Government fiscal policy deals with Economic study and the impact of different taxes, duties, and levies on individuals, groups, and economy as a whole. These fiscal and tax policies cannot be viewed in isolation but as part and parcel of economic and social goals persuaded by the government. When we look at the historical background on fiscal policy changes in Sri Lanka during the post-independence period from 1948 to 1977 in an analytical manner, it can be categorized into three types of policy changes.
Ad hoc changes for revenue requirements or due to budgetary constraints.
Changes due to changes in socio-economic goals and development strategy
Changes consequent on periodic overall reviews of the fiscal and tax system
(Kelegama & Tennakoon, 2009)
Immediate post-independence period
At the immediate post-independent period, which is the years after independence in 1948, political history and also the fiscal history was converted. And fiscal and tax policies came to be motivated by not only in considering revenue demands but also by concerning corrections of adverse balance of payments, encouragements and protection of local firms, reduction of cost of living for social goals and as a bridge for economic development.
These changes resulted in rapid and much-complicated changes in fiscal policies and made heavy demands on tax administration and tax structure. And also they were able to reach revenue targets and fulfill other objectives of fiscal policy.
The main issue facing the government of Sri Lanka since independence was the concordance of fiscal measures to provide savings and investments along with the maintenance of welfare and subsidies. During the period of 1950-1960, main government objectives were health, growth distribution and fiscal policy were used to protection and distribution of domestic manufacturers and also to increase household savings.
During this period, the tax system used to accomplish various purposes, and that resulted in rapid changes in the tax system. From 1953-1954 to 1965-1966 period, twenty-one new taxes and levies were imposed. Most of them were experimental in character, and fifteen of them were abandoned by 1966.
Kalder Scheme
During the post-independence period, the government attempted to go for radical integrated tax policy to encourage savings and investments in the form of the self-checking tax system. The Kaldor scheme which is a comprehensive reform of direct taxation by prof. Nicholas Kalder was an interrelated scheme for increase investible surplus by reducing the marginal income tax rate from high rates to 45% ensuring that this surplus was channeled for investments and not for consumption purposes.
This kalder system was short-lived, and it failed in Sri Lanka and also India. This scheme was a successful self-integrated system on paper, but in practice, it failed. Because it failed to consider local socio-economic and political conditions and also its administrative complexity for both taxpayers and tax administration. The expenditure and land taxes were abandoned in 1963 after only three years. (Kelegama & Tennakoon, 2009)
Fiscal policies during the sixties to mid-seventies
During 1960, Economic strategy performed by increases in labor-intensive and capital expenditure, local raw material using investment in both agriculture and industry with the purpose of import substitution and increasing employment opportunities with in the country. And also social welfare facilities such as food subsidies, health, and education subsidies were concerned and those subsidies accounting for over 40% of total recurrent expenditure. Some tax holidays were made to promote Industries which were focused on being of national importance, Pioneering industries.
During this period also showed the rise in taxes on domestic good and services, especially the charges on the sale of product and commodities. Those were easily collectible and reduce disincentive effects. Taxes on local purchases of goods and commodities was first introduced as the form of a direct sales tax in 1962. But it was not properly worked out with little preparatory public education on the issue of receipts.
In 1963, Business turnover tax (BTT) was introduced, and it was resulted to fall in import duty revenue. Actually, this was a multi-stage tax levied on gross receipts with comprehensive coverage on manufacturing, retail trade, wholesale and services. This BTT and turnover taxes were a significant part of the Sri Lankan tax system until it was replaced by a value-added tax system in the form of goods and services tax (GST).
This value-added tax system is more superior form of sales taxation implemented by more than 140 countries up from just in 1968. The turnover tax was a more flexible instrument that can be adjusted to changing fiscal conditions, natural to collect, and better understood by both taxpayers and businesses. And also during 35 years of history, there was no BTT or turnover tax fraud recorded.
Period 1970 to 1977
In the mid-1970, the united front government formulated socialist-oriented policies in Sri Lanka. As a result of it, government fiscal and tax policies were changed. They are,
In 1971, the government imposed a capital levy which affected on wealth in the form of housing, industry, land and also plantations.
