Revenue Response to Gross Domestic Product in Sri Lanka, 1963-76

Abstract The degree of response of tax revenue to changes in GDP has a significant bearing on public finance policy in developing countries. It appears that a highly income-elastic revenue structure is an important asset for countries where the scope of financing development expenditures is rather limited. This study gives attention to the response of the revenue structure to changes in GDP in Sri Lanka. The objective is to provide a quantitative assessment of the ability of the Sri Lanka tax structure to generate proportionately higher tax revenues through automatic response and discretionary change. For this purpose, the elasticity and buoyancy of the tax system as a whole and its major components are estimated and analysed for the period 1963-76. Several interesting conclusions emerge from the analysis. First, it turns out that the built-in elasticity of Sri Lanka's tax system has been low during the period under consideration; this points to possibly high rates of tax evasion and deficiencies in tax collection. Second, these negative influences have been somewhat offset by the introduction of discretionary changes especially in the case of indirect taxes; discretionary changes were instrumental in raising the buoyancy of fiscal revenues closer to unity. Third, a significant outcome of the low buoyancy of the tax system has been that the entire burden of financing successive budget deficits has fallen on the non-tax financial sector. These considerations point to the conclusion that in Sri Lanka mobilization of additional resources through tax policy is of paramount importance for future economic development.