Poor governance is holding back post-conflict Sri Lanka from healing wounds and realising equitable growth, says the Sri Lanka Human Development Reports 2012, compiled by the UNDP and the Institute of Policy Studies, while a regime of heavy indirect taxation contributed to poor governance.
“There is now an opportunity to correct the problems arising from Sri Lanka’s prolonged conflict, but progress in the domain of governance has been slow. Among other causes, this is due to difficulties in agreeing on the way forward; the complexities of rebuilding trust among different population groups; the constraints on the re-development of governance infrastructure in conflict affected areas; and the challenges of educating people, especially those who were unable to access public services, and making effective use of existing governance structure,” the report said.
“Ultimately, it is what happens in peoples’ lives that matters. Unless more and better jobs are created, unless the fruits of growth are more evenly distributed, unless people are aware and involved in governing their lives, and unless all of these elements are attended to in a timely manner, it might be difficult to contain social discontent. In essence, the country faces the challenge of expanding good governance in the context of securing peace,” it said.
Chapter 6 of the report titled ‘Bridging Governance Gaps: State Capacity and People’s Participation’ shows the relationship between governance and the taxation regime.
Economists have shown how governments heavily relying on indirect taxation tended to have poor governance structures.
“When taxation becomes more visible, such as through a shift from indirect trade and consumption taxes to more direct taxes on income, tax payers are more likely to mobilise politically, fostering healthy state-society relationships oriented around accountability and better governance. In Sri Lanka, taxation remains heavily skewed towards indirect taxes, however, which generated nearly 81 percent of income between 1977 and 2010. Direct taxes contributed about 19 percent of total tax revenue,” the UNDP/IPS said.
With the state being the primary provider of social services such as education and health, the government needs to strengthen its financial capacity, with low investment and wide disparities prevalent in both the education and health sectors. Improving tax revenue is critical, not keeping up with recent economic growth, while ad hoc policy too burdens the system. Public investment on education fell from a peak of 2.7 percent of GDP in 2006 to 1.9 percent in 2010. Healthcare spending accounted for 4.1 percent of GDP in 2008, with 86.7 percent of this spent directly by citizens.
“Tax revenue as share of GDP dropped to around 15 percent during 2003-2008, compared with 19 percent before 1995. The benchmark tax to GDP ratio for a lower income country is around 18 percent, is 25 percent for a middle income country. Sri Lanka’s tax ratio was just 12.4 percent in 2011, having declined from a peak of 24 percent in 1987,” the report showed.
According to recently published Central Bank data, tax revenue declined to 6.53 percent of GDP for the first seven months of this year from 6.69 percent a year earlier. The fiscal deficit for the seven months period has reached 5.5 percent of GDP with the full year target being 6.2 percent, an indication that fiscal performance would be significantly off target.
According to the UNDP/IPS report, full implementation of recommendations made by the Presidential Commission on Taxation, which sought to reform the tax system and substantially improve revenue, has not taken place due to competing stakeholder interests and political sensitivities.