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Revenue Vs. Expenditure

Budget 2017 

by Wiraj Silva

  • One of the main hurdles for accelerating growth has been the lack of fiscal discipline which was exhibited candidly during the numerous budgets under the Rajapaksa regime
  •  The government anticipates to bring in Rs. 140 billion of new revenue in 2016
  • Sri Lanka now has one of the lowest tax revenue-to-GDP ratios in the world, and it has been declining for decades

Presenting Appropriation Bill 2017 to Parliament last month, Finance Minister Ravi Karunanayake pledged to the august house that Budget 2017 was themed on accelerating growth with social inclusion and thus the goal of the United National Front for Good Governance (UNFGG) was not only to provide relief for the people of Sri Lanka but also pave the way for sustainable growth.

One of the main hurdles for accelerating growth has been the lack of fiscal discipline which was exhibited candidly during the numerous budgets under the Rajapaksa regime. However, Karunanayake promised that the total government expenditure for 2017 would be kept at Rs. 1,819.5 billion recording a decrease of staggering Rs. 121.5 billion or 6.26% in contrast to government expenditure anticipated to be incurred in 2016 which stood close to a staggering Rupees two trillion or at Rs. 1,941 billion.

According to 2015 Annual Report of the Central Bank of Sri Lanka (CBSL) the country’s GDP (Gross domestic production) stood at Rs. 11,183 billion recording a budget deficit of -7.4%. This with the growth rates projected by the World Bank is slated to reach Rs. 11,719.78 billion (up 4.8%) in 2016 and to Rs. 12,305.7732 billion (up five percent).

Statistically, with the government anticipating towards increasing government revenue by 15% of the GDP or roughly to Rs. 1,845.865 billion by 2017 and reducing to expenditure Rs. 1,819.544 billion for the same year shortfall would be kept at staggeringly low of Rs. 26.321 billion. A number of measures have been proposed to increase tax revenue, chief among which is to introduce a three tier income tax rate structure of 14%, 28% and 40%. The government has also proposed a number of expenditure proposals that are aimed at socio economic development.

Revenue dilemma

The government anticipates to bring in Rs. 140 billion of new revenue in 2016. Statistically, with the government anticipating towards increasing government revenue by 15% of the GDP or roughly to Rs. 1,845.865 billion by 2017 and reducing expenditure to Rs. 1,819.544 billion for the same year, technically-speaking the government would be able a budget surplus of Rs. 26.321 billion.

New revenue

Budget deficit – A perennial problem

Sri Lanka’s government has demonstrated a strong commitment to fiscal consolidation in the recent past, the World Bank lauded in its last Systematic Country Diagnostic titled ‘Sri Lanka – Ending Poverty and Promoting Shared Prosperity.’

“In the decade before end of conflict, the country averaged fiscal deficits of around 7-8 percent. However, over the past five years, the government has trimmed budget deficits each year, going from 9.9 percent in 2009 to an estimated 5.7 percent in 2014. The public debt, which was hovering around 106 percent of GDP in 2002, was reduced to 75.5 percent of GDP by 2014. Moreover, the government has committed to reduce the fiscal deficit to 3.8 percent of GDP by 2017 and public debt to 60 percent of GDP by 2020. With the exception of a spike in 2009 linked to massive recovery and rehabilitation needs immediately after the war’s end, this has been achieved by reducing government expenditures.”

This overall strong performance masks four structural weaknesses in the government’s fiscal position: low, declining fiscal revenues; increasing rigidity of expenditures; insufficient spending on key public goods and services, particularly for human development; and inefficiencies in the public sector. Preserving fiscal balance will become increasingly challenging owing to an extremely low revenue base combined with long-term-expenditure commitments including a relatively large public service. If current trends continue, the government will have limited fiscal space to facilitate development. At the same time, experience of regional and MIC comparators suggests that Sri Lanka is not investing enough in human development. The country’s past success in these areas cannot be expected to continue without significant increases in spending, which in turn requires greater fiscal space.

Honoring commitments initiated in 2015 while maintaining continued commitment to fiscal sustainability will require measures to secure long-term revenue increases. Fiscal debt sustainability analysis has shown that slower-than-projected growth, higher primary deficits, or higher borrowing costs could quickly lead to sustainability concerns. With public debt amounting to 76 percent of GDP at end-2014, continued commitment to fiscal consolidation is critical. Reflecting the government’s commitment to sustainability, the budgeted fiscal deficit is expected to narrow in 2015.

