Recent and Upcoming Fiscal Reforms: Sri Lanka

Dushni Weerakoon

Institute of Policy Studies of Sri Lanka

Institute of Policy Studies of Sri Lanka

Fiscal Challenges

• Fiscal situation remains weak in the face of post-conflict reconstruction challenges

• Revenue as a percentage of GDP has been declining consistently from the mid-1990s– From 20% of GDP to 14.5% by

2009– 90% of revenue from taxes

• Sri Lanka has been grappling with fiscal deficits in the range of 8-10 per cent on average over time

Fiscal Performance: 1990-2009

-20

-10

0

10

20

30

40

1990 2000 2009

% o

f GDP

Deficit Revenue Expenditure

Source: Central Bank of Sri Lanka.

Institute of Policy Studies of Sri Lanka

Past Fiscal Reforms

• Fiscal decentralization– Decentralization of fiscal responsibility at provincial level in 1987– Rationale political rather than economic– Provincial revenue accounts for 4% of total central govt. revenue;

by contrast, provincial expenditure 20% of total central govt. revenue

– Created additional layer of govt.; 80% of expenditure of recurrent nature (bulk on personal emoluments)

• Tax reforms– moved from turnover to Goods & Services Tax (GST) in 1998– Introduced at ‘less than neutral’ rate, plus exemptions– National Savings Levy (NSL) introduced to compensate for revenue

loss– GST and NSL amalgamated to Value Added Tax (VAT) in 2002

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Past Fiscal Reforms

• Other – Introduction of indirect taxes such as Nation Building Tax (NBT)– Tax concessions to both domestic and foreign investors– Periodic tax amnesties (11 amnesties since 1964)

• Fiscal Management Responsibility Act (FMRA) 2003– Provides necessary legal framework to meet transparency

practices– However, implementation/enforcement of FMRA incomplete– Some due to recovery costs of 2004 Tsunami– Some improvement in budgetary information (Annual Report,

Mid-year Review, etc.)

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Progressivity

Composition of Tax Revenue (2009)

Income tax

VAT

Excise tax

Import duties

Other

Share of Taxes on Income and Expenditure

0

20

40

60

80

100

%

Income Production & expenditure

• Some improvement in ‘progressivity’ of tax system– Share of taxes on income on the rise

• Other measures– VAT offers exemptions on basic commodities– High import duties on ‘luxury’ goods, etc.

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Weaknesses in Expenditure

• Cutting current spending has proved difficult– Salaries, transfers and

subsidies and interest payments on debt take 1/3 each of govt. revenue

• Capital expenditure has borne brunt of cuts– Realized capital expenditure

has consistently been below budgeted amounts

– Capital spending largely financed through borrowing

Approved and Realized Capital Spending

0

2

4

6

8

10

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009

% o

f GD

P

Realized Approved

Current Spending (2009)

Goods & services

Interest payments

Transfers &subsidies

Institute of Policy Studies of Sri Lanka

Impacts on Promoting ‘Inclusive’ Growth

• Fiscal constraints have imposed limits on expenditure in key sectors such as health and education

• Sri Lanka has also experienced growing regional ‘imbalances’ in economic growth and poverty across sectors/provinces– amongst other causes, lack of

investment in infrastructure has been identified as a key bottleneck

Expenditure on Education and Health

01122334

% of

GDP

Education Health

Source: Central Bank of Sri Lanka

Institute of Policy Studies of Sri Lanka

Impact on Macro Stability

• Partly in response to fiscal developments, Sri Lanka has faced high and volatile inflation rates

• Of even greater concern, is long run fiscal stability in the face of growing debt dynamics– While total debt has declined

from a high of 105% of GDP in 2002, decline was partly in response to galloping inflation

– The decline in foreign debt to GDP masks Sri Lanka’s increased exposure to external debt servicing obligations

Rate of Inflation

0

5

10

15

20

25

%

Inflation

Public Debt

0

20

40

60

80

100

120

% o

f GD

P

Foreign debt Domestic debt Total debt

Institute of Policy Studies of Sri Lanka

Impact on Macro Stability

• Sri Lanka is resorting to costlier commercial borrowing to meet its fiscal needs– Share of such borrowing risen from 4.4% in 2006 to over 23% by 2009– Ratio of foreign debt service to exports risen from 7.1% to 14.6% over

the same period

Foreign Debt Dynamics (2006-09)

2006 2007 2008 2009

Concessional % share 92.7 82.9 84.7 72.2

Non-concessional % share 2.8 3.4 3.9 4.4

Commercial % share 4.4 13.7 11.3 23.3

Total foreign debt/exports % 124.6 127.4 132.2 170.7

Foreign debt service/exports % 7.1 8.2 13.9 14.6Source: Central Bank of Sri Lanka, Annual Report, various issues.

Institute of Policy Studies of Sri Lanka

Future Areas of Reform: Tax

• Presidential Taxation Commission – Simplify/rationalize tax system– Broaden tax base– Improve tax administration

• Simplify/rationalize tax system– Has over 20 taxes at national level– A relatively high corporate tax of 35% compounded by different

rates

• Problems with VAT– Exemptions– Periodic change to rates/differential rates– Large refund element– Administrative weaknesses

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Future Areas of Reform: Tax

• Broaden tax base– Narrow base, low coverage, low compliance, etc.– Exemptions for groups (1.2 million public servants)– Exemptions for companies (local and foreign investors)– Poor compliance due to anomalies, tax ‘culture’, amnesties,

etc.

• Improve tax administration– Organizational structures, audit, human resources, etc.– Coordination between Inland Revenue, Excise and Customs – Significant discretionary powers that can lead to corruption– Some reforms under way under ADB supported Fiscal

Management Reforms Program

Institute of Policy Studies of Sri Lanka

Thank You

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