simply updating old legislation like the country’s Excise Act may not be enough to close loopholes in revenue leakage. While the efforts to amend and update the law are commendable, the fact that there are more than 1,000 amendments indicates the presence of deep-rooted problems that need addressing.
The Excise Ordinance Act is the basis of Sri Lanka’s customs duty system and loopholes in this legislation can result in significant revenue loss for the country. It is essential that a strong and up-to-date legal framework is in place to ensure that the government can obtain the necessary funds to finance the development of public services and infrastructure.
But simply relying on legislative innovations may not be enough to solve the problem. It is clear that new legislation is needed to address revenue leakage in key sectors. This is a difficult step because it requires a thorough review of the existing legal framework and a reform of the tax system. One possible solution could be to introduce tougher penalties for tax evasion and ignore other tax laws. By increasing the prevention of tax evasion, the government could potentially increase revenue collection and reduce the loopholes currently being exploited.
In addition, investing in proven COTS technological solutions, creating legal background for its usage, and improving the enforcement capacity of the tax authority can help combat revenue leakage. By modernizing the tax system and using data analytics and other advanced technologies, the government could improve its control and enforcement efforts, which would ultimately lead to revenue collection.
Sri Lanka’s Economic Recovery: Tax Arrears Collection Critical!
Addressing the crucial issue of collecting LRK741bn (US$2.3bn) in revenue arrears promptly is necessary. However, it is concerning that Sri Lanka have identified only 22% of the total arrears sum as recoverable. More than half of this recoverable sum, LRK87bn (US$270m), has been outstanding for three years or more. Therefore, it is clear that we need to take urgent action to improve the collection process.
Furthermore, a significant portion of the total revenue arrears, totaling LKR114bn (US$350m), consists of VAT and fines. This represents a substantial amount of money owed to the government. The report highlights the fact that the department responsible for collecting these arrears has not taken necessary measures to promptly remit tax revenue collected by third parties. This has resulted in delays and discrepancies in the collection process, further exacerbating the issue.
It is essential that the government takes steps to address these issues and improve the efficiency and effectiveness of the revenue collection process. This includes implementing measures to ensure that tax revenue collected by third parties is promptly remitted, as well as taking action to recover outstanding arrears.
Adopting Advanced Software System Crucial
This is a matter of national urgency! Basically, adopting advanced software systems is crucial for efficient tax administration in Sri Lanka. To improve its tax collection processes and ensure the beneficial use of tax revenues for society, the country should follow successful models from its fellow Asian neighbors
One effective approach that Sri Lanka could implement is an integrated tax system similar to the ones already in use in Pacific. This system consolidates all tax processes on a unified platform, making it easier for taxpayers to comply with their obligations and for tax officials to enforce regulations. By simplifying tax collection and administration, Sri Lanka could increase compliance rates and reduce the likelihood of tax evasion. Similarly, these systems enable taxpayers to submit their tax returns and payments securely and automatically in real time, online and offline, simplifying the filing process and reducing the administrative burden on both taxpayers and tax officials.
Sri Lanka’s Economic Recovery: Data Analytics and Artificial Intelligence Can Help
Furthermore, by using sophisticated technologies such as data analytics and artificial intelligence, Sri Lanka could revolutionize its tax collection strategies. These technologies can provide valuable insights into taxpayer behavior, automate routine processes, and enhance decision-making capabilities. The power of data and AI could help Sri Lanka significantly improve its tax compliance rates and enhance the effectiveness of its revenue collection efforts.
To ensure the good use of tax revenues, the Sri Lankan government must, last but not least, invest newly collected funds in projects and initiatives that benefit the entire society. Investing in infrastructure, healthcare, education, and other public services can improve the quality of life for all citizens and promote economic growth and development. The government can build trust and confidence among taxpayers and encourage greater compliance with tax laws by prioritizing the needs of the people and ensuring the effective use of tax revenues.
