By Lalith Dhammika Mendis –

Lalith Dhammika Mendis

Dawn of 2024 at Zero Hour on 1^st January 2024 was greeted by a gala musical extravaganza at popular Galle Face esplanade with glitz and glamour. People momentarily buried their perennial woes in razzle-dazzle of enthralling music grooving and gyrating to lively beats of popular numbers. As the music faded away at first flush of morning, the GOSL unveiled its controversial amendment to VAT bringing in host of items under VAT net to significantly boost tax revenue.

VAT today is practically the all-consuming hot topic of every household. New Year has ushered in an era of skyrocketing cost of living dealing a devastating economic blow on poor already down and out with no hopes for a better tomorrow. How man on the street will navigate unbearable cost of living only timely will tell.

Latest Amendments to VAT Regime

Sri Lanka (SL) is facing the brunt of a VAT Regime that accompanies sweeping socio economic implications. It comes as part of the commitments undertaken by the GOSL to comply with the stringent criteria laid down by the IMF bailout package termed “Extended Fund Facility” (EFF). EFF it is said is offered to extricate SL from the unprecedented debt crisis it has got mired in today. Although volume of credit offered by the EFF is hardly sufficient to literally bail SL out of the debt crisis, it is expected to boost SL’s credit standing in global financial markets enabling SL to restructure foreign debts and gain access to bilateral and multilateral credit once again. New VAT regime is expected to rake in additional revenue to bridge the yawning gap between annual revenue of the GOSL at present with the revenue required to meet fiscal commitments of 2024 and beyond.

Devastating Debt Crisis & its Deep-seated causes

SL declared bankruptcy in April 2022, when it announced a sovereign default for the first time in the post-independence history. SL’s inextricable debt trap has been ascribed to mammoth scale corruption, misuse, extravagance, waste & embezzlement of public funds by political apparatus aided by complicit officialdom under successive dispensations. Besides, the myopic strategy adopted by the GOSL in raising debt finance, and composition of debt itself too have been adversely impactful on the worsening debt situation.

SL became a victim of an inescapable debt trap due to her own appetite for International Sovereign Bonds (ISB’s) and increasing reliance on China for financial assistance, which saw SL getting entrapped in predatory lending of China in its quest to finance post conflict mega infrastructure development. This ultimately led to erosion of debt sustainability. As reported by Advocata Institute, SL issued ISB’s from 2007 and ISB’s which initially accounted for 12% of the external debt tripled during the period from 2010 to 2021.  Moreover ISB’s were said to carrying coupon rates from 5% to 8% and accounted for whopping 70% of the interest payments made in 2021. In fact most of these debt funded infrastructure investments lacked reciprocal capacity to generate revenue and led to further Debt Spiral.

As per UNDP Sovereign Debt Crisis Report covering the period from 1998 to 2022, External Debt to GDP ratio in SL peaked in 2022 at 74.7% with 2008 reporting the lowest at 38.8%. Total National Debt too rose to 115.54% of GDP in 2022. During this period export as a percentage of GDP declined from the highest in 2000 at 39% to 21.4% in 2022. Fast developing crisis exacerbated with Tax Revenue drastically depleting up to its lowest of 7.37% of GDP in 2021. A major bungling in tax policy involving sweeping tax concessions & exemptions, reduction in VAT rate and drastic increase in annual VAT threshold from 12 Million to 300 Million made from January 2020 led to unprecedented deterioration of tax revenue in 2021. With debilitating impact from Covid, SL suffered double whammy setbacks with debt sustainability hitting rock bottom.

IMF database and country specific reports reveal monstrosity of SL’s annual interest payments, which stood at colossal 71.7% of the national income with the total public debt standing at little over 100% of GDP in 2020. However countries such as Japan and Greece which carried public debts at 256% and 231% of their respective GDP’s were paying as low as only 8.2% and 6.2% of respective national incomes on interest. This clearly demonstrates the predicament faced by SL due to its short sighted policy of resorting to ISB’s and predatory finance carrying exorbitant interest.

Regressivity of VAT as an instrument of taxation

VAT is an indirect tax applied on goods and services. It is applied across the board covering all strata of income. People of high income brackets and low income segments have to pay the same amount of tax irrespective of income levels when purchasing goods and services. Rate of VAT has been increased from January 2024. This would result in higher tax on goods and services. Also VAT is payable on a plethora of goods and services hitherto did not fall within the VAT net. This would lead to further shrinking of disposable incomes and purchasing power of low income segments. Moreover, energy costs and costs of many goods and services would soar impacting profitability of businesses. Increase in cost of fuel will have a devastating ripple effect across many goods and services consumed by people. Although prices tend to hike when energy prices are increased, SL has never seen downward adjustments in prices whenever energy costs witness reductions. Whilst corporate sector will experience escalation of costs and drop in profits, SME Sector, Micro Enterprises and self-employed will have to contend with the bleak prospect of ensuring sustainability of businesses under harsh economic conditions. Consequently many a small-time businesses may get wiped out.

