Are We Finally Done Taxing Aunty Flo?

Originally published in Colombo Telegraph, Pulse, Economy Next, The Island, Daily FT, Ceylon Today, Kolomthota

By Nishtha Chadha

One of the most talked-about election promises this week has been Sajith Premadasa’s promise to distribute free sanitary hygiene products. Labelling himself as a #padman, Premadasa tweeted that “until sustainable cost-effective alternatives are found” he promises to provide sanitary hygiene products free of charge.

Indeed, access to menstrual hygiene products is a serious problem in Sri Lanka and has become a popular issue across political parties. In March this year, SLPP’s Namal Rajapaksa also tweeted about the issue, asking “What rationale could a Gov have to tax half it’s populace on a dire necessity? Is the Gov aware of studies on poor hygiene practices & cervical cancer?”

Taxing menstrual hygiene

Although 52% of Sri Lanka’s population is female, with approximately 4.2 million menstruating women, access to safe and affordable menstrual hygiene products remains somewhat of a luxury for many Sri Lankan women. A leading contributor to the unaffordability of menstrual hygiene products in Sri Lanka is the taxes levied on imported menstrual hygiene products. Sanitary napkins and tampons are taxed under the HS code HS 96190010 and the import tariff levied on these products is 62.6%. Until September 2018, the tax on sanitary napkins was 101.2%.

The components of this structure were Gen Duty (30%) + VAT (15%) + PAL (7.5%) + NBT (2%) and CESS (30% or Rs.300/kg). In September 2018, following social media outrage against the exorbitant tax, the CESS component of this tax was repealed by the Minister of Finance. Yet, despite the removal of the CESS levy, sanitary napkins and tampons continue to remain unaffordable and out of reach for the vast majority of Sri Lankan women.

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Figure 1: Breakdown of taxation structure (before September 2018)

General Duty     VAT     PAL     NBT     CESS    Total                                                

      30%        15%     7.5%     2%     30%    101.2%            

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The average woman has her period for around 5 days and will use 4 pads a day. Under the previous taxation scheme, this would cost a woman LKR 520 a month. The estimated average monthly household income of the households in the poorest 20% in Sri Lanka is LKR 14,843. To these households, the monthly cost of menstrual hygiene products would therefore make up 3.5% of their expenses. In comparison, the percentage of expenditure for this income category on clothing is around 4.4%.

Internationally, repeals on menstrual hygiene product taxation are becoming increasingly common due to their proliferation of gender inequality and the resulting unaffordability of essential care items, commonly known as ‘period poverty’. Kenya was the first country to abolish sales tax for menstrual products in 2004 and countries including Australia, Canada, India, Ireland and Malaysia have all followed suit in recent years.

The impact of unaffordability

The current cost of menstrual hygiene products in Sri Lanka has direct implications on girls’ education, health and employment.

Source: Menstrual Hygiene Management In Schools In South Asia, Wash Matters, 2018.

According to a 2015 analysis of 720 adolescent girls and 282 female teachers in Kalutara district, 60% of parents refuse to send their girls to school during periods of menstruation. Moreover, in a survey of adolescent Sri Lankan girls, slightly more than a third claimed to miss school because of menstruation. When asked to explain why, 68% to 81% cited pain and physical discomfort and 23% to 40% cited fear of staining clothes.

Inaccessibility of menstrual hygiene products also results in the use of makeshift, unhygienic replacements, which have direct implications on menstrual hygiene management (MHM). Poor MHM can result in serious reproductive tract infections. A study on cervical cancer risk factors in India has found a direct link between the use of cloth during menstruation (a common substitute for sanitary napkins) and the development of cervical cancer; the second-most common type of cancer among Sri Lankan women today.

The unaffordability of menstrual hygiene products is also proven to have direct consequences on women’s participation in the labor force. A study on apparel sector workers in Bangladesh found that providing subsidized menstrual hygiene products resulted in a drop in absenteeism of female workers and an increase in overall productivity.

Towards a sustainable solution

If the Government is serious about finding sustainable solutions to the issues associated with unaffordability of menstrual hygiene products in Sri Lanka and promoting gender equality, it should be looking to slash the heavy import taxes currently levied on these products. Current taxation rates are keeping prices high and out of reach for a majority of Sri Lankan women. By reducing these rates, the cost of importing sanitary napkins and tampons will simultaneously decrease and stimulate competition in the industry, further driving prices down and encouraging innovation.

