Tax Reforms: Should The VAT Be Abolished?
Hema Senanayake
Sri Lanka needs complete and meaningful tax reforms. Where should we begin? I suggest that we should begin from economic fundamentals not from ad-hoc adjustments of VAT. If you need a quick solution, then, I would say again, you have to begin from fundamentals by correcting what you put wrong from the budget for the year 2016. Let me explain this matter very briefly.
What kind of money in the economic system should we tax basically? We should always tax part of the consumable income allocated in the system. This is the fundamental principle. For a moment if you ignore the consumable income allocated from stock market share trading transactions, in general, consumable income is allocated by revenue generating production based enterprises only. This means that producers of revenue generating enterprises pay all the taxes, no matter taxes are collected at various points and various names. For example if a government employee pays tax then his or her tax is truly paid by the producers of revenue generating enterprises. When you understand how the system works, you may easily understand this process.
When we tax, we deprive certain consumable income to individual producers (in revenue generating enterprises which produce goods and tangible services), but they are in turn benefited as members of the larger society, when we use that tax money to produce common interests such as education, judicial service, general administration, research and development, infrastructure development etc. Therefore, if a highly paid government employee pays tax he or she pays it from the money collected by depriving certain income to producers. So, you may understand now that taxes can truly paid only by producers. However, if this government employee does not produce anything that can be defined as common interest then producers are not get benefitted as members of society by paying taxes. In this regard, the best example is our Jumbo Cabinet.
However, when taxes are collected the economic efficiency of the system must be a concern. For an example, remove the VAT from all economic produce (goods and services). Then economic produce represent the true price of present day economic relations. These prices reflect the present day economic efficiency of production. Isn’t this important? It is important. VAT distorts these prices. It is bad. It is bad even if all countries in the world use VAT. However, the United States, one of the biggest economies in the world does not use VAT. I guess State Minister of Finance Lakshman Yapa Abeywardena might well understand this point now.
VAT is an anomaly in tax collection. As I mentioned above, it is a part of the consumable income that we need to tax. The consumable income is the income that goes to the households as salaries, wages, distributable profit, etc. There is another part too. It is the un-invested component of the capital reserve (profit reserve) accumulated in the balance sheets of businesses. These are the two main income components that should be taxed. Usually, these two kinds of entities (households and businesses) are reluctant to pay taxes, but we could change that phycology if any unperceived risk is absorbed in proportion to the taxes they pay. That is one area we need reforms. Instead of doing it what the new government did was that it ignored the fundamental principles of taxation from the approved budget for 2016.
