Senaratne is a driver of meager means, but when he was put on the waiting list of a government hospital for a cataract surgery, he decided that he didn’t have months to spare. He managed to scrape the 20,000 rupees that it would cost to get the procedure done at a private hospital. Of course, Senaratne is not his real name, but his problem is very real. Although the Finance Ministry has not yet gazetted VAT medical goods and services, it wouldn’t be long before people like Senaratne fall through the cracks, unable to afford private medical charges.

“Had he been forced to pay a higher amount, he might have been forced to take his place in the waiting list,” said Colombo University, Economics Department, Professor in Economics, K Amirthalingam. This is why according to economic theory, life-saving goods and services should not be taxed.

“Not even indirectly,” said Amirthalingam.

It would be downright absurd if you had to pay extra to remove an appendix. After all it is minus a body part. It would be equal to having to pay taxes for being sick. The more the illness intensifies, the higher the tax, dealing a double blow on the common man.

“VAT has to be borne by the patient, not the institutions,” said Private Hospitals and Nursing Homes Association president, Wijaya Ransi.

He pointed out that this discourages people from seeking treatment from private medical facilities and ultimately the government has to bear the burden of the extra number of patients who seek free health services from government medical establishments.
“Different packages have different charges and so far the Finance Ministry has not gazetted VAT-tax goods and services,” pointed out Ransi.

He admitted that newspaper reports are all they have to go by at the moment. “What’s worse is that patients do not get this concept of VAT, they think private medical facilities are increasing their rates,” he said.

“Government health costs for increased number of patients due to imposing of VAT for private medical goods and services would be double the amount they can hope to earn from VAT,” said Ananda Kuruppu Arachchi, a retired government servant currently attached to a private medical facility. “This is impractical as the tax is charged from the patient.”

An economic theory says life-saving goods and services should not be taxed at any cost. In the case of indirect taxes such as VAT and NBT, excise tax and customs duties the tax burden is shifted to the consumer who uses these goods and services. “The difference is that, in direct taxes, tax burden cannot be shifted,” said Prof Amirthalingam.

Take for example milk powder. The importer pays import duties but at the end it is added to the commodity price, forcing consumers to bear the tax burden.

“The government cannot measure the income of a farmer, for example,” elaborated Amirthalingam. “And for this reason the government cannot impose direct taxes. It can only impose indirect taxes.”

The second stage of economic development is characterized by urbanization, with the industrial and service sector playing a dominant role with their contribution for GDP. Economic activities are mostly formal which allows governments to impose direct taxes.
Life-threatening goods and services such as tobacco and alcohol should be taxed heavily according to Amirthalingam.

Drinking (alcohol), smoking and driving (vehicles and petroleum) are good tax bases. Personal income tax and corporate income taxes are progressive taxes on interest and when the income tax rate is increased rich people have to pay more taxes.

“The problem with Sri Lanka is that although it’s already in the second stage of development, the tax system is still stuck in the first,” said Amirthalingam. He explained that although Sri Lanka’s GDP composition is made up of the industrial and serves sector and agriculture sector contributing 90 per cent and 10 per cent respectively, its tax revenue is largely made up of indirect taxes.

Expanding tax base
“The Sri Lankan tax revenue is only 10 to 11 per cent of GDP. So, one has to understand that the government is desperate to earn revenue to reduce the burden of debt, but burdening essential life-saving goods and services by imposing indirect taxes is not the way to do it,” reiterated Amirthalingam.

He emphasised that although Sri Lanka ranks first place in South Asia in terms of access to electricity, it ranks seventh place in tax payment, worse than Afghanistan.

Amirthalingam pointed out that Sri Lanka should expand its direct tax base. “This is not to say that Sri Lanka should increase taxes,” said Amirthalingam. “Rather the direct tax base. Instead the government is increasing indirect taxes. In fact, 80 per cent of the total tax revenue is from indirect taxes, which even people of low income are forced to pay. This is regressive,” said Amirthalingam.

Take for example, two people with an income of Rs 100,000 and Rs 10,000. Both of them are taxed equally when they pay the retail price of a pack of milk powder.

“There is no need to increase tax rate,” said Amirthalingam who suggested that Sri Lanka can even reduce tax rate if the government expanded the tax base.

He said that lack of a proper monitoring mechanism allows for tax evasion. “Most high income earners do not pay taxes.  So the money is already out there, it’s just a matter of tapping it”, said while adding that the whole tax system has to be revamped and economy formalized to increase tax revenue. This would mean digitization and strict monitoring.
He pointed out that a proper monitoring mechanism would send the message that they are ‘being monitored’ and would be an effective deterrent to corruption.

Informal economy
Amirthalingam pointed out that a major obstacle for expanding direct tax base is the inability of tax collecting authorities to calculate people’s income. “No one knows how much a doctor earns. The Inland Revenue Department has no way of keeping a tab on such information, said Amirthalingham.

“Take another example: when someone pays for a meal at a restaurant, a bill is issued indicating VAT percentage.  But what’s the guarantee that the IRD will receive this amount”, questioned Amirthalingam. He pointed out that the IRD has no monitoring mechanism to keep a tab on tax revenue due.

Amirthalingam suggested that ideally credit card use be encouraged and all banks be connected to IRD so that it knows how much is paid and by whom. “When you pay cash it’s an informal transaction and there is no guarantee that the IRD will ever receive the tax amount”, he said.

As of now only Bank of Ceylon and People’s Bank are connected to the IRD system.
To make this happen Amirthalingam pointed out that necessary laws have to be passed by the government.

He said that there are fundamental obstacles for switching to formal economy. “For example, in Sri Lanka people are discouraged from using plastic,” pointed out Amirthalingam.

“If the economy was formalized through credit card use, the IRD could trace every transaction made by a single individual through the PIN.

Undeclared income is often spent on luxury goods and services. If the economy is formalized these can be easily taxed through expenditure and excise taxes, suggested Amirthalingam.

“The trick is to tax them when they earn or while they spend. For such a monitoring mechanism a tax intelligence unit must be developed. Corrupt officials must be penalized while rewarding dedicated officials with incentives”, he said.