From 1971/72 to 1975/76 introduced a compulsory saving scheme.
They charged high rates of marginal income tax for both companies and individuals. (individuals 65-80 percent and companies 50-60 percent)
Reintroduced expenditure tax in 1976
Actually, these fiscal had both positive and negative results. From the positive side, the trade balance was positive, the balance of payment favorable and local industries increased, foreign reserves were high and also inflation was relatively low. On the other hand, there were lower growth rates(about 3.2%), increased unemployment over 20% of the labor force, and also reduced domestic savings of only 12.7%. And this closed economy resulted in making food transport barriers and shortages of capital and consumer goods with queues.(Kelegama & Tennakoon, 2009)
During this period, fiscal and tax policies led to disincentives to both investments and savings. High-income tax rates on narrow base, complex rate structure and series of short term levies resulted in a complicated fiscal structure, law compliance, tax evasion, and a loss of credibility in the tax system.
Government Budget during the period from 1948 to 1977
Every economy in the world represents their government duty through its budgetary policy. In Economics, government fiscal policy focus on how to budget deficit or surplus effect on employment and growth in an economy. (Samarasiri, 2010). Before the 1930s, most of the governments were practiced to present their budget as a surplus. But after the 1930’s they started to prepare their budget as a deficit. From 1950,s Sri Lankan government also practiced this method since they get a budget deficit. In 1950 budget deficit was 5 million and in 1965 it was 55 million. (Appendix 1, Table 1).
In the early 1950s, the government budget and which were in the region of 16% of GDP were managed satisfactorily within the available reserves. At the end of the 1950s the government, the budget was running into grave problems. While government revenue had increased from about 14% of GDP in 1950 to about 21% in 1960. Public expenditure had risen from about 18% to 27% during the same period and the overall budget deficit from 3.6% of GDP to 6.4% of GDP. (Appendix 1, Table1).
During the 1959-1960 period, tariff taxes were 57% of GNP, and in 1960, export taxes were 28% of GDP. But during the 1969-70 period tariff taxes were fallen up to 34% due to restrictions of imports after 1960. In the 1970s export taxes were dropped up to 17% of GDP due to fluctuations in import prices. (Appendix 1, Table 3). During that period, common export commodities were Tea, Coconuts, and Rubber.
From 1970 to 1977, indirect taxes were 75% of the government revenue due to the expansion of foreign government trades.1971 budget introduced compulsory savings tax on people who earn more than Rs.9000 per year. In 1973, Decentralized Expenditure system, which is focus to expend a small part of the government expenditure in the decentralized method, was introduced. In 1974, government revenue was 4786.7 million, and it was 5738.9 million in 1976(Appendix 01, Table1).1976 government budget introduced a direct tax in the form of saving tax to promote domestic savings.
Since 1950, there was a continuous budget deficit in Sri Lanka, excluding 1954 and 1955 years (Appendix 02, Figure 02). If a particular economy exceeds its budget deficit more than 5% of GDP, it is not a favorable economic situation for that economy. According to the Keynes (1930), when there is a situation where a particular country having an economic recession, that economy can increase its aggregate demand by expanding their government expenditures. The government can increase its spending through the process of money creation. Finally, it resulted in increased production and higher economic growth.
Government fiscal operations for 1977 exerted a contractionary impact of 716 million on the economy. (Appendix 01, Table 04).Capital expenditure in 1977 dropped by 19%. This lower Capital expenditure in 1977 could be attributed to an absence of the usual vigilance over performance in an election year and the temporary administrative dislocation that occurs with the changes of governments.(Appendix 01,Table 04).
In 1977, recurrent expenditure 6147 million revealed an increase of 11% over last year due to the higher cost of maintenance supplies, new staff recruitments for public services, and higher personal emolument to civil servants. During this year government revenue amounted to 6686 million, revealing an increase of 17% than the previous year due to the buoyant export prices and the relatively high value of imports(Tea tax, Export duties, Tobacco tax ).
