Photo courtesy of Suara

The recent tax proposals have created quite a ruckus in all quarters of Sri Lanka. While the popular opinion was that economic reforms would be opposed by the poor and the trade unionists, those who understand the political economy of Sri Lanka knew that opposition would come from the strangest of places.

Several groups of people and businesses have opposed the new taxes: the SJB, the apparel sector, corporates, SMEs, professionals, IT associations, consumers and, most strange of all, the JVP. Sri Lanka has promised the IMF that it will achieve a rather ambitious 2.3% primary surplus in its government budget by 2024. A primary surplus means achieving a positive difference between government revenues and government expenditure, excluding interest payments on debt. In the 72 years since 1950, Sri Lanka has only ever put up a primary surplus in 5 years (1954, 1955, 1992, 2017 and 2018).

“The prevailing tax system has contributed to the collapse of the domestic economy by entirely discouraging domestic entrepreneurs. We would, instead, introduce a tax system that would promote production in the country”, reads Chapter 5 of the Viyathmaga-drafted Vistas of Prosperity and Splendor manifesto. Furthermore, it goes onto state “speedy implementation of our economic policies and the immediate impacts of proposed tax reductions will help reduce cost of living”.

I am sure all of us, against our will, are now very much aware of how terrible that new tax regime was, and its impact on the cost of living. Instead of becoming richer and happier with tax cuts, we have all become poorer and angrier.

What many fails to understand is that the crisis is a macroeconomic crisis, and we all form the macroeconomy. Tailoring fiscal or monetary policy to suit the narrow needs of a select group of people will only make macroeconomic vulnerabilities worse, making us all worse off as a collective. It is such policy making in the first place that lead us here. We are in a deep, deep crisis, of course we cannot expect to be comfortable through it; everyone must bear the burden.

The already heavily burdened poor are bearing an even heavier burden; they are eating fewer, smaller, less nutritious meals, their babies drink plain tea instead of milk, their children do not attend school because they cannot afford school supplies or sanitary napkins. The middle and the upper income earners must also adjust and this means taking a hit to one’s standard of living. It is painful and frustrating.

Business collectives complain of high interest rates making it difficult for them to borrow to meet expenses, but high interest rates are needed at the moment to attempt to mitigate inflation, which is nearing 100%. High interest rates encourage saving, and discourage consumption. Yes, it will reduce aggregate demand, but a contraction of the economy is what is needed. Under Cabraalesque monetary policy, which expanded money supply by 40%, kept interest rates low, and the exchange rate fixed, it was cheap to borrow and spend.

So, borrow and spend we did, putting pressure on the rupee to depreciate further as import demand increased (it is cheap to borrow at 7% and buy an imported an iPhone at Rs. 180 a dollar than it is to borrow at 30% and buy an imported an iPhone at Rs. 360 a dollar). Aggregate demand was rising, despite severe Covid-related supply shocks. With a fixed exchange rate in place, the Central Bank used more and more of its scarce foreign reserves to defend the rupee, dwindling foreign reserves to near nothing by early this year.

Finally, when this impossible trinity of controlled interest rates, controlled exchange rates and the money supply expansion could no longer be sustained, all hell broke loose. Inflation rose rapidly, fuel prices doubled, interest rates were hiked, fuel queues lengthened, power cuts reached 13 hours, the rupee depreciated overnight, Sri Lanka defaulted and the IMF was called into resuscitate the country. If interest rates are kept low, it is will further spur on aggregate demand as it discourages saving and encourages consumption. This will drive inflation higher and the rupee lower, eroding purchasing power and making us all worse off.

What seems unappreciated is that, citizens did not have any problem with consuming subsidized fuel and electricity, nor buying imported things at overvalued exchange rates, nor attending free public schools, nor driving private vehicles on public roads, nor even supporting corrupt politicians –  all paid for, in the absence of adequate tax revenue, with borrowed money. For the most part we paid for this with debt, and debt is delayed taxation.