The conventional argument in favour of import tariffs is the protection of the local industry. However, in Sri Lanka, sanitary napkin exports only contribute a mere Rs. 25.16 million, or 0.001%, to total exports. Increased market competition would also incentivise local manufacturers to innovate better quality products and ensure their prices remain competitive for consumers.

Other common concerns pertaining to the issue of low-quality products potentially flooding the Sri Lankan market if taxation is reduced are unlikely to materialise since quality standards are already imposed by the Sri Lankan government on imported products under SLS 111.

In addition, making these products more affordable would align with Sri Lanka’s commitment to Article 12(1) of the International Covenant on Economic, Social and Cultural Rights (ICESCR), which promotes the right of all individuals to enjoy the highest attainable standard of physical and mental health. By keeping prices high, present taxation methods are contributing systematic obstruction of many women’s right to equal opportunity to enjoy the highest attainable level of health, and thereby do not meet the ratified standards of the ICESCR.

If menstrual hygiene products are made more affordable, it is likely that more Sri Lankan women will be able to uptake their use. Sri Lanka should thus remove the remaining import levies on menstrual hygiene products as soon as possible, via the means of an extraordinary gazette. Removing the PAL and General Duty components alone would bring taxation levels down by 43.9% to a total of 18.7%. This would remove a significant barrier to girls education, women’s health and labour force participation, and create a wide-scale positive impact on closing Sri Lanka’s present gender gap and facilitating more inclusive economic growth. There has been a lot of rhetoric around keeping women safe and making them a priority this election – so what better place to start than this?

Cost of construction and controlled prices on cement

Originally published in Daily News

By Ravi Ratnsabapathy

Sri Lanka suffers from high construction costs which makes housing unaffordable. A study on domestic migrant workers by Caritas Sri Lanka (2013) showed that for 61% - one of the reasons to migrate was to build a house. Numerous other surveys confirm this finding.

High construction costs also present problems for businesses, particularly tourism where the cost of the building forms a large part of the initial capital outlay. Last week, an article in the Daily News reported that a top executive in a private-sector property company had stated Sri Lanka’s construction cost is at least 30% higher than of Malaysia; a country that it several times wealthier than Sri Lanka.

How can someone on a Sri Lankan salary expect to build a house paying 30% more than someone in Malaysia?

According to a report by Jones Lang LaSalle (2014): “high project development costs coupled with the high borrowing costs for housing loans have breached affordable limits and restricted the home buying prospects for Sri Lanka.

Based on our understanding from the affordability assessment, only the top-income-earning resident Sri Lankans can buy homes in Colombo. Residents with limited income are forced to opt for properties that are at least 20-25 km away from the city limits.”

This is a complex problem and the government controls the price of cement to keep costs under control, but this is obviously not working if construction costs are much lower in other countries.

There are a number of reasons for high costs including supply constraints-shortages of sand and aggregates as well as high cement costs that contribute to high costs of concrete. Then there is the high price of other materials which are high due to protective taxes including steel bars and rods (taxed at 89.66%), ceramic Tiles (taxed at 107.6%), sanitaryware (taxed at 72.4%) as well as aluminium extrusions, granite, electrical fittings and carpets,

Apart from protective taxes, the lack of scale amongst contractors, low labour productivity, outmoded methods and long delays in approvals all contribute to higher overall costs.

The impact of the taxes may be illustrated by comparison to regional prices. For example according to information collated in in September 2016, steel costed around USD 723mt in Sri Lanka but costs only USD500mt in Thailand and USD 470mt in China.

What is surprising is that even cement is higher than the region, despite the price control. How can this be? The problem is in the way the government goes about setting price controls, the Consumer Affairs Authority applies a narrow range of controlled prices on cement which vary by product and manufacturer. The prices are determined based on cost estimates for each product provided by each manufacturer.

Usually if a controlled price is set too low it results in shortages but there are no visible large scale shortages, although these are not unknown, being witnessed in 2011 and 2014. Temporary shortages of cement occur from time to time due to hoarding when traders hoard stocks, in anticipation of price revisions.

