By Ameer Ali –
“It should be known that at the beginning of the dynasty, taxation yields a large revenue from small assessments. At the end of the dynasty, taxation yields a small revenue from large assessments”. (Ibn Khaldun, The Muqaddimah: An Introduction to History, translated by Franz Rosenthal, Princeton University Press, NY 1958, v. 2, p.89)
From an expected budget deficit of 9.9% of GDP in 2022, President cum Finance Minister Ranil Wickremesinghe (RW) is hoping to bring it down to 6.8% in 2023, and aiming to reduce it further to 5% thereafter – a tall order in the context of the state of the economy, but necessary to satisfy IMF conditionalities. IMF’s emergency financial assistance to rebuild the economy, negotiate with private creditors, restructure national debt and prescribe an agenda to revive growth, hinge on deficit reduction. That requires increase in tax revenue and reduction in public expenditure. It is with regard to increasing tax revenue that the 14th century Arab sociologist and historian Ibn Khaldun wrote the above quote in his masterpiece, Prolegomena. It is worth reminding that it was on Ibn Khaldun’s idea that the controversial Laffer Curve in economics came into prominence, which underpinned the massive tax reduction introduced by Ronal Reagan in 1980s. However, the central point in Ibn Khaldun’s statement is not the tax rates as such but the volume of revenue they bring in to the treasury. Fixing the rate is one thing but administering its implementation is quite another. This is where the problem lies for RW.
He had raised the value added tax (VAT) from 8% to 12% and corporate tax from 24% to 30%. The first is a direct hit on consumers while the second will also impact them through higher prices charged for goods and services produced by the corporate sector. Students of economics would know that all taxes, tariffs and quotas cause deadweight losses in terms of consumer surplus. Apart from that, higher taxes on producers who cater to foreign markets would lose their competitiveness; and more importantly, businesses that have international connections would try to shift their businesses to countries like Singapore with lower tax rates. Newspapers are reporting that it is already happening. This would be a dead loss to RW’s expected revenue collection.
But the most crucial point to note here is the administrative inefficiency of the tax department. When a tax officer for instance sends tax notice to an individual or a firm and then goes and advice the receiver on how to minimize or seek exemption from the levy, in return for a fee, how does one expect the department to maximize revenue collection? A newspaper editorial recently noted that “Sri Lanka’s corruption has graduated from chronic to endemic; from the very very top to the plebian, whoever has any discretionary authority … have to be greased or monies remitted to offshore accounts to get a job done” (The Sunday Times, 16 Oct. 2022). Are tax assessors and officials untouched by this corruption? If not how does RW expect to reach his revenue target? There are two many avenues for tax aversion in the name of tax minimization in the system, which makes it difficult to reduce budget deficit.
Ibn Khaldun quoted from a letter written by Caliph Mamun’ General, Ibn al-Husain to his son Tahir, who was appointed by Mamun as the Governor of Raqqah. In that letter the father advised his son on the principle of justice in fiscal administration. It is relevant to requote from it in the current context of widespread tax evasions and exemptions in Sri Lanka, “… Distribute (the land tax) among those to whom it belongs, and do it justly, fairly, equitably, and generally. Do not make a nobleman pay less because of his nobility, or a rich man because of his wealth, or one of your secretaries, or one of your inmates and entourage” (v.2, p. 150). Would the tax office reveal therefore, whether all our ministers, parliamentarians and their wealthy henchmen had fulfilled their tax obligations over the last two years at least? Would the tax office also reveal whether the richest person or corporation in the country had paid the largest share of tax? If the richest earner and the largest tax payer do not match then there is something terribly wrong with the system, and it calls for a systemic change.
The second half of the budget equation is to cut government expenditure to bring down the deficit. Ibn Khaldun argued for its increase, because he, like Keynes, was looking at the multiplier effect of government expenditure. “The dynasty (state) is the greatest market” (v.2, p. 103) he wrote, and if state expenditure shrunk other markets would do likewise, he said. But once again, what mattered to Ibn Khaldun was not expenditure per se but the nature of it. “The ruler should provide for the comfort of the poor, orphans and widows. He should give them the assistance from public funds, so that they may enjoy a comfortable life. He should establish homes for the sick with attendants to care for them and doctors to look after their illness”, he wrote. But where did our Sri Lankan rulers spend state funds?
The Ceylon Chamber of Commerce, while acknowledging the need to increase corporate taxes calls on the government to “accelerate reforms and ensure greater accountability for its spending”. The concept of accountability has become a nightmare for RW, and neither he nor his ministers would even want to mention that term in their public deliberations. In fact, it was the absence of accountability that brought the aragalaya youth to the street, demanding systemic change. That issue has now been taken up by UNHRC and other international agencies also.
IMF insists that there need to be serious reforming in government’s recurrent expenditure. In 2021 for example, 31% of that expenditure had gone to public sector salaries of which 30% had been consumed by the Provincial Councils and another 34% by defense and public security. More than 300,000 army, navy, air-force and paramilitary and police personnel have become a colossal drain on the country’s meagre finances, and there seems to be no willingness to reduce that number. In short, public administration, overpopulated with an otherwise unemployable army of graduates, and defense and security constitute the dependency burden of the government. The country is also burdened with too many rulers at too different levels, enjoying too much salaries and perks for too little service. What a waste?
There is no denying that budget deficit has to be reduced and no healthy economy could survive long with twin deficits, one in domestic budget and the other in Balance of Payments. But that reduction involves a lot more than raising taxes and pruning expenses. In the context of Sri Lanka, it requires a radical overhaul of the prevailing system of economic and political management. That overhaul is impossible with the current generation of politicians. That point was made loud and clear by the aragalaya youth.
Once again, Ibn Khaldun’s thoughts on dynastic cycle becomes relevant. According to him, at the early stages of a dynasty’s rule economic management is marked with principles of justice and equity. As a result, markets thrive, economic development and public welfare improve, and cultural activities flourish; but as opulence leads to extravagance and waste, injustice intrudes, equity vanishes, and development and welfare retard. That makes the dynasty and its ruler unpopular and paves the way for a change of dynasty. Chinese called it the loss of Mandate from Heaven.
RW’s budget crisis needs a lot more than an increase in tax rates and slashing of government expenditure. It requires a systemic change and that in turn requires regime change.
*Dr. Ameer Ali, Murdoch Business School, Murdoch University, Western Australia