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Is wealth tax the solution to Sri Lanka’s low tax revenue collection?

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By Sathya Karunarathne

Successive governments have run fiscal deficits. Inadequate revenue collection and unrestrained government expenditure have worsened the country’s fiscal position.

Tax revenue which averaged over 20% of GDP in 1990 has declined to under 10% of GDP in 2020. Ad hoc tax policy changes have significantly eroded the tax base. Weak tax administration has also contributed to the sharp decline in tax collection.

While tax revenue has contracted, government expenditure has ballooned over time. Today, government revenue is not sufficient even to meet its expenditure on salaries and wages and transfers and subsidies to households which include pension payments and social welfare payments such as Samurdhi.

In this context, there are various proposals put forward to raise government revenue. One proposal is the reintroduction of the wealth tax.

A wealth tax is expected to bridge the gap between the rich and the poor, achieving equality. This tax shifts the tax burden to affluent households, taxing an individual’s net wealth, which is the market value of total owned assets. Proponents of wealth taxation argue that this is a progressive system of taxation and is a more powerful tool in comparison to income, estate or corporate taxes as it addresses the issue of wealth concentration.

Moreover, a tax should ideally satisfy basic characteristics of taxation: it should not be distortionary; it should be fair, and it should not be difficult to collect.

The rationale for a wealth tax

One of the earliest proponents of the wealth tax for developing countries was Nicholas Kaldor. Based on his recommendation, a wealth tax together with an income tax, expenditure tax and a gift tax were introduced in Sri Lanka in 1958.1 However, these new taxes yielded little revenue due to difficulties in determining the tax base and problems in administration. Following the recommendation of the Tax Commission in 1990,2 the government abolished the wealth tax from the year of assessment 1992/1993.3

Wealth taxes have mainly been implemented in European countries. In 1990, twelve countries in Europe had a wealth tax. Today, there are only three: Norway, Spain, and Switzerland. Several non-European countries have also imposed wealth taxes from time to time including such as Argentina, Bangladesh, Colombia, India, Indonesia, Pakistan

In recent times there has been renewed interest in wealth taxes. Presidential candidates in the US proposed various forms of a wealth tax. In the UK and France, there were proposals to impose “super taxes” on the rich. The primary justification was to address the increasing inequality in society.

Issues with a wealth tax

Despite renewed interest in the wealth tax as a progressive tax based on equity, it scores poorly on the criteria of efficiency, and administrative feasibility.4

Many factors have justified the repeal of wealth taxes in OECD countries. The reasons cited are related to efficiency costs, risk of capital flight particularly in light of increased capital mobility and wealthy taxpayers’ access to tax havens, failure to meet redistributive goals as a result of narrow tax bases, tax avoidance and evasion, high administrative and compliance costs compared to limited revenues (high cost yield ratio).5

To understand the efficiency costs of wealth taxes one can look at taxing a person’s wealth accumulated through savings. Despite the common consensus that taxing savings is an effective way to redistribute, a person’s saving decisions reveal little about their underlying lifetime resources and wellbeing. It only reveals their preference to consume tomorrow rather than today. Thereby a wealth tax imposes a tax on those who prefer to spend their money later as opposed to taxing the wealthy.6 Efficiency costs refer to the reduction of the welfare of the taxed individuals by more than $1 to generate $1 of revenue.7 Therefore, the efficiency cost of a wealth tax in terms of taxing savings is a reduction of future consumption that can be bought with earnings, reducing incentive to work for those who prefer to consume the proceeds later and reducing incentive for young people to save for their retirement.8

Capital flight is the possibility of holding assets outside of one’s resident country without declaring them.As wealth taxes are imposed on residents it increases the risk of the wealthy reallocating their assets to avoid taxation. Therefore a high tax burden encourages taxpayers to change their tax residence to a lower tax jurisdiction or tax havens.9