It is likely that involvement of the industry in the price setting process means that they set at a level comfortable to the industry. With set prices there is no competition among producers on price, so normal competitive forces do not function either.

Quality

Why not solve the problem of high priced local cement by simply importing cheaper cement, if it is available elsewhere? The local cement industry claims this will lead to low quality (and low cost) cement imports, something that has been experienced in the past. Cheap cement is available overseas but the possibility of substandard cement or construction work is of serious concern since the consequences will manifest long after construction is completed and carry grave consequences.

Cheap imports of cement would benefit consumers but how should quality be ensured?

The problem is that Sri Lanka lacks a comprehensive building code; essential for consumer protection and public safety. Although old regulations such as the Factories Ordinance exist these are not up to date and enforcement is weak. A Standard Code of Practice to regulate and enforce design, construction and compliance requirements is necessary.

While a uniform code is absent, a multiplicity of approvals exist: at provincial, district, Pradesheeya Sabaha, urban and municipal level. These become even more complex when central agencies such as Urban Development Authority (UDA), Sri Lanka Land Reclamation and Development Corporation and Department of Agrarian Development. This leads to overlaps of authority, conflicts of instructions, contradictory regulations and compliance loopholes.

There is a lot of red-tape but it does not improve safety.

A proper code, legally enforceable, covering all classes of buildings and including safety, structural stability and accessibility is needed. The code should be enforced by holding the building contractors and architects responsible for any failures and carry criminal and civil penalties.

Along with a code, building contractors and architects should be licensed and carry professional indemnity insurance. The objective of licensing is to ensure that work is done by people who are conversant with the standard (which should carry statutory force) and conduct their duties competently and professionally.

In the event of any failure in buildings they may lose their license to practice. This is apart from any action taken in the courts. The insurance ensures that consumers can receive compensation for shoddy work.

Specialist licenses should be necessary for more complex work including:

(a) Piling works

(b) Ground support and stabilization works

(c) Site investigation work

(d) Structural steelwork

(e) Pre-cast concrete work

(f) In-situ post-tensioning work

Underinvestment

Sri Lanka has abundant limestone deposits in the North but even ten years after the end of the conflict the cement plant in the area remains closed

Underinvestment in the sector may be attributed to a combination of the uncertainty surrounding prices and protectionism. Investment decisions are long-term and price controls; despite industry influence in setting them, does add a new level of uncertainty over future profits, deterring investment. This is particularly so in the cement industry because the start-up costs are high and the gestation period for a plant is long.

In 2013 the Government imposed a restriction on the number of cement plants that may be operated in a port limiting it to one per port. If a new factory is to be set up, priority has to be given to existing operators in the port, effectively limiting competition.

Overall construction costs

Despite price controls being imposed on cement, Sri Lanka has high costs of construction. There is no coherence in policy with different objectives are being pursued in isolation, unlike for example in the UK where the Government in partnership with industry has developed a strategy to improve the performance of the construction sector by 2025. Objectives include lowering costs: a 33% reduction in the initial construction of new build and the whole-life costs of built assets, a 50% reduction in the overall time, from inception to completion of construction and a 50% reduction in greenhouse gases.

Overall, intervention in the construction market has resulted in raising, rather than lowering construction costs.

Further, by failing to understand the proper role of the state and intervening unnecessarily in setting prices it has neglected its core responsibility – regulation to protect consumers. Although in most circumstances the best protection is the common sense of an individual consumer, in instances where technical knowledge is needed to detect poor quality there is a case for regulation, particularly if public safety is involved.

The lack of a building code is a serious failure on the part of the state.

To protect consumers the Government should stop regulating the price of cement and focus on drawing up and enforcing a proper building code.

To lower costs the tax structure on construction materials must rationalised and competition facilitated.

Dysfunctional Taxation

Originally published in Echelon

Much of Sri Lanka’s money problems can be traced to its weak income tax.

By Ravi Ratnasabapathy

It may seem paradoxical; the idea that higher taxes will spur economic growth. The theory goes that high taxes are a drag on growth by taking away resources from people and companies that can otherwise be productively deployed. However, in poor and middle- income countries, where tax collections relative to the size of the economy is low, the opposite is often true. Taxes help pay for critical infrastructure and social services; without roads, schools and hospitals, private sector wouldn’t invest.

