LNP – Budget deficit expands despite higher taxes and expenditure cuts

Barely into a year since the present administration opted for an International Monetary Fund (IMF)-assisted fiscal reset by raising taxes and rationalised spending, the budget is still running a higher deficit than a year ago, the data showed.
Sri Lanka raised taxes across the board, ended exemptions and introduced new taxes such as Social Security Contribution Levy while suspending big time spending to plug the fiscal hole, which many repeatedly claimed was the root cause for the economic crisis last year.

Despite implementing significant changes in economic management approximately a year ago, the country continues to face challenges in reducing its budget deficit.
According to the most recent data available up until March 2023, the budget deficit for the first three months amounted to Rs.624.8 billion, a slight increase from Rs.484.3 billion during the same period last year.

As expected, the country witnessed growth in revenue from Rs.446.9 billion to Rs.635.3 billion, primarily driven by increased tax income.
However, this growth was hindered the higher tax rates and the prolonged, significant decline in the overall economy, which seemed to have undermined the full potential of tax collection.
The economy in the first quarter contracted by 11.5 percent after shrinking a record 7.8 percent in 2022, when the country ran out of its foreign exchange and other supplies, firing inflation and interest rates to insurmountable levels. The economy is believed to have exited the recession in the second quarter, which ended last week, providing perhaps some fillip into the tax incomes, helping to cut the deficit in the remainder of the year.

But with true prices and interest rates still remaining at red-hot levels, alongside excessive taxes both on businesses and personal incomes, a fast turnaround in spending by the two groups could take longer than anticipated.

Multilateral agencies still expect the overall economy to contract in 2023 although the second half could register a recovery.As the interest rates are expected to come down, it is likely that credit flows will resume, benefiting the real economy. However, in order to unlock the full potential of certain sectors, it will be necessary to implement tax cuts by next year. This measure will help alleviate constraints and provide the necessary boost for those sectors to thrive.
Sustained growth in tax incomes and economic growth cannot be expected in an economy where the tax rates are restrictively high, specially when so-collected taxes aren’t providing the taxpayers a return by way of improved services from the government with efficient and less corrupt public service, better infrastructure and less red tape.