Impact of Value Added Tax on Poverty in Sri Lanka

Abstract

This paper examines the impact of Value Added Tax (VAT) on poverty in Sri Lanka, by considering the amount of VAT paid by the household on the consumption of food items. The study based on Household Income and Expenditure Survey (HIES) data of Sri Lanka in 2012/13 and Ordered Probit model was applied for empirical estimation. The results confirm that, despite VAT contributes to national tax revenue significantly, it essentially increases the probability of being extreme poor, poor and vulnerable non-poor by 0.0061%, 0.4942% and 1.4760% respectively, while reducing the probability of being non-poor by 1.9764%. Apart from that, the recent hike in VAT rate of Sri Lanka from 11% to 15% increases probabilities of being extreme poor, poor and vulnerable non-poor by 0.017%, 1.39% and 4.16% respectively, while decreasing the probability of being non-poor by 5.57%. Thus, the study recommends to rationalize and continue VAT exemptions, introduce a twin VAT rate for essential and luxury goods and services along with a gradual shift from indirect to direct taxes in order to lessen VAT burden on lower income groups while ensuring higher tax revenue for the government.