Mahinda Rajapaksa, president of Sri Lanka.
Sri Lankan President Mahinda Rajapaksa may cut taxes to spur investment next year as he seeks to boost economic growth and shrink the budget deficit in a nation recovering from civil war.
A state-backed commission on taxes has recommended that the government lower rates and reduce the number of levies on companies to about 15 from 25, according to Saman Kelegama, executive director of the Institute of Policy Studies in Colombo and a member of the panel. Rajapaksa, due to unveil the 2011 budget in parliament on Nov. 22, may predict a smaller budget gap next year, a Bloomberg News survey shows.
The government has focused on reviving Sri Lanka’s $42 billion economy since Rajapaksa defeated the separatist Liberation Tigers of Tamil Eelam in May 2009 to end a 26-year civil war. A reduction in levies would test the role of tax policy in bolstering economic expansion while avoiding large- scale fiscal deficits, an issue debated by policy makers across developed and emerging markets.
“The experience in the U.S. under presidents Ronald Reagan and George W. Bush did not seem to support the notion that lowering tax rates would increase government revenues,” said David Cohen, Singapore-based head of Asian forecasting at Action Economics. Nevertheless, “as long as the budget is not too far in deficit, it might still be useful in promoting economic development.”
The budget gap may narrow to 7.5 percent of gross domestic product next year, according to the median of six estimates in the Bloomberg survey. The government expects a shortfall of 8 percent of GDP in 2010.
Sri Lanka’s benchmark Colombo All-Share Index has climbed over 90 percent this year, lagging behind only Mongolia, and companies including Aitken Spence Plc are boosting investment as peace spurs an economic recovery. The Sri Lankan rupee has gained about 3 percent since the war ended and traded at 111.65 per dollar yesterday.
Rajapaksa has pledged to spend $1 billion a year on infrastructure and the central bank lowered interest rates in July and August to boost growth even as counterparts from India to Australia raised borrowing costs this year. Aitken Spence, Sri Lanka’s biggest operator of resorts, said Sept. 30 it will build a hotel with Six Senses Resorts & Spas in an investment worth as much as $40 million.
“A reduction in corporate and personal tax rates will be an economy-boosting measure and help improve revenue collection,” said Sarath Rajapakse, director of research at Capital Trust Securities Pvt.in Colombo. “The government may also reduce more excise duties on imports, which additionally will ease pressure on the rupee and cost of living.”
Russia credits the adoption of a 13 percent flat income- tax rate with helping boost revenue 12-fold over eight years. In the U.S., tax reductions during the administrations of John F. Kennedy and Ronald Reagan might have helped bolster revenue because they reduced relatively high marginal rates, according to the Washington-based Tax Foundation.
By contrast, reductions from lower levels enacted by former President George W. Bush added about $1.7 trillion to deficits between 2001 and 2008, according to the Center on Budget and Policy Priorities.
Sri Lanka, which secured a $2.5 billion loan from the International Monetary Fund last year, has pledged to overhaul its tax system based on the recommendations of the panel set up by Rajapaksa. Banks and tourism companies may benefit from tax cuts, said Bimanee Meepagala, a Colombo-based analyst at NDB Aviva Wealth Management Ltd., the nation’s biggest non-state fund.
A reduction in the 20 percent value-added tax on financial services would release more funds for lenders, including Commercial Bank of Ceylon Plc, said Samantha Amerasinghe, a Colombo-based economist at Standard Chartered Plc.
The country has earned 15 billion rupees ($134 million) this year after cutting the import tax on cars in June as shipments increased to 11,815 vehicles, compared with 1,282 a year earlier, the government said on its website.
“The move towards a lower corporate tax regime is essential if Sri Lanka is to become a regionally competitive business hub,” Amerasinghe said. The tax rate on Sri Lankan companies is about 35 percent, compared with 25 percent in Malaysia.
The tax commission has also recommended “widening the tax base,” said Kelegama. Sri Lanka, where only about 3 percent of the 20 million population pay taxes, may bring more people under the tax net and remove some concessions offered through the Board of Investment, central bank Governor Ajith Nivard Cabraal said on Nov. 11.
“A more equitable tax system will ensure more people will pay because it is not too much of a burden,” Cabraal said. “People also like to see a more level playing field for investment. Concessions for some have discouraged people in general.”
Economic expansion may increase tax revenue to 15.5 percent of GDP in 2011 from 14.9 percent currently, giving Rajapaksa room to keep spending on public works, said Amerasinghe. The South Asian island’s economy, which has been performing better than policy makers had expected, may expand as much as 8 percent in 2010 and 2011 as agriculture and tourism grow, Cabraal said Nov. 11.
Sri Lanka is also expected to announce easier foreign- exchange rules, including enabling overseas investors to buy corporate debt on the island, Cabraal said.
The president may also offer minority stakes in recently “renationalized” companies by listing them on the Colombo Stock Exchange, said Capital Trust’s Rajapakse.
Sri Lanka this month purchased a 51 percent stake it didn’t already own in the local unit of Royal Dutch Shell Plc for $63 million. The government in July bought out Emirates Airline’s 44 percent stake in SriLankan Airlines for $53 million to gain full control of the company.
“The government’s policy is to draw more foreign direct investment to sustain 8 percent economic growth. This policy will be enunciated in the budget,” Deputy Finance Minister Sarath Amunugama said on Nov. 17.
The budget “will also be revenue generating and help boost growth,” he said.
Media Release – 18 November 2010