Government plays Critical Role of Revenue and Fiscal Reforms

By: Staff Writer

September 03, Colombo (LNW): The economic crisis in Sri Lanka was exacerbated by weak government revenue, a problem that has been worsening over the past three decades, the finance ministry elaborated.

A significant factor was the ill-timed tax cuts in late 2019, which led to the country’s credit rating downgrades and, eventually, a sovereign debt default.

By 2021, government revenue had declined to 8.3% of GDP, while public expenditure remained high at 20% of GDP, ministry sources said .

This imbalance forced the government to finance its budget deficit, which stood at 11.7% of GDP, through inflationary monetary financing (money printing).

Consequently, urgent revenue measures were needed to phase out this practice and control inflation, which peaked at 70% in 2022 and severely impacted the poor, it added. .

The government’s macroeconomic reform program included fiscal consolidation as a key component, aiming for a primary budget surplus of 2.3% of GDP by 2025.

To achieve this, government revenue needs to increase to 15.1% of GDP by 2025. In Sri Lanka, where natural resources are limited, taxes are the primary source of government revenue, contributing about 80%.

Contrary to popular belief, revenue from exports, tourism, and other external inflows goes to private enterprises, not the government. Non-tax revenue from state enterprises is minimal due to their consistent losses, making taxes crucial for government revenue.

Improving tax compliance and administration is essential but takes time to show results. Although such measures were implemented alongside tax rate increases, the immediate revenue increase was primarily due to higher tax rates.

The IMF does not consider gains from better tax administration as a reliable short-term revenue measure.

With urgent cash flow needs, such as mandatory payments on interest, salaries, and welfare, the government had to rely on specific revenue measures rather than hope for gains from reducing tax leakages.

Several tax administration and compliance improvements were implemented, including digitizing tax processes, mandatory information sharing between government agencies, and upgrading the Inland Revenue Department’s management information system.

These measures led to a 128% growth in active tax files in 2023 compared to 2022. As the tax base expands, the government hopes to gradually reduce tax rates without compromising revenue targets.

The government has also taken steps to curtail public expenditure, focusing on maintaining fiscal discipline and transparency.

Measures include restricting new hires, overtime payments, fuel consumption, and foreign travel. Digitization initiatives, such as the Integrated Treasury Management Information System (ITMIS), and zero-based budgeting for the largest ministries, aim to eliminate waste and improve efficiency. 

Despite these efforts, the non-discretionary nature of most public expenditure, coupled with the need for increased spending in priority areas, means that the government must continue to expand its revenue base from the record low of 8.3% of GDP to at least 15% of GDP to support long-term sustainable economic growth.