Poor countries struggle to raise adequate tax revenue to pay for public infrastructure. This is the cost of being poor; most people are penniless, and much of the economic activity is in the informal sector, which puts it beyond the taxman’s reach.

Businesses and wealthy people who should pay tax on profit or income don’t feel compelled to do so because the government is usually corrupt, infrastructure derelict and nobody else is paying taxes anyway. Income tax that businesses and self-employed pay on their profit, and those with jobs pay on their income is relatively easy to dodge. Although tax dodging, also called evasion, is a criminal offense gathering evidence to prove this is impossible where cash transactions are the norm, and companies don’t keep detailed records.

The other primary tax source is consumption. A country with enough resources invested in the administration can successfully enforce consumption tax by requesting companies pay a portion of turnover as tax. Enforcement is easy because it’s a simple, efficient and difficult to evade tax.

Since, consumption tax has evolved into taxing just the value addition at a higher rate than the entire turnover at a relatively low rate. Poor countries, on average, collect the equivalent of 13% of GDP in taxes. In the rich world, this number is around 34%. Middle-income countries have tax collections that fall in between those collected in the poor and the rich.

Sri Lanka is not a poor country. In fact, in 2019, when per capita GDP crossed the $4,000 threshold, it was classified as an upper-middle-income country. It rose above abject poverty ranks following the economy’s opening to market forces in the late nineteen seventies.

During the years between 1950 to 1989, the government’s tax take averaged 21 percent collected in income tax, turnover tax and import levies, combined. (see Chart 1) Sri Lanka’s total tax income as a percentage of GDP has since fallen to 11.9% in 2018, lagging behind all its developing country peers in taxto- GDP: Georgia 24%, Samoa 23%, Ukraine 18%, Armenia 17.5% and Tunisia 21%, according to IMF data.

Tax collections as a percentage of GDP now are lower than those of even sub-Saharan Africa. The Center for Tax and Development estimated three years ago that the average tax take in sub-Saharan Africa rose from 12% of GDP in 1990 to 15.1% by 2018. The turnaround in sub-Saharan Africa is due to the implementation of value-added tax, and the creation of autonomous tax agencies. Sri Lanka’s main challenge is that at the equivalent of 2% of GDP, the income tax contribution to revenue is low. The government had set a goal in its medium-term economic plan to increase income tax contribution to total tax revenue from 20% to at least 40%. Income tax is paid by companies on profits, and individuals on their earnings.

However, in 2018, three years after that announcement, income tax-to-GDP stood at 2.1 percent. This is also a much lower rate of collection than Sri Lanka’s peers in the middle-income group: Georgia and Mongolia have 9%, Bhutan 7.7%, Samoa 5.6% and even troubled Egypt has 6%. If the income tax to consumption tax ratio is to improve from  regarded as a comfortable level for equitable growth, income tax-to GDP-must reach at least 6% assuming no taxes and rates are changed.

A tax-paying population will keep governments honest, since taxpayers will want to see that their money is not squandered or worse, stolen. Even the United Nations’ Millennium Development goals included an aspiration for all countries to at least raise tax income equivalent to 20% of GDP. Mick Moor, who is the founding Chief Executive of the International Centre for Tax and Development (ICTD) of UK, identified five factors that have led to the quarter-century-long revenue decline in Sri Lanka.

Some of the problems are clear. Income tax evasion here is widespread for an economy in Sri Lanka’s state of development, the tax code has too many loopholes making it easy to avoid taxes (which isn’t an offence), Sri Lanka’s revenue department not being an autonomous agency, and broadly because governments have failed to adapt to significant changes in economic structure, by modernising the revenue system.

Moor, who published “The Political Economy of Long-Term Revenue Decline in Sri Lanka” in 2017, makes five main arguments. The first is the declining electoral pressure of large scale public spending on welfare.

Sri Lankan governments from the 1940s to 1970s undertook large scale spending on social welfare. Unusually high human development indicators were a result of mass state supply of health, education and subsidised food.

However, since the revenue was high during those decades, it was possible to sustain a ratio of government spending to government revenue of over 1.3 to 1.7 times, without too many adverse implications. (see Chart 2)

Tight budget deficit management has been a feature since the present government took office. As a result, the ratio of government spending to income has declined in the four years to 2018 to 1.4 times. By containing costs, domestic taxes now cover all recurrent expenses, excluding interest payments. The trend is impressive because its a feat previously only achieved a few times, since independence.

