Part Four
Replicating Asian Miracle:
Strengthening Budgetary Revenue
In the previous three parts, the essential prerequisites for rapid economic growth, namely, the need for establishing strong and viable trade relations with the rich west, creating an atmosphere resembling a developed economy and the importance of maintaining macroeconomic stability were discussed. It was noted that the first two had been respectively termed by Singapore
High expenditure, low revenue
Historically, Sri Lanka’s government has been spending a little more than a quarter of the country’s total Gross Domestic Product or GDP for maintaining the existing government services, known as recurrent expenditure, and improving the infrastructure facilities, known as capital expenditure, needed for rapid economic development. To spend this amount of expenditure, the government has been raising, on average, revenue slightly less than a fifth of GDP. During the last ten year period, its revenue record has been so dismal that it has fallen to an unsustainable level of 15% of GDP and, to everyone’s woe, taken a declining trend after 2007.
Biggest challenge: Raise adequate revenue
With the expansion of the government expenditure programmes, the demand for more funds from the budget by different government agencies has increased in leaps and bounds. The government too has unknowingly contributed to this demand by successively expanding the government sector and thereby placing itself in the miserable position of having to water an ever – sinking well. Two such instances from the recent past may be mentioned here: first, when a private bank had failed due to fraudulent business practices, by overruling the earlier adopted policy of the Central Bank to liquidate the bank in question, the government took it over in an apparent bid to save a few thousands of depositors. Second, when a budget airline was incurring losses due to mismanagement and could not continue to operate any longer, the government thought it prudent to rescue it by taking over its debt to two state sector banks. These precedents, as unanticipated consequences, have reinforced an already held hard view in people that the government is there to rescue them in whatever the situation. Against this background of a voracious appetite for funds, raising the revenue needed to finance the government budget has been the biggest challenge which the Minister of Finance faces today.
Kautilya’s recommendation
While emphasising the importance of augmenting the wealth in the treasury (or having a surplus budget continuously), Kautilya in The Arthashastra, recommended several revenue enhancement measures for the king. These measures take the form of raising revenue in the short run through direct revenue enhancement methods and create conditions conducive for generating revenue in bigger volumes in the long run.
The short run measures include the following:
• Ensuring profitability in state activities and state enterprises
• Streamlining tax collection systems through appropriate incentives to state officers
• Reducing tax exemptions and tax remissions
• Eliminating the theft of state revenue once it has reached the treasury by false accounting or misappropriation by ministers and state officials
• Preventing the looting of revenue by chiefs, enemies, tribes and highwaymen before it has reached the treasury
• Increasing the cash income of the state (or, in today’s context, ensuring a positive cash flow for the treasury)
The long run measures recommended by Kautilya require the king to promote prosperity by ensuring faster economic growth and maintaining peace and stability in the state. They include the following:
• Increasing agricultural production (or in today’s context, promoting overall economic growth or raising GDP year after year)
• Promoting trade within the country as well as with foreign nations.
• Avoiding troubles and calamities by maintaining peace and stability
Kautilya recommended the strict enforcement of discipline on ministers and state officials, because it is not possible to know whether and how dishonest officials hide their ill-gotten revenue. This is because as he explained, ‘it is possible to know even the flying path of birds in the sky, but not the ways of the dishonest government servants’. Hence, his approach was to use both the carrot and the stick: reward and make permanent those who bring the highest revenue to the treasury; punish those who cause losses by requiring them to pay back and transferring them to positions and places where they cannot misappropriate state revenue. He advised the king to inspect their activities daily, because, ‘men are, by nature, fickle and like horses, change after being put to work’.
How to raise revenue?
Sri Lanka Sri Lanka
Proven tax policies
A severe revenue leakage occurs in Sri Lanka due to ad hoc tax policies being adopted by the government from time to time and the losses made by government enterprises almost on a continuous basis. Import duties are used by the country not as a revenue source but as a political weapon: duty free motor vehicles to parliamentarians and other legislators, duty waivers granted for essential food items in run up to elections and tax exemptions granted not on the basis of economic rationale, but to get the support of certain sections of the community are some of the examples that could be quoted from the country’s recent experiences.
