Stress at work increases the risk of heart attack! – The Island

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by Professor Aruna Shanthaarchch
(Department of Economics and Statistics
Sabaragamuwa University of Sri Lanka)

Who is the middle class?

The term middle class has been defined in various ways. Historically, it was a social class characterized by intellectuals, who were neither capitalists nor workers. They were well-educated service providers and small entrepreneurs, who worked hard and had relatively secure and substantial incomes that enabled them to own homes, demand better services and lead comfortable lives. Despite its initial classification in social terms in recent times, economists have chosen to define the middle class using economic terms such as income or consumption to better quantify it. These definitions are based on two approaches: the relative approach and the absolute approach. Literature defining the middle class using an absolute approach, defines it as those earning a benchmark income range. For example, Bhalla (2021) defines the middle class as those earning more than US$3,658 (at 2020 prices) per year or US$10 per day in purchasing power parity terms. Kharas and Gertz (2020), adopting the absolute approach, define the middle class as households whose daily expenditure is between USD 10 and USD 100 per person per day in terms of purchasing parity.

Sri Lankan middle class

For ease of exposition, people living in households, spending $2 to $10 (not including $10), will be referred to as the “local middle class”; people living in households spending less than $2 per day per person will be called the “poor” and people spending $100 or more per person per day will be called the “rich”. The middle class made up 10% of the Sri Lankan population in 2020/21. The majority of Sri Lankans belong to the local middle class which was 75.2% in 2010 and it has drastically decreased due to the economic crisis and according to the World Bank it was 48% in 2021. There are three middle class, lower middle ($2 to $4), middle class ($4 to $6) and upper middle class ($6 to $10) categories.

Middle class and economic development

Middle-class consumers have received more attention lately due to the belief that a strong and large middle class is a prerequisite for sustained economic growth and development. Demand-led growth, as opposed to export-led growth, has also been seen as a way to pull an economy out of the middle-income trap, which is the phenomenon of an economy that stagnates at the middle-income level. The size and wealth of the middle class determines its power over the economy and governance structures. Thus, the size of the middle class has become an important indicator of the growth and development of an economy. The middle class is credited with driving growth in several ways. Primarily, the middle class drives economic growth by shifting aggregate demand. But that’s not its only channel for fostering growth. The middle class, which mainly depends on labor for its income, promotes values ​​such as savings and the accumulation of human capital which are beneficial for growth. Middle-class consumers are also known for supporting meritocratic governance systems that allow them to promote themselves and improve through hard work. More selective middle-class consumers encouraged innovation in affordable yet effective products. These products range from service goods such as insurance and banking services to manufactured goods such as hygiene products. What’s different about this new wave of innovation trends is that it caters to a more discerning set of consumers who are harder to please.

The literature shows that the expansion of the global middle class will pave the way for new businesses. For example, unlike the local middle class, the global middle class spends money on traveling abroad and on new technologies. The global middle-class demand for private medical and professional institutions, as well as private educational institutions, is also higher. There are signs that this is already happening in Sri Lanka. However, alongside these positive aspects, a growing global middle class may also put pressure on the existing social infrastructure. This will partly be explained by the growing taste for better and more convenient services. Literature shows that the demand for electricity, water, roads and other infrastructure is higher among global middle class consumers. Already, there are signs that improving living standards in Sri Lanka are putting pressure on the country’s physical infrastructure and natural resources. The demand for electricity and energy in the country has increased over the past decades. Electricity demand grew at a much higher rate than expected. To avoid constraints to economic development, the country will need to carefully study the growing trends in infrastructure demand and plan well in advance to meet that demand in the most efficient way.

Tax revenue in Sri Lanka

The tax ratio is generally considered a kind of “symbol of national virility”. It indicates the proportion or share of national income transferred to the public sector to meet budgetary needs in order to accelerate the pace of economic development without causing inflation. (Zuhair, 1985). In high-income countries the ratio is around 42%, middle-income countries around 25-29% and developing countries around 20%. Sri Lanka’s performance compares poorly to that of countries such as Vietnam (21.1%), Thailand (22.6%) and Malaysia (22.2%), but it is better than that of its eastern neighbors. South Asia, such as Bangladesh (7.6%). The irony of the situation is that while overall GDP as well as per capita income in Sri Lanka has steadily increased over the years, total revenue and state tax revenue have steadily declined. Table 01 shows the relationship between GDP growth and per capita income and government revenue. It can be seen that total government revenue as a percentage of GDP has steadily declined from 21.1% in 1990 to 16.8% in 2000, 12.7% in 2010 and 11.4% in 2014. The tax revenue ratio decreased from 19.0% in 1990 to 14.5% in 2000, 11.3% in 2010 and 10.1% in 2014 and 7.7% in 2021.

New tax policy

A person who earns more than Rs 100,000 will have to pay taxes, depending on the additional amount he earns. This means that the annual non-threshold income is Rs 1,200,000. This threshold was previously Rs 3,000,000 and has now been reduced by 60%. Tax brackets of 3,000,000 after non-threshold income are now reduced by more than 83% to 500,000 rupees. For every 500,000 taxes, there is an additional 6% tax. If a person earns three million rupees annually, which was tax exempt before, the first 500,000 rupees after the tax exemption threshold of 1,200,000 rupees, he will be charged 6%, the next 500,000 at 12%, the next 500,000 at 18% and the remaining 300,000 at 24%. However, according to the new tax policy, monthly income tax from Rs 100,000 and income tax of 6% for monthly income from 100,000 to 141,667 and for each additional slot of Rs 41,667 , the tax improvement is 6% until the tax rate is 36%. The person whose gross income exceeds Rs, 308,335, should pay a tax rate of 36%. The proposed tax shown in Table 01, based on gross income.

Jable 01: Gross income and tax payment

Are they forced to migrate because of the proposed new income tax policy?

The proposed income tax policy would significantly harm the purchasing power of local and global middle class families in the country. The sharp increase in personal income tax rates would discourage employment, negatively affect the lives of middle-class families and, above all, in an environment of high inflation, could increase the brain drain. Wage earners are disproportionately affected as they are taxed at source with a sharp drop in disposable income which could also create a personal debt service problem. Middle class incomes will be limited to consumption and all other investments will be controlled. Since the income of the middle class is greatly reduced with the new tax, the natural income flow from the middle class to the poor income category will be limited. This will be a negative effect in the medium and long term for the country. A flat personal tax rate would have been fairer; it would not have discouraged revenue growth.

The new tax rates will reduce people’s disposable income, which will be a huge burden on those who actually pay taxes. Many professionals who wish to stay in Sri Lanka and contribute to the economy will leave the country. Sri Lanka has already seen many professionals leave the country due to the unprecedented economic crisis. This should be viewed in the context of semi-literate politicians dictating terms to educated people.

As the prices of fuel, cooking gas, electricity and water rose alongside a more than 50% depreciation of the rupee, many professionals adjusted their consumption to reflect the drop in disposable income. These new tax increases without taking into account current inflation and the cost of living will be the final nail in the coffin of the careers of local professionals. They will try to migrate at all costs.

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