However, so far, it has not managed to improve overall revenue. Income tax revenue, the weakest component of the tax structure are rising, although, in the overall revenue, they are still too small to show an impact. Income taxes accounted for 18 percent of total revenue during the January – April 2019 period, after Value Added Tax, which contributed 27 percent and excise duty, which brought in 22 percent.

Total revenue from income tax increased by 9.6 percent to 104 billion rupees in the first four months of 2019, from a year ago, with revenue generated from corporate and non-corporate income tax up 10.2 percent to Rs43 billion. Revenue generated from Pay-As-You-Earn (PAYE) tax increased by 18.6 percent to Rs22.4 billion in the eight months to August 2017 from a year ago. This was because employee incomes rose and tax administration became more efficient, according to the finance ministry’s Fiscal Management Report – 2018.

The second reason for the declining revenue; is the availability of easy foreign aid. Following the 1977 general election aid flows increased rapidly. Suddenly governments were able to, without much pressure, run much larger budget deficits. During the 1970s and 80s, the demand and prices for Sri Lanka’s commodity exports began to decline impacting tax collections. Export taxes, now anathema, were a source of government revenue then. During the five years to 1975 export taxes contributed 11%, and in the five years to 1980, 23% of annual government revenue. By the late nineteen eighties, import taxes had all been eliminated.

Tax exemptions for foreign and local investments are the third factor in the steep tax revenue decline. By 1982 the Greater Colombo Economic Commission, the precursor to the Board of Investment, had both the authority to grant tax holidays, and took over the power of Customs in the management of the Export Processing Zones. Foreign investors, besides, received generous depreciation allowances and duty-free permits, for all investors and not just for those producing for export. Sri Lanka’s policy of the President holding also the job of the Finance Minister eroded the urgency for focusing on revenue, and adapting the tax department to significant changes in the economic structure. Except for 29 months between December 2001 and April 2004, when the government and the executive were from two parties, the president has also held office as Finance Minister.

Mick Moor suggests there is strong evidence that the absence of a powerful minister of finance has undermined revenue collection. An absentee finance minister is the fourth reason for ineffective revenue performance. The fifth challenge is its high reliance on taxing imports to make up for the poor tax revenue performance. Import duties have long been a significant source of revenue, because they are easy to collect. Compared to the late 1930s, Sri Lanka remains similarly reliant on taxing imports for revenue. (see Chart 3) World over governments revenue is earned mainly by taxing income and consumption. Because of the many economic growth impairing eff ects of taxing imports, many counties do so only sparingly.

Ignored so far but in Sri Lanka are property taxes. So far property tax implementation, including land tax, at municipal council level has been crude. It’s a tax that naturally falls on those who can afford to pay, and is an efficient tax since it does not discourage productive activity. It was only the relative ease with which the plantation economy could be taxed that generated a high tax rate in the mid-twentieth century. Income tax has raised significant revenue since 1932. Self-assessment was introduced as early as 1972 and a relatively sophisticated turnover tax introduced in 1963. This was replaced by VAT in 1998. That income tax success revered after 1990.

Now they generate about a third of the revenue it should be making. Instead of serving the population around a third of revenue is consumed by an exploding bill for civil servants, and another third of revenue for pensioners. Weeks ago the government announced pay and pension hikes and thousands of new state sector jobs. More tax will not disappear into an ever more bloated bureaucracy. Th ere is also light at the end of the tunnel.

Sri Lanka’s last constitutional amendments permit only members of parliament can be appointed ministers. Th e president will not be able to hold ministerial posts in the future. A powerful minister to manage finance can ensure revenue targets are met.

Improvement in revenue administration via a cloud-based application known as RAMIS of the Inland Revenue Department also helped improve the tax collection mechanism. Its already showing results in enhancing income tax collections. If indeed income tax collections do rise because the wealthier sections are paying their share of taxes on income, property values and other wealth, the underfunded public education, health and social protection systems can be fixed. The government implemented in 2015 new revenue-raising measures with some success. Taxes are never popular, and there are no easy ways to overcome such resistance.