FINANCIAL CHRONICLE – Sri Lanka has achieved significant advancements in tax collection, particularly by enhancing its value-added tax (VAT) system. This improvement is aimed at funding state employee salaries, providing education and healthcare, and generating cash flows to service interest on existing debt. After enduring aggressive macroeconomic policies under a 5% inflation target, which resulted in recurring currency crises and multiple International Monetary Fund (IMF) programs post-civil war, taxing the populace has become crucial. However, the extent of taxation has limits, particularly concerning income and taxes on savings, which could hinder capital investment and aspirations for Sri Lanka’s growth trajectory.
Savings and investments stem from already taxed income, and some tax types could discourage investment. Wealth taxes, for example, are levied on assets without cash flow, potentially discouraging housing investments and increasing rental costs. In the U.S., similar taxes have negatively impacted housing maintenance, inflating property values and triggering higher taxes. Historical examples, such as the rollback of high taxes in the UK post-World War II and Germany until its conclusion, highlight the complications of excessive taxation. On the contrary, East Asian nations and GCC countries maintain low tax rates, fostering high growth and monetary stability.
Taxes are inherently coercive and can become confiscatory, undermining essential property rights for market economies. As analyst Ravi Rathnasabapathy points out, the coercion in taxation differentiates it from charity but blurs the line with confiscation when tax rates compel the sale or transfer of property to satisfy tax obligations. Even non-confiscatory taxes challenge the principle of private property, which should not be appropriated for public purposes without fair compensation. Yet, taxation remains a state’s prerogative, intertwined with property rights; without private property, there is no economic substance to tax. The state, tasked with upholding property rights, relies on resources derived from taxation.
The coercive element in taxation places administrators in a powerful position relative to citizens. The challenge lies in preventing power abuses, achievable only through robust institutions, rule of law, and a sound justice system. Weak institutions lead to citizen oppression. In Sri Lanka, institutional integrity and citizen rights are compromised, partly due to the absence of permanent secretaries, as highlighted by the Asian Human Rights Commission and other analysts. Such sentiments are reflected in Sri Lanka’s ranking of 74th out of 143 countries in the World Justice Project’s 2025 report.
Investors face challenges, such as protracted audits spanning multiple years, resulting in stress and uncertainty. For instance, one investor, faced with audits revisiting matters 15 years old, chose to simplify his affairs, moving from active business to passive investment, demonstrating how aggressive tax administration can skew economic behavior. Basic justice principles dictate that state powers, which can deprive individuals of property or livelihood, must be restrained.
Rathnasabapathy emphasizes that taxation, affecting property and livelihoods, necessitates due process. Errors in tax administration occur, necessitating safeguards to rectify them fairly. However, in Sri Lanka, legal safeguards largely exist only on paper. Effective oversight, timely appeals, and accessible remedies are weak or non-functional, making it nearly impossible for taxpayers to challenge revenue authorities. Consequently, taxation can become oppressive under such conditions.
The broader breakdown of the rule of law in Sri Lanka exacerbates taxpayer difficulties, often discussed in human rights contexts. Administrative power, whether by police, regulators, or revenue authorities, operates without effective restraint. Sri Lanka’s recent tax hikes coincide with Western nations’ moves towards higher income taxes following fiscal stimulus, thwarting the development of efficient, growth-friendly tax systems. Increased tax collections do not guarantee debt reduction, especially if monetary instability persists, leading to crises and economic contractions.
Sri Lanka’s first significant tax hikes occurred post-1952’s central bank balance of payments crisis, when national debt was less than 20% of GDP. The IMF program emphasizes increasing tax revenue, leading to new taxes, rate adjustments, and a broadened tax net since May 2022. Income tax files have more than tripled, and VAT registrations have doubled, resulting in a 55% tax revenue increase in 2023, followed by 25% growth in 2024 and the first half of 2025.
The surge in tax collection has garnered praise, yet a fundamental question remains: Is the tax being collected justly? The rush for revenue might lead to undue pressure on taxpayers through broad interpretations of tax law or arbitrary assessments. The IRD’s extensive powers, intended to deter non-compliance, create fear in a country with inadequate oversight and weak redress mechanisms.
In the UK, HM Revenue & Customs (HMRC) operates with multiple oversight levels to protect taxpayers from arbitrary treatment. HMRC’s structure promotes impartiality in enforcement, with accountability to a Board that includes independent directors. The Taxpayer Charter ensures performance reviews and compliance monitoring. In contrast, Sri Lanka lacks such oversight, and redress procedures are costly and protracted.
Taxpayers in Sri Lanka must navigate a cumbersome redress process involving an internal review, an appeal to the Tax Appeals Commission (TAC), and potentially the courts. The process is lengthy and lacks independence, often leaving taxpayers with no practical means to dispute claims, especially when historical records are unavailable.
Tax administration practices reveal systemic issues: arbitrary assessments, excessive audits, and disregard for statutory limits. These practices burden taxpayers, with some companies receiving demands for decades-old disputes. The self-assessment system is undermined by officials rejecting returns without valid reasoning, forcing settlements to avoid costly appeals.
In conclusion, justice principles necessitate constrained state powers in taxation. Sri Lanka’s legal safeguards are weak, making it difficult for taxpayers to challenge authorities. This situation reflects a broader rule of law breakdown, exacerbating administrative power abuse.
Without effective oversight and redress, tax administration practices can become oppressive. The absence of comprehensive oversight mechanisms in Sri Lanka hampers taxpayer rights and deviates from legal fairness. While some tax increases are unavoidable, relying on revenue extraction in a weak legal environment is counterproductive. Arbitrary taxation deters investment, suppresses growth, and erodes the tax base.
Sri Lanka’s business environment already faces challenges, and aggressive tax administration exacerbates them, deterring investment and growth. Signs of taxation reaching its limits are emerging, evident in the IT/BPO sector’s downsizing following a 15% tax imposition on service exports. Continued reliance on aggressive taxation risks stalling growth and diminishing the export sector, ultimately stunting the economy.
