IMF urges Sri Lanka to move fast on tax hikes announced in March

ECONOMYNEXT - The International Monetary Fund urged Sri Lanka to move fast on tax hikes proposed in a cabinet paper by Prime Minister Ranil Wickremesinghe in March with one third of the tax year already gone.

Mission Chief Todd Schneider asked Sri Lanka to "move quickly on tax and expenditure policy decisions endorsed the Cabinet," in statement released after discussions in Colombo.

The cabinet decision suspended all tax cuts proposed in a 2016 budget for a year and proposed raising value added taxes to 15 percent from 11 percent and removing many exemptions.

Corporate tax form most companies will be17.5 percent instead of 15 percent.

Sri Lanka's revenue authorities announced the tax changes to be effective from April 01 but the circular was suddenly withdrawn.

Despite being a parliamentary democracy in name, Sri Lanka's elected ruling class and state workers have developed a 'shoot first ask questions later' type of taxation where taxes are collected from the people before they are legislated.

The procedure practised widely in Sri Lanka including through midnight gazettes is characteristic of a serfdom where taxation is by Royal (or Minister's) Prerogative, freedom advocates have said.

An IMF program is expected to be finalized over the next week with talks continuing with Sri Lankan officials on the side-lines of annual meeting of the IMF and World Bank in Washington to hammer out the final program.

Sri Lanka is hoping to get a little over a billion US dollars under the program disbursed over three years to the central bank and more program financing for the budget from other multilateral partners including the World Bank and Asian Development Bank.

The deal is expected to go through the corridors of the IMF over the next several weeks.

However seasoned watchers of IMF deals say the tax hikes have all the hallmarks of a prior action that has to be implemented to get the reform program to work as planned.

Already one third of the tax year is gone.

The March cabinet paper proposed to cut the overall budget deficit to around 680 billion rupees with domestic borrowing to be 378 billion rupees instead of 557 billion rupees.

Foreign borrowing, which would include program funding, would be about 300 billion rupees instead of 248 billion rupees.

The deal would be reform heavy Extended Fund Facility as outlined by EN's policy columnist Bellwether two weeks ago.

It would focus heavily on improving revenue collections and the taxation system in general and well as state enterprises reforms and spending.

Among the likely structural benchmarks in the program would be a new income tax code (Inland Revenue Act). Monday's statement also mentioned the implementation of computerised systems for customs and other tax collections.

Pricing formula for energy are also needed to stop politicians from giving subsidies financed with central bank credit to de-stabilize the economy, every time oil prices go up.

The program also would have any elements of monetary reform.

While budgets are the trigger, analysts have pointed out time and again that Sri Lanka's balance of payments troubles are a result of central bank accommodating deficits with printed money.

Sri Lanka has had BOP crises even when tax to revenue ratio was 20 percent of gross domestic product or higher and when oil prices were high or when oil prices were low.

The IMF statement itself admitted the problem saying current BOP crisis came despite an improvement in 'terms of trade'.

"The fiscal deficit expanded, public debt increased, and the balance of payments position deteriorated despite an improvement in the terms of trade.

Terms of trade is a concept used to describe relative prices of imports and exports and the reference is to falling oil prices.

But if money is printed (central bank credit is used to finance the deficit or liquidity is injected to fill liquidity shortages coming from foreign exchange interventions) the balance of payments would deteriorate regardless of terms of trade benefits, or other perceived Mercantilists 'favourable' trade effects including falling imports, or narrowing merchandise trade or current account deficits.