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Sri Lanka

Budgetary Process, Revenues, and Expenditures

The budget is announced annually in the budgetary speech of the finance minister, which is normally made in November. This speech reviews the economic situation of the current fiscal year, which corresponds to the calendar year, previews the government's expenditure program for the next year, and sets forth any proposed changes in taxation. Sometimes adverse public reaction, or pressure from members of parliament within the ruling party, forces changes in the measures announced in the finance minister's speech, but once formally introduced in parliament, the budget proposals are normally passed intact. All money bills must be introduced by a minister acting on behalf of the government. Opposition members may propose amendments to reduce expenditure under a specific head, but the success of such a motion would be a major defeat for the government and would probably cause its resignation. No amendments concerning taxes or to increase expenditure are allowed. Supplementary provisions are often presented by the government during the year. The government's finances are monitored by an auditor-general appointed by the president.

The colonial administration was heavily dependent on indirect taxes, especially import and export duties. Some changes in the structure of the revenue system were set in motion by the report of the Taxation Inquiry Commission, which was published in 1968. At that time, the tax system proper (exclusive of such items as fees, charges, and sales) of the central government consisted of various separate revenue sources: personal income taxes, corporate income taxes, wealth (luxury) tax, business turnover tax, import and export duties, resale of automobiles tax, and the levy on the transfer of property to nonnationals. The system was characterized by high taxes on major exports, by a miscellaneous collection of import taxes, and by high rates of income taxation. The income tax on corporations was 50 percent, and the top marginal rate on individuals was 80 percent, with rapid rates of progression. The wealth tax on individuals was also high.

The Taxation Inquiry Commission concluded that, for steady revenue flow, dependence should be placed on a broad-based set of consumption taxes, with differential rates to minimize the regressive tendency inherent in the consumption tax. This was recommended on a strictly pragmatic basis because both incomes and exports were already being taxed almost to their limit. There was thus no alternative to more and higher import duties and excises to secure the necessary additional revenue. Because the commission believed that taxable imports would in the future be replaced by domestically produced substitutes, it argued that consumption taxes would increasingly have to bear the brunt of the search for new revenue. The commission also advised the government to raise the exemptions, lower the top rates, and ease the progression rate on income, wealth, and gift taxes; to raise the excise taxes on tobacco, arrack, beer, and domestically consumed tea; and to increase the coverage and reduce the exemptions of the turnover tax. Most of these recommendations were implemented soon after the publication of this report.

In 1975 sales and turnover taxes raised almost 30 percent of the government's revenue, and income taxes and tariffs each raised about 15 percent. A little over a decade later, in 1986, the importance of the sales taxes and tariffs had increased, but income taxes raised a smaller proportion of the revenue than earlier (see table 11, Appendix A). In 1986 the general sales and turnover tax raised 15.4 percent of revenue, and selective sales taxes, which were primarily imposed on tobacco and liquor, raised 10.7 percent. Import duties accounted for 24.1 percent and export duties for only 3.8 percent. Income taxes raised 11.5 percent of state funds in 1986, over two-thirds of which came from corporate sources. Studies carried out in the 1970s, both before and after the liberalization of the economy, indicated that the tax system as a whole operated in a progressive manner. Almost 25 percent of the government's revenue in 1986 came from nontax sources, mainly interest, profits, dividends, and other receipts from government-owned enterprises.

In 1988 the maximum rate of personal income tax was 40 percent and the ceiling on both income and wealth tax was 50 percent of a person's income. The 1988 budget reflected a cut in the highest level of import duty from 100 to 60 percent. A large proportion of revenue from business came from the established forms of economic activity because new industries, such as tourism and the free trade zone factories, had preferential tax treatment.

No postindependence government has attempted to change, as a matter of policy, the proportion of the nation's GDP that it takes in revenue. This proportion generally hovered at just over 20 percent between 1950 and 1983. Annual variations derived more from external factors than from changes in government policy. Revenue from export duties on tea, rubber, and coconut, for instance, varies according to the price of these commodities on the international market. In 1984 when the price of tea rose temporarily, the government increased the export duty in order to gain a share of the windfall profits, and total revenue rose to 24.5 percent of GDP. In 1987 government revenue was only slightly below this level because of tax increases brought about by increased fiscal pressures, largely the product of higher defense allocations and the heavy foreign debt.

Government expenditure has consistently exceeded revenue, often by a considerable margin. From 1960 to 1977, expenditure was about 28 percent of GDP. After 1977 it increased, mainly as a result of investment in infrastructure. Between 1978 and 1987, the government spent around 38 percent of GDP. Of the nearly Rs70 billion spent in 1986, about half was classified as recurrent expenditure, and half as capital expenditure.

Governments have used expenditure as a tool of social policy. In comparison with other Third World countries, Sri Lanka has a long tradition of public spending on health, education, and other social services. These programs have contributed at least in part to the nation's very high levels of literacy and life expectancy relative to its per capita income (see Social Services , ch. 2). In the period between 1960 and 1977, about 9.5 percent of GDP, or one-third of the government's budget, was devoted to such programs.

After the liberalization of the economy in 1977, there were reductions in some social programs. In June 1978 the long-established system of rice rationing, which provided free and subsidized rice to nearly the entire population, was replaced by a food stamp program that covered only about 50 percent of the population. The value of the stamps was not indexed in order to keep place with inflation, and as a result the program's cost fell from 14 percent of government expenditure in 1979 to 7 percent in 1981 and 2.6 percent in 1986. Although there was a drop in the standard of living for the very poor, in early 1988 the food stamp program continued to provide a safety net more effective than programs existing in other parts of South Asia. Overall, social services, education, and welfare accounted for just under 15 percent of government spending in 1986.

Data as of October 1988

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