Sri Lanka’s Shifting Personal Income Tax Policies - 2005 to 2025
6 Personal Income Tax Regimes in 20 years
Personal income taxes form a core part of any tax system in ensuring contribution to revenue collection through direct taxes, adding a necessary component of progressive taxation. A critical aspect of a ‘good’ tax system is predictability so that both taxpayers and tax administrators can plan ahead. But during the last 20 years, from 2005 to 2025, Sri Lanka has had 5 different personal income tax regimes. Many of these changes have happened as political promises made during elections to reduce taxes. In effect, every political transition in Sri Lanka has been accompanied by an introduction of a new personal income tax policy. This article aims to understand how these frequent changes have come about and the impact they have had on revenue collection.
The historical analysis showed that before 2020, the introduction of the Advanced Personal Income Tax (APIT), there were two separate personal income tax structures. One structure applied to salaried income earners in both the government and private sectors. This was known as the Employment Income Tax, commonly called Pay-As-You-Earn (PAYE). Under this system, taxes were deducted directly from employees' salaries by their employers before the income was paid to them. The other structure was the Individual Income Tax (IIT), which applied to self-employed individuals and other non-salaried earners. Unlike PAYE, where tax was automatically deducted, individuals under this system had to declare their earnings and calculate their tax liabilities voluntarily. The introduction of Advanced Personal Income TAX (APIT) in 2020 replaced these two systems with a more standardized approach to income taxation.
Summary of the Political Economy of Personal Income Tax Changes for the Last 25 Years
In 2005, Sri Lanka underwent significant political and economic changes. This period followed the devastation of the tsunami and saw a political transition with Mahinda Rajapaksa serving as Prime Minister before being elected as President later that year. As part of the tax reforms introduced in 2005 to stimulate economic growth, tax slabs were widened, and the lowest tax rate was reduced from 10% to 5%. Under the revised tax structure, the first Rs. 25,000 of an individual’s monthly income was tax-free. The next Rs 25,000 was taxed at 5%, while subsequent income of Rs 16,667 was taxed progressively at rates of 10%, 15%, 20%, and 25%, with a maximum cap of 30%. Additionally, the PAYE system was introduced for public servants, with their income initially assumed to be half of their gross salary.
The next major change in Sri Lanka’s personal income tax system occurred in 2011, following the end of the 30-year civil war and the beginning of Mahinda Rajapaksa’s second term as President. At the time, the government prioritized rapid economic expansion despite the country’s high fiscal expenditure, particularly driven by expenses on defense. To support economic growth, the individual tax-free threshold was raised to Rs 41,667 monthly. Income beyond this threshold was taxed at progressive rates. Every additional Rs 41,667 was taxed at 4%, 8%, 12%, and 16%, while the next Rs 83,333 was taxed at 20%, with the maximum rate capped at 24%. Additionally, the government fully incorporated public sector salaries into the PAYE system, applying similar tax rates and brackets, with a monthly tax-free threshold of Rs 50,000. However, under the PAYE system, numerous exemptions were introduced for allowances. For example, monthly motor vehicle allowances of up to Rs 50,000 were exempt from PAYE. This indicates that, although the tax brackets were smaller compared to current rates, many allowances were not taxed. This tax structure remained in effect until 2018.
In 2015, the Yahapalanaya government, led by President Maithripala Sirisena in coalition with Prime Minister Ranil Wickremesinghe, came into power. By 2016, Sri Lanka was struggling with fiscal imbalances, particularly twin deficits, leading the government to enter an International Monetary Fund (IMF) program. As part of revenue consolidation efforts, a new tax structure was introduced on April 1, 2018. The individual income tax was slightly altered, with tax brackets raised from Rs.41,667 to Rs.50,000 per month while maintaining the same tax rates and tax-free threshold as the previous IIT structure. However, the PAYE structure was overhauled. The tax-free threshold was raised to Rs. 100,000, and every subsequent Rs 50,000 was taxed progressively at rates of 4%, 8%, 12%, 16%, 20%, and capped at 24%. While the changes appeared to increase the brackets and tax-free threshold, the 2018 IRD Act amendment included all allowances under the PAYE tax system, with no exemptions. This led to a significant increase in overall income tax revenue.
In 2019, a new government led by President Gotabaya Rajapaksa was elected. As part of an election promise, the administration significantly reduced personal income taxes in its first cabinet meeting. The monthly tax-free threshold was raised from Rs 100,000 to Rs 250,000, and subsequent income was taxed at just two rates: 6% on the next Rs 250,000 and 12% thereafter, with a cap at 18%. Additionally, the government introduced the Advanced Personal Income Tax (APIT), which merged the Individual Income Tax and PAYE systems. While the APIT system made tax collection more efficient and simpler, the broadened tax brackets and increased tax-free threshold contributed to poor fiscal performance. This, in turn, played a role in the country’s worst economic crisis.