The government loses in these cases on two counts: the direct loss of tax revenue and the indirect loss of productivity and output due to what economists call ‘the proliferation of rent seeking’. The latter takes place on account of the misuse of the facility by the recipients to make money by selling their concessions in the secondary market. The absence of a proper policing system or unwillingness of the authorities to police the misuse at all has contributed to a proliferation of such practices leading to further revenue leakages.
Kautilya has frowned upon tax holidays and tax remissions because they lead to abuse of powers and malpractices. Tax holidays are granted because of the general belief of policy makers, in both developing and developed countries, that private entrepreneurs could be seduced to make more investments by offering them selective tax holidays and thereby artificially raising their profit levels. But the experience shows that such tax exemptions lead to a number of distortions which in turn cause to reduce the tax base of the country. The reason for this is that it encourages everyone to be in the tax exempt category which in turn reduces investments in other areas that are subject to normal taxation. This was a general experience even in Kautilya’s time. Hence, he advised the king that under no circumstances those in tax-paying villages be allowed to settle in tax-exempt villages.
Hence, instead of offering selective tax holidays and causing shrinkage of the tax base in the long run, the government should reduce taxes in general and maintain low inflation and macroeconomic stability to promote private investments.
Increase in the tax base
In an economy where per capita GDP has now exceeded US $ 2000, the number of income tax payers at less than 300,000 is a testimony of the failure of the tax net to capture all individuals with potentially high incomes. Many self-employed people and those leading above average luxury life do not pay taxes; it is only those who are subject to Pay As You Earn or PAYE tax have regular tax files. These people who evade taxation should be brought to the tax net promptly. In addition, a recent survey conducted by an expatriate academic on the country’s Small and Medium Enterprise Sector revealed that only a handful of these companies pay taxes, though their incomes are well above the threshold levels for paying taxes. It appears that the evasion in question is being committed by them in active or tacit collaboration with the auditors.
Since Income Tax authorities depend on the audit reports regarding the compliance of companies with tax laws, it should be made mandatory for auditors to report separately a company’s status with respect to the payment of all taxes including the payment of dues to local authorities.
Corruption of tax collectors
It is an open secret among tax payers that immense possibilities available for them to have their tax liabilities reduced significantly through devious means. Those who have got these facilities whisper in private circles that such methods have been employed by them in collaboration with willing officials who are in the habit of misusing their positions for monetary gains. This is a perennial problem present in all countries where officials have got discretionary powers: the collusion by two willing parties to maximise their own economic benefits at the cost of depleted revenue to the treasury. Kautilya recommends the severest punishment to those officials who make illegal money by using their positions in the government. He has even recommended to the king that spies should be employed to collect evidence and apprehend such officials who have resorted to corrupt practices.
Profit making by State enterprises
In Sri Lanka, leading public enterprises have been making losses year after year thereby becoming a burden to tax payers on the one hand and denying the government the opportunity of enhancing its revenue through annual profit transfers on the other. In 2009, according to the Central Bank Annual Report, six leading public enterprises had made thumping operation losses amounting to Rs.49.5 billion, slightly more than 1 % of GDP for that year. Kautilya’s recommendation was that the king should insist that all public enterprises should contribute to the wealth augmentation of the treasury by running them as profitable businesses. Those who fail to do so should be severely dealt with, since, according to Kautilya, ‘they not only eat up the wealth of the nation but also the labour of the workers who work in those enterprises’.
It is of utmost importance that the government appoints people of proven entrepreneurship as heads of those enterprises and requires them to make a turnaround in them within a given period.
A time bound revenue enhancement plan
Given the above situation, the government should introduce as the top most priority a time bound revenue enhancement plan to raise the revenue of the government from the current 15 % of GDP to around 25 % of GDP over a period of 5 to 7 years. Ministers and top public servants should be made a part of this plan and, as Kautilya has recommended, should be ‘well rewarded if they deliver the targeted outputs, but severely dealt with if they fail to do so without acceptable reasons’.
