Vehicle Imports and the missed opportunity

After five years, the Sri Lankan government has decided to lift the ban on vehicle imports. Originally imposed in 2020 as a response to the country’s economic crisis, the ban was intended to curb foreign exchange outflows and stabilize the economy. When lifting the ban, the government is prioritizing two key factors:

• Dollar Outflow: How much foreign currency will be spent on importing these vehicles?
• Impact on the Financial System: Will this strain Sri Lanka's existing financial system?

Other considerations, like potential revenue, economic benefits, and affordability for average workers, come second.

When it come to the personal vehicles, the government should create a system that allows only people to import vehicles who have enough capital to afford a vehicle or who can pay back a loan.

Let's examine the recent actions taken by the government.

The government changed the tariff structure, imposing higher taxes on vehicles with higher CIF (Cost, Insurance, and Freight) value that seems to be the only consideration. The new tax calculations don't consider whether vehicles are petrol, diesel, hybrid, or electric. They've added CID, PAL, VAT, and SSCL taxes (which weren't previously applied) along with a surcharge, essentially inflating vehicle prices in Sri Lanka to a point where they might never decrease.

The government expects approximately 2550 in customs revenue this year compared to 1500 in 2024. This means the government anticipates about 1 Trillion rupees revenue from vehicles.

With this decision, new vehicle prices have increased significantly, which should reduce the dollar outflow.

Also, the prices of new and old vehicles (over 5 years old) have become similar, people will continue paying their leases. So, the financial system will likely not face any problems.

Let's assess whether this approach is correct or if a better alternative existed.

Currently, the second-hand car market in Sri Lanka has inflated prices, far exceeding the true value of the vehicles. This situation arose partly from financial institutions making the leasing options readily available for everyone without much scrutiny into whether they would be able to pay back the amount or not.
Ideally, the government should have assessed the impact of allowing vehicle imports at the previous tax rates. It is not the government's duty to manage the financial risks of these institutions. Leasing companies and banks should have handled their financial risks by adjusting their lending and leasing practices in anticipation of the impact of vehicle imports at previous rates.

If the government had allowed vehicle imports under the previous rates, these institutions would have faced losses due to the inflated market. However, that burden should have been borne by the institutions themselves. Instead, the government has effectively shifted the financial burden onto those waiting to purchase vehicles or, in the long run, onto the entire economy.

A more effective strategy would have been to limit the number of vehicle imports without increasing taxes. This would carefully control the dollar outflow and generate steady revenue. For example, a 2023-2024 income tax payers list can be used to categorize each tax payer into income slabs depending on the amount of tax they have already paid the CIF value of the imported vehicle should have capped.

In a legal sense, those who are paying tax have income, need a vehicle to pay finance, and also have a disposable income left. If one does not pay taxes, then they may be not allowed to purchase a vehicle or unable to pay lease.

If the same approach was followed in the current year, then businessmen who make cash businesses, lawyers and tutors would declare their income properly, as they would want to import their dream vehicles. This would lead them to tax properly. The government could use this to assess how much can be paid on taxes, and could again create slabs to determine CIF thresholds.

Before the new tax system, there were less than 2,000 people in Sri Lanka who paid more than 500,000 in tax per year. When looking at Tax, there are only a few people (~40000) who can pay a lease installment of about Ru 40000.

Rather than a one-time tax revenue from vehicles, this approach would ensure a continuous income stream, which is a sustainable way of generating revenue.

This approach could have addressed both the issue of tax evasion and the lack of income collection in Sri Lanka.

Regarding EVs and hybrids, when considering dollar outflows, the government should have looked at the outflow in 10 years.

Currently, EVs can travel around 6km per kWh. Suppose a normal vehicle has a mileage of 12km per liter. Assuming a gasoline or diesel price of USD 1 per liter for the next 10 years, a vehicle would require a USD 1 outflow to travel 12 km. An EV would need 2kWh for the same distance.

At the current CEB (Ceylon Electricity Board) tariff, the average cost is around Rs. 25 per kWh, making 2kWh cost Rs. 50. So, EVs are 6 times cheaper.

Even if diesel power plants (lowest in the merit order) are used to charge EVs, the dollar outflow is still 30% less compared to ICE (Internal Combustion Engine) vehicles.

As solar-based charging stations become more commercially successful with increased EV adoption, the per-kilometer cost will decrease significantly.

Sri Lanka's tax policies are still based on the 2019 vehicle import mindset. In 2018, electric vehicles accounted for only 2% of total vehicle sales; now, they make up 20%.

The government should compare the net dollar outflow of an EV and an ICE vehicle within 5 years, factoring in CIF value. The tax system should be designed so that the EV costs about 20% less.

The current tax system is akin to promoting horse-drawn carriages when cars were replacing them in the 1930s.

Based on the tax structure, cabs offer the most value for money. It's difficult to understand the rationale behind encouraging citizens to import cabs.

The biggest problem with increasing taxes is that assets like vehicles become over-inflated, limiting people's disposable income, which is detrimental at a macroeconomic level.

It's like burying gold nuggets in the backyard, which doesn't benefit anyone.

Imagine if that money was used for a family trip, benefiting the driver, restaurant owner, accommodation provider, peanut vendor, and flower seller, stimulating the economy. The same applies to investing in a company.

Expect to see billions in disposable income wiped out from stock market investments and diverted towards vehicles in the coming days.

The only way to overcome an economic crisis is to grow out of it. This means reducing taxes to allow money to flow into the economy, increasing GDP, and subsequently increasing tax revenue as a percentage of GDP.

Around 10 years ago, Anura Kumara Dissanayake, in his speeches, repeatedly spoke about Sri Lanka's missed opportunities—such as winning the World Cup, the tsunami, and the end of the war—as moments that could have united the nation but were ultimately squandered.

Economically, Sri Lanka is missing a similar opportunity. A chance to rewrite the rules of a system that generates about 20% of Sri Lanka's tax income, under a new government, after 5 years.

Like importing rice, this isn't a crisis solution. There's no urgency to implement it. Without a creative, forward-thinking, and sophisticated policy decision, and by choosing the laziest option from all available options, it's difficult to believe that the government will lead Sri Lanka towards a revalution.