However, by 2023, Sri Lanka had defaulted on its debt due to weak fiscal management. The economic crisis and mass protests (Aragalaya) led to Gotabaya Rajapaksa’s resignation, and Ranil Wickremesinghe was sworn in as President. To restore fiscal discipline under the country’s new IMF program, the government introduced a revised personal income tax structure. The monthly tax-free threshold was set at LKR 100,000, with subsequent income taxed progressively at 6%, 12%, 18%, 24%, 30% and a maximum rate of 36%. The accompanying graph illustrates that this system effectively imposed higher taxes on high-income earners.
In 2025, following Anura Kumara Dissanayake’s election as President, another tax reform was implemented, fulfilling a key campaign promise. The new structure increased the monthly tax-free threshold to Rs 150,000. The next Rs 83,333 was taxed at 6%, while every additional Rs 41,667 was taxed at 18%,20%,24%, and 30%, with the maximum rate capped at 36%.
Tax Payables as a % of Monthly Income
While these changes affected only one component of tax revenue, their spillover effects were substantial. Among the five different tax regimes introduced over the years, the 2023 tax structure stands out as the most progressive as it places a greater tax burden on high-income earners compared to previous systems. The chart above clearly illustrates the vast difference between these four tax policy changes that happened over 8 years (2018-2025). These shifts in tax burdens suggest that certain tax policy changes were strategically designed to target specific income groups, providing insight into the political and economic motivations behind these reforms.
The chart below illustrates the tax-free income threshold as a percentage of the nominal GDP per capita (in LKR terms) over time. This ratio offers valuable insight into the relationship between the income individuals are allowed to earn before being taxed and the overall economic output per person within the country. Notably, the tax policy changes introduced in 2020 led to a significant spike in this ratio, reaching a historic high of 420%. Such a high ratio typically indicates that a large portion of the population is exempt from paying personal income taxes. The most recent tax changes have brought the ratio back down to around 121%, aligning closely with the levels seen during the historic period of 2012-2013. The fluctuation of this ratio over time highlights the government’s changing approach to taxation
Annual Tax-free threshold (PAYE) as % of GDP per capita
Looking at the overall tax structure, income tax plays a crucial role, contributing approximately 30% of the total tax revenue, as illustrated in the chart below. Frequent policy changes in income taxation not only impact individual taxpayers but also have broader fiscal implications, influencing government revenue stability and economic planning.
Income Tax as % of total tax revenue
The chart illustrates PAYE’s contribution to income tax revenue: By 2024, it accounted for approximately 19% of total tax revenue. This highlights the critical role PAYE plays in the overall tax system. Therefore, it is essential to establish and maintain a sustainable income tax policy rather than frequently altering tax structures based on electoral promises. A stable and well-planned tax framework ensures predictability for both taxpayers and administrators, ultimately strengthening revenue collection and economic stability.
PAYE generated revenue as a % of Income Tax revenue
Looking at the big picture, PAYE is one of the easiest forms of income tax for a government to collect. This is because it primarily targets the formal sector, where individuals' income and employment details are well-documented. However, while governments tend to focus on taxing the formal sector, they must also consider how to extend taxation to the informal sector to create a more equitable tax system.
A key challenge in Sri Lanka’s tax system has been the frequent changes in tax policy: six different tax regimes in the last 20 years. These constant shifts create significant difficulties for tax administration. Since 2018/19, the government has attempted to improve tax collection efficiency by digitalizing the system through RAMIS (Revenue Administration Management Information System). However, frequent policy changes require continuous updates to this system, adding administrative burdens. Moreover, individuals who were once within the tax bracket may fall outside it under new regimes, complicating efforts to expand the tax base. Instead of focusing on broadening the tax net, tax administrators are often preoccupied with adapting to the latest policy shifts.
Another issue is the narrow scope of PAYE taxation. Since it primarily applies to the formal sector, mainly salaried professionals in the urban middle class, there is growing frustration among these taxpayers who feel they bear an unfair share of the tax burden while individuals in the informal sector remain largely untaxed. While this concern is partially valid, it should be addressed through comprehensive income tax reform rather than frequent, short-term policy changes. A well-structured reform should aim to expand the tax base, ensuring a fairer distribution of the tax burden across all economic sectors. Additionally, the formal sector, being highly unionized and politically influential, often lobbies for policies that serve its interests, further complicating efforts to implement sustainable tax reforms. This influence was evident in the 2019 and 2024 presidential and parliamentary elections, where the voting patterns of the salaried urban middle class played a crucial role in election outcomes. This has led to a concerning trend where politicians use personal income tax policies as a political tool to attract votes rather than as a mechanism for sustainable economic management.
Ultimately, a country’s tax policy should not be dictated by politicians or powerful lobbying groups. Instead, it should be designed by professionals and economic experts who can develop a long-term, strategic plan for national fiscal stability. Taxation should be a simple, sustainable, and transparent instrument for economic governance rather than a short-term political tool used to sway elections.
Disclaimer: The views expressed are solely those of the author and do not represent the opinions of any organization the author is currently or previously affiliated with. The author assumes full responsibility for any errors or omissions.