VAT '16

How much will the intended raise in the Value Added Tax (VAT) hit our purse? As we approach the May 2 date of implementation of the increased VAT, we naturally anticipate a certain increase in the costs of many, if not most, items of consumer products and services except for medical drugs and power and water supplies.

As the higher VAT - raised from 12 per cent to 15 per cent - begins to be levied from next week, the test will be to see how much a burden of higher living costs Sri Lankans can bear.

While some political fear-mongers currently raise a hue and cry about the social impact of this tax hike, there are two socio-economic realities that must be simultaneously confronted and acknowledged. One reality is that of the powerful macro-economic imperative to resort to taxation among other measures to quickly address the looming national debt crisis before the crisis drags the country down into a socially damaging economic relapse. The other, is the more comforting reality of rising socio-economic well-being that will likely enable a relatively softer experience of the heightened cost impacts of the VAT. On the one hand, the country faces an enormous debt burden and trade deficit. But, due to the greatly improving socio-economic indicators, Sri Lankans no longer feel such budgetary financial impacts in the same drastic manner that we did when our socio-economic condition was at the level of the other least developed countries.

In the 1960s, for example, the gross domestic product (GDP) per capita - i.e. as per every individual Sri Lankan - stood at just US$ 336. Malnutrition levels were high - some thirty percent of the population were at one time classified as not receiving minimum levels of nutrition. Stunting was a noticeable phenomenon, especially in the areas of extreme poverty among the hill-country estate community and in some dry zone rural areas. In those times, an increase in the price of bread by a few rupees was a hot political issue because of the difference it made to the household economy of the large numbers of seriously impoverished Sri Lankans. An increase in bus and train fares also had the same high sensitivity.

That was over three decades ago. By the 1980s, thanks to the bold economic reforms during the J. R. Jayewardene regime, the entire socio-economic picture was changing. We were escaping the straightjacket of a once-colonial economy: the industrial, semi-industrial and service sectors took over from the plantations as the key players. Labour migration nurtured a less parochial outlook among Sri Lankans and broadened their capacity not only to exploit new global economic opportunities but also to absorb various social and economic rigours as they took their own initiatives for economic upliftment.

Today, we have moved out of the category of 'under-development' and joined the club of rapidly developing societies. By the 2000s, Sri Lanka approached 'middle-income country' status and by last year, we had indeed joined that club of more fortunate middle-income developing countries where extreme poverty is being minimised. Sri Lanka, today, enjoys a GDP per capita of US$ 2,135 although the geographical spread of this wealth is yet greatly skewed. Even such poor social and geographical distribution of resources can be overcome given time and a continued, steady growth trend.

But growth trends depend on external factors as well as internal factors. While the global situation is not conducive for a gush of foreign direct investment, the drop in oil prices provides opportunities for taking advantage of these savings to allocate more investments for development. Furthermore, reduced oil costs also reduce pressures for price hikes in oil-related services such as transport and products such as industrial energy.

What put a spanner in the works are the massive borrowings and unviable expenditures in the past decade. Billions have been borrowed at expensive commercial rates; these borrowings are far in excess of the actual project implementation needs, thereby being highly inflationary; and, much of these billions have gone to grandiose but financially unviable projects which have yet to show returns and are unlikely to ever recover their costs unless drastically revised in their functions. All this has left a huge burden of public debt on the one hand. On the other, the declining investment climate and serious current account deficits have reduced capacities for a resort to external resources such as foreign investment and concessionary credit. The Government debt of about 72% of GDP remains among the highest in emerging markets. This has meant that the nation must dig deeper into its own pockets to help finance our debt and also our recovery from a corrupt, unplanned economy to a dynamic and progressive one.

Hence, the Government's resort to increased taxes. Already, on the President's own initiative, the scope of the enhanced VAT has been modified to reduce impact on the more vulnerable social layers. But the hard fact remains that general commercial taxation does not target those who can pay as opposed to those who cannot or who barely can. Rich and poor alike must bear the same burden. We are a society where the upper ten percent of the population can enjoy expensive foreign whiskies and holidays overseas while the lower fifty percent have to make do with the local tipple, and domestic tourism. In such circumstances, a general tax such as VAT takes far more from the pockets of the lower fifty percent than it does from the richer ten per cent.

While the generally improved socio-economic status of the population as a whole gives the lie to the warnings of mass starvation as a result of the higher VAT, popular perceptions become negative when the not-so-rich have to pay more out of their incomes as taxes to the State as compared with the rich. It is imperative that the Government is seen to be taking additional steps to target the wealthier sections in more precise ways to obtain greater support from such layers for the revival of the national economy. In addition to the VAT, there is a need to use other types of targeted taxation as well as a far more efficient taxation system that identifies those qualifying for taxation.