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National Budget 2021—Challenges and the Balancing Act

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On November 17, the incumbent Government will present the National Budget for 2021 to the Parliament. As the first step of the budget process, the Appropriation Bill was tabled in the parliament on 06 October. According to the Appropriation Bill, the Government expenditure for the year 2021 has been estimated at Rs. 2,678 billion. The second reading of the Appropriation Bill which is often referred as the budget reading or presentation of the budget will take place on 17 November 2020.

This Budget comes in the backdrop of the Government’s relief effort to manage COVID-19 pandemic which is a challenging task to the Government due to several reasons. Mainly, the Government is encountered with the challenge to raise the tax revenue and reduce the budget deficit while reviving the economy in the post COVID era. Presenting the Budget 2020 to the Parliament, Prime Minister Mahinda Rajapaksa noted that budget deficit for 2019 was 9.6 percent of the GDP due to the unaccounted expenses for 2020. This deficit would be the highest recorded since 2009. The Government estimates indicate that the budget deficit for 2020 would be 7.9 percent of GDP while IMF projections state that Sri Lanka’s net borrowing would reach 9.6% of GDP in 2020.

The rise in the deficit is a result of a slowdown in economic activity,  increase in expenditure to meet COVID-19 related challenges and the tax relief provided in November 2019. The tax reliefs were provided post the Presidential election in November 2019 with the aim to stimulate economic growth through encouraging consumption and production. Sri Lanka’s economic growth rate has been sharply declining over last few years and reached 2.3 percent in 2019, which was the lowest growth recorded since 2001. The tax changes included cutting down the Value Added Tax (VAT) by almost half and reducing income tax rates amongst other changes.

 

However, with the impact of the COVID-19 pandemic, expected economic expansion for 2020 was short-lived with the tax benefits provided not yielding the expected outcomes. . In this context, the Government is left with a tough challenge of managing an economic contraction with a significant reduction in tax revenue. Reports have indicated that the tax revenue of the Inland Revenue Department (IRD) for 2019 would be as low as the revenue collected in 2016 and would experience a reduction over 15% compared to the revenue collected in 2018. Thus, the Budget for 2021 is largely about striking a balance between reviving economic growth and keeping the budget deficit in check.

On top of the tough challenge to raise the tax revenue, Budget 2021 will require to adopt policies to address the Balance of Payment (BoP) challenges. While the short-term remedy to address BoP issues has been import restrictions, it is often not a viable policy option that can be sustained in the medium to long run. While import restrictions have controlled the foreign currency outflow during last few months, continuation of this policy could hurt the competitiveness of Sri Lankan products. This means, continuation of import restrictions could result in a stagnation of growth and reduction of exports in the medium term as a result of the lack of competitiveness. In that context, the Budget 2021 requires to strike a balance between import restrictions and growth and promote competitiveness of export industries.

This means that the Government would have to identify budgetary tools with strong multiplier effects (stimulus that can drive fast growth), relaxing import restrictive policies such as relaxing controls on raw material imports, identifying potential ways to increase Government revenue (both tax andnon-tax). Current fiscal position calls for the Government to adopt comprehensive strategies to increase the tax revenue without discouraging economic activities. Most importantly, the required tax reforms should sustain the growth in the medium and long term.

In this context, the Government needs to ensure the consistency and clarity in the tax law, a fundamental principle in taxation which seems to have forgotten by successive Governments in Sri Lanka. This in turn has adversely affected the country’s ability to facilitate ease of doing business (also reflected by Sri Lanka’s ranking on World Bank’s Ease of Doing Business Index). Consistency and clarity in the tax policy was amongst the key requests made by the Ceylon Chamber of Commerce (CCC) in its 2021 Budget Submission to the Government, “urging the tax laws and rates to be kept consistent for at least for the next five years”.

During the last few years, there have been tax laws which were enacted with retrospective effect while some major amendments to tax laws have been implemented based on paper notices and public circulars. These raise doubts regarding the clarity on tax reforms and create ambiguities. Subsequently, such ambiguities and lack of clarity leads to avoidance of tax as well as underpayment of taxes. Therefore, the Government needs to introduce tax reforms through comprehensive laws to ensure clarity and stability which is beneficial for both the Government and the taxpayer.

With the ongoing pandemic and the economic weaknesses of Sri Lanka, the Budget 2021 is not merely a representation of the Government finance for next year. The Budget 2021 is an opportunity for the Government to set the path for Sri Lanka’s economic development for at least next five years and will be an indication of the commitments of the Government towards economic growth and development.


DISCLAIMER:
The views and opinions expressed in this blog are those of the authors and do not necessarily reflect the official policy or position of any the organisation.

Senior Research Associate- EIU

Umesh Moramudali

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