Both income-generating and non-income generating assets are taxed under wealth taxation. They can include land, real estate, bank accounts, investment funds, intellectual or industrial property rights, bonds, shares, and even jewellery, vehicles, art and antiques.10 However, this tax base for wealth taxes has often been narrowed through exemptions. These exemptions have been justified most commonly on the grounds of social concerns such as the negative social implications of taxing pension assets. Further liquidity issues (eg – farm assets), supporting entrepreneurship and investment (eg- business assets), avoiding valuation difficulties ( eg- artwork and jewellery) and preserving countries cultural heritage (eg – artwork and antiques) have also been cited as reasons for wealth tax reliefs. While some of these exemptions can be justified, they have led to the reduction of revenue raised from wealth taxes. They have also contributed to wealth taxes being less equitable as the wealthiest such as businesses benefit from these exemptions defeating the very purpose of imposing a wealth tax which is to meet its redistributive goals.11

Narrow tax bases in wealth taxation often leads to tax avoidance and evasion opportunities. For example, Spain’s 1994 wealth tax exemption for the shares of owner managers resulted in wealthy businesses reorganizing their activities to reap benefits of the exemption resulting in a significant erosion of the wealth tax base.12

Further, several other factors have also discouraged countries to sustain a wealth tax. They are namely, the difficulty in determining the tax base or what assets to be taxed, underreporting and undervaluation of assets, difficulty in measuring wealth taxes13, distinguishing between individuals who are asset rich but cash poor, the constant need to value assets and audit returns increasing administrative and enforcement costs .

Low revenue collection as well as the other reasons discussed have led to the abolishing of wealth taxes in most countries (See Table 1 for details) . Tax revenue from individual net wealth taxes in 2016 ranged from only 0.2% of GDP in Spain to 1.0% of GDP in Switzerland. Sri Lanka’s experience with wealth taxation was no different with the tax yielding low revenue as reported by the 1990 Tax Commission.14

Conclusion

Taxing the wealth of the rich to generate income and to eliminate economic inequality sounds promising in terms of political debate. However, wealth taxes have failed to generate adequate revenue, failed to meet redistributive goals as a result of narrow tax bases, proven to have high administrative and enforcement costs, resulted in tax evasion and avoidance due to underreporting and undervaluation of assets, increased the risk of capital flight and access to tax havens and may have contributed to the reduction of investment and employment.

Therefore, imposing a wealth tax may not be the ideal policy response to Sri Lanka’s low tax revenue, especially given the country’s previous experience with the tax yielding low revenue.

Sathya Karunarathne is the Research Analyst at the Advocata Institute and can be contacted at sathya@advocata.org. Learn more about Advocata’s work at www.advocata.org. The opinions expressed are the author’s own views. They may not necessarily reflect the views of the Advocata Institute, or anyone affiliated with the institute.



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ESOFT Metro Campus holds Graduation Ceremony 2021

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Dr. Dayan Rajapakse – Chairman and Managing Director of the ESOFT Group (Right) presenting a certificate to a graduate

The Annual Graduation Ceremony of ESOFT Metro Campus was held at the Bandaranaike International Memorial Hall (BMICH) on the 23rd and 24th of November 2021. A total of 1,800 students graduated at this year’s event. Successful students received their Pearson BTEC Higher National Diplomas, Pearson Level 7 Qualifications, London Metropolitan University (UK) Degrees and MBA’s, Kingston University (UK) Degrees and MSc’s.

It was held across two days and split into 9 sessions, to be in full compliance with health guidelines. In addition to the conferring of degrees, batch tops were awarded gold medals and special awards were made to the top achievers of the programmes.

Keynote addresses were by an eminent group of academics and industry leaders including Mr. Conard Dias CEO, LOLC Finance PLC, Mr. Thushera Kawdawatta – CEO, Axiata Digital Labs, Dr. Dayan Rajapakse – Chairman and Managing Director of the ESOFT Group, Dr. Sampath Wahala – Chairman, Sri Lanka Accreditation Board, Mr. Tishan Subasinghe – Managing Director and joint Managing Partner Moore Stephens Consulting (Pvt) Ltd and Moore Stephens Aiyar, Prof. A.A.C Abeysinghe – M.Phil. PhD Programme Coordinator, Senior Lecturer Faculty of Management & Finance, University of Colombo.

