IMF Mission Chief for Sri Lanka, Evan Papageorgiou, has announced that an IMF mission would visit Sri Lanka from 24 to 30 June. He confirmed that the mission would engage with the Government and a broad range of stakeholders to review Sri Lanka’s ongoing economic reform program and assess the implementation of critical structural reforms. Papageorgiou stated that the IMF looked forward to constructive and productive discussions during the week-long mission.
Meanwhile, the Government has already announced several measures aimed at improving tax compliance, digitalisation, and the efficiency of the tax system. Two important changes have been introduced, and the necessary legislative amendments have been presented to Parliament. First, VAT obligations will be extended to non-resident providers of digital services supplied to Sri Lankan consumers through electronic platforms, thereby ensuring equal tax treatment between overseas providers and resident businesses. Second, the two applicable taxes (VAT and the Social Security Contribution Levy) will be consolidated into a single effective tax rate of 20.5% to simplify tax administration.
Deputy Finance Minister Dr. Anil Jayantha Fernando stated that maintaining fiscal discipline, strengthening revenue administration, and adhering to the principles of good governance remain essential for safeguarding macroeconomic stability and keeping Sri Lanka’s recovery on track. He further remarked: “We have understood that one of the key factors in stabilising the country and taking the economy towards our objective is the quality of public financial management.”
The Government’s repeated emphasis on fiscal management appears to be a disguised attempt to extend the current IMF program, which is based on the infamous Washington Consensus, beyond March 2027, the scheduled completion date of the existing Extended Fund Facility program.
This article seeks to refute two fundamental principles on which the Washington Consensus is based. It argues that the IMF program is nothing more than barbs wrapped in velvet. Sri Lanka should therefore withdraw from the IMF program and pursue an alternative, pluriversal path of development. Earlier the better.
Distinction between State and household
The IMF’s notion of fiscal management rests on a fundamental misconception that equates the State with a household. According to this view, the Government, like a household, should ensure that its expenditure at any given time does not exceed its current revenue. The revenue constraint is of paramount importance in household income management.
Heterodox economics rejects this analogy. Unlike a household, the State has the authority and responsibility to issue the currency that is legally valid within its jurisdiction. Consequently, it can spend in excess of its current revenue without immediately facing a liquidity constraint. As far as domestic expenditure is concerned, a sovereign State cannot become insolvent in its own currency so long as productive resources remain underutilised. Admittedly, the issue becomes more complex in the case of developing countries integrated into the global capitalist economy. This problem of balance of payment disequilibrium should be dealt with a different policy package the details of which has to be addressed separately.
Nevertheless, by combining (1) Adam Smith’s distinction between productive and unproductive labor, (2) David Ricardo’s class-based theory of economic growth, and (3) the Keynesian conception of the State as deus ex machina, it is possible to formulate an alternative development strategy that is fundamentally different from the prescriptions of neoclassical economics.
State may spend without taxing
When the Jaffna Fort was surrounded by the LTTE, the Chandrika Bandaranaike Kumaratunga Government purchased multi-barrel rocket launchers from the Czech Republic without immediately imposing new taxes. Likewise, when the Sri Lankan Government launched the final military offensive against the LTTE in 2008-09, it financed the war without first raising taxes.
By contrast, the LTTE was ultimately unable to sustain a prolonged war partly because it lacked a sovereign currency that was widely accepted even within the territory it claimed as the Tamil homeland. This illustrates a fundamental point: a sovereign State cannot exist without its own currency, with the partial exception of countries that have voluntarily surrendered monetary sovereignty by joining the European Monetary Union.
For the same reason, Ceylon abandoned the Currency Board system despite its relative stability. The newly independent nation required its own currency to consolidate its sovereignty and national identity.
The principal misconception underlying the IMF’s doctrine of fiscal management is the belief that all Government expenditure must first be financed through taxation. Furthermore, it assumes that the country’s economic difficulties are primarily the consequence of fiscal indiscipline. Certainly, excessive money creation can generate inflationary pressures, and excessive taxation can also produce adverse economic consequences. Historically, English monarchs are said to have withdrawn and even destroyed tax revenues when excessive money in circulation threatened inflation.
If Governments do not require taxes in order to obtain money for spending, what, then, is the purpose of taxation? Taxes serve at least four essential functions:
To promote economic growth by encouraging productive investment, consistent with the Ricardian principle of taxation.
To discourage socially undesirable behavior.
To improve equity through the redistribution of income and wealth.
To reduce inflationary pressures by withdrawing excess liquidity created through Government spending.
Since the overriding priority for a country in the Global South such as Sri Lanka should be the creation of a productive economy, two Ricardian principles of taxation deserve particular attention. First, Ricardo argued that taxes on essential commodities should be kept to a minimum because they raise of the cost of living, increase wage costs, and ultimately reduce profits and in turn capital accumulation. In today’s context, this would imply a zero or very low rate of VAT on essential goods. Such a policy would not only ease the burden on low-income households but also help contain inflationary pressures.
Second, Ricardo mentioned that luxury goods should bear relatively heavier taxation, since taxes on luxuries have far fewer adverse effects on production and economic growth.
The tax policy suggested by the IMF moves in the opposite direction. The repeated increases in VAT have disproportionately burden low- and middle -income households. Over the past four years, under the IMF regime, the VAT rate has been raised from 8% to 18% with an effective increase for certain goods 20.5% following the consolidation of VAT and Social Security Contribution Levy. As a result, the prices of essential goods, medicine, educational materials and many other necessities have risen significantly placing an additional burden on ordinary citizens while doing little to promote productive investment.