This was written by Rojie Ekanayake. She is a Programme and Research Officer at Arutha. Arutha is a Colombo-based policy think tank focused on economic research and communication with a special interest in public debt and taxation. Its economic civic education initiative, Default LK, was established during Sri Lanka’s first-ever sovereign default in 2022
A proposal for a new tax on imputed rental incomes set social media abuzz recently. People were confused about who would have to pay and how much. The Ministry of Finance clarified that the tax targeted the very wealthy but with no indication of what they defined as ‘wealthy’. This issue has reignited a longstanding debate in the country: should Sri Lanka tax wealth? The short answer is yes, but the real question is, how should we tax wealth?
Why tax wealth?
Anyone who needs convincing that wealth needs to be taxed need not look further than the estimate that the wealthiest 10% of Sri Lanka’s population owned around 64% of wealth while the least wealthy 50% only owned around 4%. But this case is not unique to our country. At the G20 there is currently a debate on a global minimum tax for the world’s wealthiest individuals, which is part of a larger discourse on addressing inequalities.
The need to generate more revenue to avoid dependence on debt is certainly an important sentiment. But with the limited revenue potential of wealth taxes, an arguably more important point is that Sri Lanka has been overly reliant on its sales and border taxes as opposed to direct taxes, burdening the average citizen with revenue generation as opposed to those who can afford to pay. Introducing wealth taxes could help correct this to some extent. Wealth taxes also have the added benefit of facilitating data collection on assets, allowing measures like income taxes to be more effectively implemented as well.
In principle, taxing wealth is necessary for creating better and equal societies. The administration of these taxes, however, is complex. For instance, net wealth tax, which may be the ultimate form of wealth tax, is rare in practice.
Even under the best circumstances, those imposed in economies such as Spain, Norway, and Switzerland generated only 0.5%, 1.1%, and 3.9% of total tax revenue, respectively. In countries with less sophisticated administrative capacities, this figure is likely to be lower. However, there are ways to tax specific proxies of wealth such as property and these may still contribute to improved equality if their administrative costs are managed.
Doesn’t Sri Lanka already tax wealth?
Sri Lanka imposes some minor taxes on assets, but they are a far cry from what one would consider as comprehensive and effective wealth taxes for several reasons.
Those living in urbanised areas are likely familiar with the taxes charged on the ownership of property or land by Local Government (LG) institutions such as the assessment tax. The issue with these is that they are based on covering the costs incurred to supply public services to the locality (such as garbage collection). Therefore, the rates are low and not necessarily aimed at reducing inequalities.
Moreover, studies have shown that the tax collection process at the LG level needs major improvements as there are lags in valuation processes, and a lack of efficient tax collection and timely payments resulting in a significant gap in the estimated revenue and the actual amount collected.
If you have come into some property, you may also have encountered the stamp duty which is levied on the transfer of certain assets. However, this too is a minor tax that seems to be more of a fee on administrative costs rather than a comprehensive tax on wealth. Finally, there are wealth adjacent taxes like the Capital Gains Tax which is imposed on the gains from a capital transaction.
As it happens, Sri Lanka used to have one of the broadest forms of taxes on wealth, implemented in 1959 following the Kaldor Commission proposals. It also charged a tax on inheritances and gifts which helped discourage generational wealth accumulation. However, with time, these taxes were diluted with exemptions or met with political backlash and did not generate a significant amount of revenue, leading to their eventual elimination.
As we once again consider taxes on wealth, it is prudent to ask, has anything changed? And can we come up with an effective wealth tax for Sri Lanka in the present day?
How can we (effectively) tax wealth in Sri Lanka?
With the limited institutional capacity and social and political appetite for taxes at present, it would be quite difficult to successfully introduce a broad tax on wealth covering a wide array of assets. Instead, a logical initial step would be to address the shortcomings of existing taxes on wealth by improving the knowledge, skills, and technological capacities of tax collection authorities from the national to the local levels.
For instance, recent research has shown that the use of digital technologies can greatly aid in detecting wealth accumulation, especially property, which is a common form of wealth in developing economies. Fully implementing inactive legal provisions, creating greater awareness regarding the function of existing taxes on assets, and engaging in more systematic data collection and information sharing mechanisms across institutions are other steps that can support this. Beyond this, focusing on strengthening wealth adjacent taxes like Capital Gains Tax can also be useful.
In the long term, based on the success of these measures, it is possible to consider newer taxes on wealth such as a tax on inheritance and gifts. But these measures will need to be carefully designed to minimise economic distortions, and an appropriate threshold will have to be set to target the wealthy as opposed to average citizens. To do so, the implementing agencies need to bolster their capacity in terms of human resources and technology that is suitable for the Sri Lankan context, and importantly, transform the culture surrounding tax collection so that taxpayers are more intrinsically motivated to comply.
In short, considering the widening wealth gaps in society, our inequitable tax structure, and the strain on the Government’s revenue, introducing taxes on wealth is a reasonable proposal. To avoid the pitfalls that we have faced in the past, it’s important to set a realistic timeline and develop the capacity and environment necessary to give these measures the best chance of success.
Photo by Kanishka Ranasinghe
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