In the next part, we will discuss the danger of resorting to inflation as a strategy to finance deficits.
(W.A. Wijewardena can be reached on waw1949@gmail.com)
High expenditure, low revenue
Historically, Sri Lanka’s government has been spending a little more than a quarter of the country’s total Gross Domestic Product or GDP for maintaining the existing government services, known as recurrent expenditure, and improving the infrastructure facilities, known as capital expenditure, needed for rapid economic development. To spend this amount of expenditure, the government has been raising, on average, revenue slightly less than a fifth of GDP. During the last ten year period, its revenue record has been so dismal that it has fallen to an unsustainable level of 15% of GDP and, to everyone’s woe, taken a declining trend after 2007.
Biggest challenge: Raise adequate revenue
With the expansion of the government expenditure programmes, the demand for more funds from the budget by different government agencies has increased in leaps and bounds. The government too has unknowingly contributed to this demand by successively expanding the government sector and thereby placing itself in the miserable position of having to water an ever – sinking well. Two such instances from the recent past may be mentioned here: first, when a private bank had failed due to fraudulent business practices, by overruling the earlier adopted policy of the Central Bank to liquidate the bank in question, the government took it over in an apparent bid to save a few thousands of depositors. Second, when a budget airline was incurring losses due to mismanagement and could not continue to operate any longer, the government thought it prudent to rescue it by taking over its debt to two state sector banks. These precedents, as unanticipated consequences, have reinforced an already held hard view in people that the government is there to rescue them in whatever the situation. Against this background of a voracious appetite for funds, raising the revenue needed to finance the government budget has been the biggest challenge which the Minister of Finance faces today.
Kautilya’s recommendation
While emphasising the importance of augmenting the wealth in the treasury (or having a surplus budget continuously), Kautilya in The Arthashastra, recommended several revenue enhancement measures for the king. These measures take the form of raising revenue in the short run through direct revenue enhancement methods and create conditions conducive for generating revenue in bigger volumes in the long run.
The short run measures include the following:
• Ensuring profitability in state activities and state enterprises
• Streamlining tax collection systems through appropriate incentives to state officers
• Reducing tax exemptions and tax remissions
• Eliminating the theft of state revenue once it has reached the treasury by false accounting or misappropriation by ministers and state officials
• Preventing the looting of revenue by chiefs, enemies, tribes and highwaymen before it has reached the treasury
• Increasing the cash income of the state (or, in today’s context, ensuring a positive cash flow for the treasury)
The long run measures recommended by Kautilya require the king to promote prosperity by ensuring faster economic growth and maintaining peace and stability in the state. They include the following:
• Increasing agricultural production (or in today’s context, promoting overall economic growth or raising GDP year after year)
• Promoting trade within the country as well as with foreign nations.
• Avoiding troubles and calamities by maintaining peace and stability
Kautilya recommended the strict enforcement of discipline on ministers and state officials, because it is not possible to know whether and how dishonest officials hide their ill-gotten revenue. This is because as he explained, ‘it is possible to know even the flying path of birds in the sky, but not the ways of the dishonest government servants’. Hence, his approach was to use both the carrot and the stick: reward and make permanent those who bring the highest revenue to the treasury; punish those who cause losses by requiring them to pay back and transferring them to positions and places where they cannot misappropriate state revenue. He advised the king to inspect their activities daily, because, ‘men are, by nature, fickle and like horses, change after being put to work’.
How to raise revenue?
Proven tax policies
A severe revenue leakage occurs in Sri Lanka due to ad hoc tax policies being adopted by the government from time to time and the losses made by government enterprises almost on a continuous basis. Import duties are used by the country not as a revenue source but as a political weapon: duty free motor vehicles to parliamentarians and other legislators, duty waivers granted for essential food items in run up to elections and tax exemptions granted not on the basis of economic rationale, but to get the support of certain sections of the community are some of the examples that could be quoted from the country’s recent experiences.