Erosion of corporate profits would dampen future prospects of progressive investments in innovations, diversifications, new technologies, expansions and strategic acquisitions etc. Besides, lessening of profits would compel businesses to cut costs and slash staff emoluments. As a result those who mainly depend on monthly salaries will find it difficult to meet living expenses. Depletion of disposable incomes would seriously undermine people’s capacity to make savings, which in turn will have macro-economic implications.

Adverse Socio Economic Impact & Undesirable Effect on Children

Higher VAT will also affect banking and financial sector. Since banks and financial institutions are unable to claim VAT on financial services they would be compelled to pass it on to the customers as higher charges and interest. Hike in interest would make cost of credit expensive. Higher cost of goods and services and costlier credit will contract purchasing power of households and make them curtail consumption. This phenomenon will impact production and supply of goods and services causing national GDP to decline as a result. Higher costs on essentials such as food items, including those consumed by children and infants will result in widespread malnutrition mainly impacting low income households. This phenomenon will have a generational impact since adverse implications on growth of future human capital will directly impact future economic growth.

As per the Annual Report of the Central bank for 2022, Sri Lanka ranked the second worst affected country in South Asian Region in terms of wasting among children defined as “low-weight-for height” that indicates severe loss of weight in children under five years of age. The report further states that underweight among children of the same age groups remains at 20% since year 2000. Demographic & Health Survey – 2016 reveals that 31.7 percent of the children in estate sector are stunted as compared to 14.7% and 17% respectively in urban and rural areas. This is mainly due to socio economic factors such as disparities in disposable incomes and economic security.

UNDP and Oxford University have developed Multidimensional Poverty Index (MPI) to measure poverty beyond monetary deprivations based on three dimensions namely Monetary Poverty & Access to Education and Basic Infrastructure Services. Child Multidimensional Poverty Indicator (CMPI) of

SL based on Household Income and Expenditure Survey of 2019 reveals that one third of the children in the age group of 0 to 4 are multidimensionally poor, and either underweight or stunted. Lack of access to education for children measured as part of CMPI criteria is bound to lead to adverse socio economic outcomes in future with pervasive implications.

VAT from 1^st January 2024 is chargeable on school equipment, which will result in serious predicament for children from low income households who are multidimensionally poor already, as it may drive some away from schools. Lack of access to education for children is a serious socio economic issue with momentous consequences, leading to social disparities and host other societal problems.

Economic woes prevailing in SL could disrupt production and supply of food items. Increase transportation and costs of a plethora of goods and services would compel low income household to opt for low-priced food items at the expense of nutritional needs particularly of children. As a result children would be the worst affected and most vulnerable to economic aftershocks of VAT hike with further increase in malnutrition which is already at undesirable levels.

As reported by “economynext”, the word bank statistics indicate that poverty in SL was projected to increase up to 27.9% in 2023 from 25% in 2022. It goes on to state, prospects for reduction of poverty would depend upon restoration of economic growth and creation of employment. Unbearably higher taxes nowadays witness mass exodus of professionals representing many spheres, including medicine, engineering, accounting etc in search of greener pastures. How situation in SL will turn out in the context of prohibitive tax regime in force will be known as time progresses through 2024.

Lack of Public Accountability 

In order to chart a prudent way forward, it is vital to ascertain the causes that made the economic downfall in SL. It is important to take a deep dive into the subject of utilizing public funds to ascertain, if it has been done in the best interests general public. As per article 148 of the Constitution, parliament has full control over public funds. This demonstrates paramount importance of using public money in the most prudent manner to best serve public interests. Moreover, parliament is responsible to ensure prudent utilization of public funds. Mostly annual recurrent expenditure and many ambitious projects undertaken by SL including mega infrastructure development have been funded by borrowings. Some of the borrowings carry exorbitant interest rates and their repayment obligations have necessitated further borrowings. SL has thus inexorably fallen into an inescapable vicious circle of debts or a debt trap. Hence, every Rupee/Dollar of borrowings misused, swindled, wasted and/or not spent on the key purpose for which borrowing has been made would necessitate additional borrowings. All such borrowings have led to public detriment as opposed to the wellbeing. Whilst repayment of borrowings leads to more tax burdens on poor, failure to judiciously use borrowings for public welfare too ultimately falls on the plate of the common man as more taxes.

