Low responsiveness of income tax functions to sectoral output: An answer to declining tax ratio in Sri Lanka?

Abstract

Tax revenue of Sri Lanka has not increased in par with its economic growth, infact, tax revenue as a percent of GDP (tax ratio) has declined overtime. Many admit tax exemptions, tax holidays, tax avoidance and tax evasion, weaknesses and corruption at the level of tax collection, accounting difficulties of actual income, etc. are as main reasons for the declining tax ratio. However, one would also wonder whether changes in the structure of the economy may have some impact on tax revenue. Over the last six decades the economy of Sri Lanka has transformed from an agricultural economy to a service economywhich may affect the collection of tax revenue. This study estimates personal income and corporate income tax functions on agricultural, industrial and service sector output for the period 1974-2013 to find out the impact of sectoral output. It is found that agricultural output has no real impact on personal and corporate income tax collections. The study finds that the personal income tax is more responsive to service sector (0.57) than to the industrial sector (0.28). On the other hand, the corporate income tax is more responsive to industrial output (0.55) than to service sector output (0.29). This low responsiveness of income tax functions to service and industrial output and non- resiveness to agricultural output may result in declining tax ratio overtime.