The government loses in these cases on two counts: the direct loss of tax revenue and the indirect loss of productivity and output due to what economists call ‘the proliferation of rent seeking’. The latter takes place on account of the misuse of the facility by the recipients to make money by selling their concessions in the secondary market. The absence of a proper policing system or unwillingness of the authorities to police the misuse at all has contributed to a proliferation of such practices leading to further revenue leakages.
Kautilya has frowned upon tax holidays and tax remissions because they lead to abuse of powers and malpractices. Tax holidays are granted because of the general belief of policy makers, in both developing and developed countries, that private entrepreneurs could be seduced to make more investments by offering them selective tax holidays and thereby artificially raising their profit levels. But the experience shows that such tax exemptions lead to a number of distortions which in turn cause to reduce the tax base of the country. The reason for this is that it encourages everyone to be in the tax exempt category which in turn reduces investments in other areas that are subject to normal taxation. This was a general experience even in Kautilya’s time. Hence, he advised the king that under no circumstances those in tax-paying villages be allowed to settle in tax-exempt villages.
Hence, instead of offering selective tax holidays and causing shrinkage of the tax base in the long run, the government should reduce taxes in general and maintain low inflation and macroeconomic stability to promote private investments.
Increase in the tax base
In an economy where per capita GDP has now exceeded US $ 2000, the number of income tax payers at less than 300,000 is a testimony of the failure of the tax net to capture all individuals with potentially high incomes. Many self-employed people and those leading above average luxury life do not pay taxes; it is only those who are subject to Pay As You Earn or PAYE tax have regular tax files. These people who evade taxation should be brought to the tax net promptly. In addition, a recent survey conducted by an expatriate academic on the country’s Small and Medium Enterprise Sector revealed that only a handful of these companies pay taxes, though their incomes are well above the threshold levels for paying taxes. It appears that the evasion in question is being committed by them in active or tacit collaboration with the auditors.
Since Income Tax authorities depend on the audit reports regarding the compliance of companies with tax laws, it should be made mandatory for auditors to report separately a company’s status with respect to the payment of all taxes including the payment of dues to local authorities.
Corruption of tax collectors
It is an open secret among tax payers that immense possibilities available for them to have their tax liabilities reduced significantly through devious means. Those who have got these facilities whisper in private circles that such methods have been employed by them in collaboration with willing officials who are in the habit of misusing their positions for monetary gains. This is a perennial problem present in all countries where officials have got discretionary powers: the collusion by two willing parties to maximise their own economic benefits at the cost of depleted revenue to the treasury. Kautilya recommends the severest punishment to those officials who make illegal money by using their positions in the government. He has even recommended to the king that spies should be employed to collect evidence and apprehend such officials who have resorted to corrupt practices.
Profit making by State enterprises
In Sri Lanka, leading public enterprises have been making losses year after year thereby becoming a burden to tax payers on the one hand and denying the government the opportunity of enhancing its revenue through annual profit transfers on the other. In 2009, according to the Central Bank Annual Report, six leading public enterprises had made thumping operation losses amounting to Rs.49.5 billion, slightly more than 1 % of GDP for that year. Kautilya’s recommendation was that the king should insist that all public enterprises should contribute to the wealth augmentation of the treasury by running them as profitable businesses. Those who fail to do so should be severely dealt with, since, according to Kautilya, ‘they not only eat up the wealth of the nation but also the labour of the workers who work in those enterprises’.
It is of utmost importance that the government appoints people of proven entrepreneurship as heads of those enterprises and requires them to make a turnaround in them within a given period.
A time bound revenue enhancement plan
Given the above situation, the government should introduce as the top most priority a time bound revenue enhancement plan to raise the revenue of the government from the current 15 % of GDP to around 25 % of GDP over a period of 5 to 7 years. Ministers and top public servants should be made a part of this plan and, as Kautilya has recommended, should be ‘well rewarded if they deliver the targeted outputs, but severely dealt with if they fail to do so without acceptable reasons’.
In the next part, we will discuss the danger of resorting to inflation as a strategy to finance deficits.
(W.A. Wijewardena can be reached on waw1949@gmail.com)
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