Whilst the GOSL is caught in a kind of catch 22 vexed tax dilemma, man on the street is eternally entangled in an ever tightening “Tax Trap” under successive regimes.

There have been many a case of mammoth misuse, waste and extravagance of public funds under successive dispensations. Some of the gigantic white elephant investments devouring Millions of Dollars of costly borrowings, but hitherto failed to generate productive outcomes for socio economic wellbeing stand as colossal monuments of economic mismanagement.

Glaringly no one has been made accountable for whopping great economic sins, although masses have been made to bear the brunt of the impact of those sins.

Accountability and rule of law are integral to Democratic Governance. Accountability is the mechanism adopted to monitor and regulate decision making processes to ensure prudence in public spending to avoid waste, abuse extravagance and inefficiency. Therefore, Accountability is “sine qua non” for good governance.

Even at this very moment where masses are suffering due to economic deprivations, stinking stories of crass mismanagement of public funds emanate from public sector. The infamous immunoglobulin scam devouring Millions of Rupees from public purse is pointing accusing fingers at higher echelons of power and top brass state health sector. It is absolutely shocking and disgusting to witness the abominable depths of moral decadence, treachery and dishonesty to which evil minded people could descend to make filthy lucre. The fact that, the scam was deviously orchestrated knowing very well the serious peril that could befall  numerous innocent and poor who are unable to afford  luxuries of costly private medical care makes it all the more despicable, abhorrent and reprehensible. This is the sorry state of corruption prevailing in SL today. What comes into open may only be the tip of the iceberg.

Sri Lanka has seen many a scam like Bond Scam, Sugar Scam & Garlic Scam and list may grow with Immunoglobulin Scam becoming the latest.

Going forward

Every rupee of additional tax imposed accompanies additional financial burdens on poor already suffering. VAT amendment reveals how prices of goods and services are hiking and its resultant impact. There could be more taxes as time progresses. Costs of utilities and essentials such as food, fuel, healthcare and even school equipment are on the rise. It is happening at a time when national poverty line too is on the rise.

Top priority at this juncture is the need for robust, stringent and foolproof measures and sound check and balances to control and regulate public spending to ensure that not a single rupee extracted from poor is not left at the mercy of evil minded elements, as public services is said to be replete with scammers. SL has sought IMF bailout 16 times before and yet finds itself in the midst of huge economic woes. Absence or weak accountability mechanisms would drive fraudsters to further evil designs for self-gain.

Thus vital to ensure every tax rupee is expended on earmarked public services in line with prudent guidelines. Whilst release of funds should be subject to strict approval protocols, there should be an independent oversight mechanism manned by competent professionals with integrity to oversee manage and control public spending.  As an integral part of this process, there should be a system of efficient & transparent reporting and review of public expenditure incurred against pre-defined clearly spelt out expenditure areas and targets to prevent abuse, waste and mismanagement.

The accountability mechanism should be designed to ensure prudence, efficiency and propriety in decisions made. Also procedures need to be established to probe deviations from approved scopes/functional areas/votes, limits/budgets, & levels of authority, to ensure conformance to the guidelines good governance norms and principles. Cases of deviations should be probed to effect remedial actions including punitive measures where necessary on mishandling of public funds.

Unless strict measures of accountability are initiated to safeguard tax payers’ money, it is futile to brag about how grand plans of tax management will extricate SL out of current economic impasse usher in so called economic prosperity by trotting out elaborate statistics at elite forums, gala talk shows, seminars and conferences in insightful manner to gain limelight, as lack of checks and balances and safeguards would defeat the end objective and ring hollow. In the same way the parliament has control over public funds, there should be a mechanism to make the parliament accountable for actions such as misuse, embezzlement, waste or mismanagement, that are inimical to public interests. As disclosed by COPA, tax in arrears including penalties and interest due to the Dept of Inland Revenue at 21^st December 2023 amounts to a whopping 904 Billion Rupees. It may be apt to argue, before imposing further tax burdens on masses, Govt apparatus has to pull up socks and get its act together to collect colossal amount of taxes in arrears, as it could substantially alleviate tax burdens heartlessly heaped on poor segments.

National Audit Office would have to be strengthened and resourced adequately to ensure that use of public funds is subjected to thorough audit.

Also, strategies of sustainable generation of revenue from non-debt-creating sources such as exports and foreign direct investments need to be implemented, as there is a limit in the capacity to generate revenue predominantly through taxes.

SL cannot afford to go for another round of IMF bailout, if this one fails. Also people should not be made to pay for the sins of those who rule the roost, as has happened time and again.

GOSL must ensure, buck should stop at the right place.