The debt was invisible, and people were none the wiser. We enjoyed the comfort of knowing that in case of an accident one could merely call up a free Suwa Seriya ambulance and be rushed to the free Kalubowila accident ward on free public roads and be attended to by free, highly trained doctors and nurses but we did not stop to question how the country paid for this.

The question really ought to not to be how much more taxes should we pay, but what we really do with these taxes and whether everyone pays their fair share. It is fair to wonder whether your taxes are achieving what taxes ought to, which is redistribution of wealth and improved public services. In some cases, it doesn’t. in the context of Sri Lanka’s political economy, a part of it does go towards funding corrupt politicians and their cronies, funding inefficient government workers, funding an overstaffed military for example. But in other cases, it does.

Despite chronic underspending on health, for example, Sri Lanka has achieved low infant and maternal mortality and life expectancies in line with OECD countries, and despite spending very little on education, Sri Lanka has a fairly educated general population in relation to its income levels and regional counterparts and even provides free tertiary education. The social benefits of a healthy and educated populace is significant.

Sure, the quality of public services leaves a lot to be desired. Sri Lanka is far from being an advanced economy – there is low female labour force participation, high youth unemployment, multiple labour market problems, issues of quality in education and health, abysmal public transport, terrible social welfare and roads with potholes.

Quality, coverage, overstaffing and inefficiency in public services, corruption and misallocation of public finances all ought to be overcome, but none of this is more or less important than also increasing tax revenues; they are all urgent, and of equal and utmost importance.

Sri Lanka also has heavy regional disparities and high income inequality. Children in state schools in richer districts have better opportunities than children in state schools in poorer districts, despite all being beneficiaries of the same free education system. On the same road in which a red Porsche races along, an elderly, malnourished man walks barefoot begging for a few rupees. To achieve sustainable, inclusive and equitable economic growth, something Sri Lanka did not ever do before, taxes are an important catalyst.

Of course, Sri Lanka’s tax system is fraught with problems. There are issues in tax administration and collection, tax evasion and avoidance are high. It is easy to tax the captive formal private sector workforce but harder to do so with the informal private sector. There are over eight million in the country’s labour force but only 650,000 registered personal income payers. There are tens of thousands of businesses operating in Sri Lanka but only some 8,000 registered corporate tax payers.

Incomes are underreported, businesses re-jig earnings into shell companies to lower their taxable revenues. Cash payments are sought by private consulting doctors to avoid paper trails when filing taxes. Tuition masters run advertisements on prime time TV, but pay little on income taxes. The problems go beyond the tax system and into the psyche of Sri Lankans. Everyone wants free education, free healthcare, clean cities and a developed country, but no one wants to pay for it.

The bottom line is the government must get its deficit in check, and achieve an ambitious primary surplus of 2.3% of GDP by 2024. Without this, it cannot receive IMF help nor help from anyone else. Our creditors too would be looking at how we plan to get ourselves out of this mess. How will the government collect monies to pay back its debt sustainably? If it does not do this, how can debt be restructured credibly? Low tax revenues are simply an impossibility at this juncture. There is no way get out of this mess without taxes.

It is incumbent upon the government to regain whatever little trust the people had in it before the crisis but recent events do little to dampen public anger and resistance. Parents and children are assaulted at protests, activists are arrested, high profile criminals are released without prosecution. Cabinet ministers laughingly admit to economically illiterate and clueless about the impending economic crisis before total collapse.

There is no accountability for presidents, prime ministers, cabinet ministers, MPs and government officials. The politics chugs on untouched but the economy is expected to undergo a massive awakening. It is hardly a surprise that the public do not feel like they have any say in how the country is dealing with the crisis, it is frustrating. There is no attempt from the government to show that it too is sacrificing something. The public is not informed about why certain decisions are taken, they are made to feel like pawns and it is not surprising that people will misunderstand and oppose even reforms which are badly needed.

It is easier to put through economic reform than it is to change the political culture and people’s mindsets but without a simultaneous change in all three, Sri Lanka will only ever achieve half-baked economic change and undoubtably end up in the same situation once again.