However, increases in recurrent expenditures are to be financed by one-time taxes, ambitious revenue targets for existing taxes, and cuts in public investment, leaving very little room to maneuver. Moreover, recurrent spending increases on wages and transfers initiated in 2015 will need to be sustained once the one-time revenue measures expire. Given government plans to increase expenditures on education and health from their present low levels, long-term increases in revenue will be needed in order to reduce the fiscal deficit and public debt.

Low and declining fiscal revenues

Sri Lanka now has one of the lowest tax revenue-to-GDP ratios in the world, and it has been declining for decades. The country’s tax revenue-to-GDP ratio amounted to 24.2 percent in 1978, after which it declined to 14.5 percent in 2000 and to 11.6 percent in 2013. The decline is in large part a reflection of Sri Lanka’s strong GDP growth with revenues increasing in absolute terms.

Nonetheless, the fact that revenues have not kept pace with economic growth and barely kept pace with inflation in absolute terms is a continuing constraint on the budget. The government has signaled the need to reverse this trend in recent budgets, each year planning for a significant improvement in the tax revenue-to-GDP ratio over the medium term. However, projections of revenue increases have consistently failed to materialize. In comparison, most of the other South Asian countries as well as middle-income countries have seen modest improvements in tax collection in the recent past.

Indirect taxes account for 80 percent of Sri Lanka’s tax revenue. The country has lower-than-expected revenues from taxes on income, profits, or capital (direct taxes) and higher collections from international trade and from goods and services (indirect taxes) than its peers, both as a share of total revenues and as a share of GDP.

The dependency on indirect taxes, – mostly VAT, excise and customs revenue – limits the country’s capabilities to expand the tax base and raises issues regarding the equity of the system and how the tax burden is distributed among social groups. The decline in tax revenue can be traced to trade liberalization, shortcomings in recent tax reforms, numerous exemptions, and difficult tax administration. First, trade liberalization and a gradual reduction of external trade taxation have lowered tax revenues from international trade. This effect was exacerbated by measures introduced in 2012 to curb imports. Second, tax reforms initiated in 2011 streamlined import taxes, unified VAT rates, and abolished some ‘nuisance’ taxes to improve the transparency and efficiency of the tax system.

However, the unification of the VAT was at a lower rate, and corporate and income tax rates were lowered without a commensurate broadening of the tax base. Third, the authorities have introduced numerous tax exemptions and holidays to boost foreign investment or support specific activities, resulting in an erosion of the tax base. Finally, tax exemptions have made tax administration more difficult, discouraged tax compliance, and created demand for new exemptions.

A decline in VAT collection is the main driver of tax-revenue-to GDP reduction in recent years – The VAT’s share in total revenue has declined from 43 percent in 2004 to 25 percent in 2013, while the decline in the tax-to- GDP ratio broadly tracks that of the decline in the VAT-to- GDP ratio.

VAT collection is weak at 2.9 percent of GDP in 2013 with a c-efficiency20 of 25 percent, which is roughly half of the c-efficiency for lower middle-income countries. Domestic-based consumption taxes have remained at the same share over time, while there has been a marginal increase in import-based taxes, excise taxes, trade taxes, and the Nation Building Tax (NBT), a cascading indirect tax using a similar base to the VAT, as a share of total revenue. On the other hand, the share of the corporate income tax collection increased, as did the “special taxes,” such as the Social Responsibility Levy (SRL) and devolved duties to Provincial Councils.

Strong commitment needed

Economist have advocated that the Government of Sri Lanka has to reduce budget deficit, improve revenue-to-GDP and tax-to-GDP ratios, restructure state-owned enterprises (SOEs), widen the tax network, streamline the tax regime, improve government revenue and export earnings and anticipates increasing revenue-to-GDP ratio from the current 13% to 25%, (see http://www.thesundayleader.lk/2016/05/29/fiscal-reforms-imperative-cbsl/ )

Sri Lanka recorded a Government Budget deficit equal to 7.40 percent of the country’s Gross Domestic Product in 2015. Government Budget in Sri Lanka averaged -7.63 percent of GDP from 1990 until 2015, reaching an all-time high of -5.40 percent of GDP in 2013 and a record low of -10.20 percent of GDP in 2001.  Continued strong commitment to fiscal sustainability will require long-term domestic revenue mobilization efforts.

 

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