The 2025-26 Budget made provision for a revenue receipt of Rs 10 Billion which was supposed to be forthcoming from the Chagos deal which, however, has not materialized. “Do not count your chicken before they are hatched” is an old adage. The immediate consequences are well-known. It blows up the already yawning budget deficit and is bound to worsen the debt burden, both crucial indicators for Moody’s rating. It leaves the government in dire straits having to scramble to find alternative revenue sources to fill the gap, a herculean task given the fragile status of the economy.

The Chagos Deal was expected to contribute a sizeable 4.5% of recurrent revenue. The ensuing recurrent budget deficit increases from 5.6% to 10.5% of recurrent revenue and its share in GDP soars from 1.6% to 2.9%. This is subject to the assumption that all other revenue targets in the current budget are attained. If there is a shortfall on other revenue items, the picture will be bleaker. It is worth noting that, even with the exclusion of the Chagos deal, revenue estimates were quite optimistic as they were projected to increase by 17.8% which is far higher than the inflation rate of 3.7%, the meagre economic growth of 3.2% or the increase in GDP at market prices of 7.2 % in 2025.

The government is walking on a very tight rope as we are almost on the eve of the next budget. As if the situation was not bad enough. We must now contend with another element which complicates matters more: the US-Israel and Iran War. It is a testing time. The Government does not have many options. There are no easy solutions although several avenues can be explored.

Resorting to government borrowing to fill in the gap is no solution since it will have the undesirable effect of further raising the public sector debt burden to almost 90% of GDP which was attained in 2024/25. We will be back to square one with the sword of Damocles dangling on our head.

The government does not have much leeway in containing expenditure with the bulk of it being allocated to social protection and wages and salaries. Nevertheless, there is room for savings and better utilization of funds if we judge from the Director of Audit report which highlights the same saga of waste year in, year out and which does not prompt any improvement in the system. In the situation we are in, even a saving of Rs1 billion in a budget of 236 billion will send the right signal of more effective fund management. It is opportune to review schemes like the free travel scheme which absorbs Rs1.7 billion annually or even reimpose municipal taxes which will generates funds and also help improve municipal services. As Milton Friedman said: there is no free lunch. It is imperative for the government to look at the expenditure side and take the bull by the horns.

Looking at alternatives to finance the shortfall, we have to turn forcibly to taxes. My first observation is related to the individual income tax. The rise in income tax threshold bears no relationship with any economic indicator except for the quest for popularity and an attempt to outdo what the predecessor had done. It is no wonder that income tax accounts for less than 9% of recurrent revenue with its share declining over the years. Barely 25% of the workforce are subject to income tax despite increases in income which means that the tax base has been severely eroded. It is a source of revenue that can be tapped.

At the upper end of the income ladder, it is surprising that, in a period of glaring inequalities, the income tax system is not progressive enough. Statistics for 2024/25 assessment year indicates that the effective tax rate for income earners exceeding Rs 2.5 M was only 15%.

Even the changes made last year did not improve the progressivity. The Fair Share Contribution at the rate of 15% of chargeable income introduced last year was a good initiative but applied only to a miniscule number of taxpayers since the taxable income threshold of Rs12 Million is on the higher side; it does not affect even 1% of taxpayers and appears more like window dressing. If the surcharge was imposed on net income of taxpayers exceeding Rs 5-6 million, it would have generated at least Rs 3 billion additional revenue. Such a level of income is more realistic and is in line with the criterion of ability to pay justifying a higher income tax rate.

In the same vein, for corporation tax, the fair share contribution and threshold need to be reviewed which has the potential of raising revenue at a time of increasing profitability of businesses. For example, the tax payable as a share of chargeable income for companies with a gross income exceeding Rs 10 million was a mere 7.2% in 2024-25, the latest year for which data have been published. The share of tax in gross income turns out to be about 1%. The point I wish to draw home is that direct taxes contributions may be enhanced without being inflationary and without creating much adverse effect.

As far as indirect taxes are concerned, the scope for additional revenue from indirect taxes is quite limited. They already represent more than two thirds of tax revenue. A 1% increase in VAT will yield Rs 4 billion. But this has the disadvantage of generating inflationary pressures at a time when so many factors are adding fuel to inflation. A selective approach may be more appropriate, but this will add to the already big increases last year.

No single measure will yield the colossal amount of Rs10 billion, but various revenue heads can contribute. No matter what decision is taken to fill the revenue gap, it will be unpalatable. While a few options may be envisaged temporarily given the exceptionally difficult budgetary situation, ultimately, we must address the key preoccupation. The budget deficit and the debt burden are a matter of urgency, but the top priority should remain our economic revival. It is only higher economic growth that will yield more revenue and impact positively on the budget deficit and the debt burden. Unfortunately, our policies so far have not triggered the momentum of investment and growth whether it is agriculture, manufacturing, the green economy and the ocean economy. Investment has declined in both public and private sectors which is alarming which means that growth prospects even for 2026 are seriously compromised. We follow a marginalist approach. We are content with marginal growth when a big leap is required. But this will not deliver the goods. A completely novel strategy is required.