Foreign delegates from the University Partners were present virtually and delivered their speeches and wishes for the graduates via video. The Virtusa careers team were also present on both days in order to provide career opportunities to the young and successful graduates. ESOFT prides itself in producing graduates who are work-ready and able to take on the challenges and opportunities presented by the new economy.

ESOFT has a rich history of 21 years and is the largest private sector higher education network in Sri Lanka, and offers a variety of programmes through an extensive island-wide network of over 40 branches and serves over 40,000 learners each year in a range of programmes from school leaver courses to postgraduate programmes.

ESOFT partnered with Kingston University London in 2012 to offer undergraduate and postgraduate qualifications in engineering and soon established a dedicated College of Engineering in Katubedda. In 2013, they partnered with London Metropolitan University to offer a range of programmes leading to undergraduate and postgraduate awards in Computing, Business, Hospitality, and Travel & Tourism. A range of MSc programmes in IT and an International Doctoral programme for IT, Science and Engineering research areas, has also been introduced via Kingston University.

The ESOFT Group has won local and international awards from Pearson (UK), BCS (UK), NBQSA, National Chamber of Commerce, Federation of Chambers of Commerce of Sri Lanka in recognition of their academic excellence and business performance. Their pinnacle accomplishment was to be recognized by the Sri Lankan Government as a Non-state Degree Awarding Institution in 2019.

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Coconut industry products raking in forex to the tune of $ 7000 yearly – State Minister

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By Steve A. Morrell

Earnings from exporting coconut products amounted to $ 7000 annually. Such exports include jaggery and treacle, which are key products relating to the coconut industry, State Minister of Coconut, Kithul and Palmyrah Cultivation Promotion Arundika Fernando said.

Although coconut, as part of the plantation industry, was not given due recognition, it was now a distinct contributor to forex earnings and was of significant importance to the economy of the country, Fernando said.

The State Minister added: “Development of the coconut plantations includes value addition promotion to its various products, which are now key to sustaining the coconut plantations.

“Such development included propagation of 600,000 nursery plants for distribution among smallholders and large-scale plantations to add further progress to the industry. As a result, the coconut industry is part of the mainstream economy.

“The coconut industry made a substantial financial contribution to the economy of the country. Value addition in all products was key to development. Coconut products, used extensively in allied local industries, were contributors to value addition. This is efficiently handled by the private sector.

“Collaboration with the Jaffna University was on-going to develop kitul and palmyrah.

“Soil testing and further inputs were envisaged for development.

“Export markets would include Europe, Canada and the US. This is particularly true of kitul treacle and jaggery. Value of these exports would reach approximately $ 2 million.”

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INSEE Cement’s 360-Degree Approach Eases Cement Shortage in Sri Lanka

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Operating at maximum production capacity with optimized distribution channels for a number of weeks, INSEE Cement has successfully helped to mitigate the cement shortage that was prevailing in the local market. INSEE Cement’s concentrated and immediate contingency measures across its entire operation at the onset of the shortage ensured an uninterrupted market supply of cement, while also logging a record-high 700,000 MT production output during the third quarter of 2021 for the company.

“As Sri Lanka’s leading cement manufacturer, INSEE Cement took on the responsibility to ensure the local construction industry’s post-COVID-19 revival remained on its trajectory,” stated Gustavo Navarro, Chief Executive Officer at INSEE Cement Sri Lanka. “We continued to fully support government regulations and industrial policies to first stabilize the market, and were able to deploy our island-wide distribution and dealership network to ensure an uninterrupted supply across the island. The loyalty and patience of our customers gave us that extra encouragement we needed to overcome the challenge.”

INSEE Cement operates at a 3.6MT maximum capacity, with a 1.5MT production at the Galle plant, a 1.3MT output from the Puttalam facility and a 0.8MT import capacity at the Colombo Cement Terminal. To mitigate the shortage the company introduced two more additional import vessels to its logistics operation to accelerate production and distribution cycles.

 

 

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