**25 |** P a g e

a systematic analysis of the implications of new rates taking effect on November 22, 2011, their eyeballing suggests some improvement over the old one. Specific Cess tariff rates are widespread for both agricultural and industrial products. Maximum ad valorem rates of Cess are still set at 35 percent.

The Cess is the most potent tool of protection used in Sri Lankan foreign trade policy. This is also a highly destructive measure contributing most to distortions in allocation of resources in Sri Lanka. First, as can be seen from the data tabulated for the pre-June 2010 period (see Table 7), Cess accounted for more than half of nominal protection afforded by the para-tariff regime. The simple average Cess rate of 9 percent was almost twice as high as the second highest para-tariff rate, PAL, of 5 percent.

Table 7: Para-tariff rates and their coverage in January-June 2010 in percent

||Simpl<br>|e average of p<br>rates<br>|ara-tariff<br>|Cont<br>tarif<br>|ribution to tot<br>f nominalpro<br>|al para-<br>tection<br>|Percent<br>coverage<br>|
|---|---|---|---|---|---|---|---|
||All|Agriculture|Industry|All|Agriculture|Industry|lines|
|SUR (Customs Surcharge)|1.67|3.56|1.34|11%|14%|9%|86.1|
|PAL (Port and Airport Levy)|4.95|5.00|4.94|31%|20%|35%|99.4|
|Cess (Export Development Board Levy)|8.79|16.43|7.46|56%|66%|53%|39.9|
|RIDL(Infrastructure Development Levy)|0.32|0.00|0.37|2%|0%|3%|1.2|
|TOTAL|15.73|24.99|14.11|100%|100%|100%||

Sources: Calculated from data in G. Pursell and Ahsan, “Sri Lanka’s Trade Policies: Back to Protectionism,” _ASARC Working Paper 2011/03_ .

Second, because of a different tax base, nominal protection generated by a Cess rate is 10 percent larger than that by a corresponding tariff rate. For instance, the products subject to a minimum Cess rate of 1 percent are protected by an eleven-percent rate simply because in contrast to MFN tariff rates, the base for assessing the Cess is the value c.i.f of a shipment plus ten percent ad valorem. In consequence, a tariff equivalent of the Cess rate of 30 percent is not 30 percent but a 33 percent MFN tariff rate. Collected Cess rate on imports, i.e., the ratio of Cess-generated revenue to the value of total imports in percent, was 2.4 percent in 2009 up from 0.6 percent in 2006. In 2009, the collected Cess rate was about half of the average of import tariff collection of 4.8 percent.<sup>26</sup> Third, the combination of higher and dispersed rates and smaller imports’ coverage by the Cess results in much higher variance in rates than for other para-tariffs. Note that PAL covers almost all imports (99.4 percent of tariff lines), SUR applied to 86 percent of tariff items, whereas the Cess covered less than half or 40 percent of tariff lines. Moreover, the coverage further declined in 2009-11 from 40 percent in 2010 to around 28 percent. Furthermore, PAL schedule was characterized by two rates: 5 percent for the bulk of products and 2 percent for a few products. As mentioned earlier, the Cess rates ranged between one percent and 35 percent.

Hence, Cess drives investments to highly protected sectors of the economy and raises prices of both domestic and imported goods. Its schedule has further magnified all harmful effects of MFN tariff schedule further driving the wedge between conditions in domestic and external markets. Despite the curtailment of para-tariffs in 2010, the para-tariff regime, however, has remained complex, nontransparent, and the source of uncertainty. Its complexity stems from differences in product coverage by para-tariffs. Frequent changes in the nominal rates of import taxes on individual products combined with waivers and exemptions infuse uncertainty into imports decisions. This applies in particular to Cess, “... which from the beginning has been used as a selective protective instrument” (Pursell, 2011, p. 31).

> 26 Averages calculated from data in _Trade Policy Review Sri Lanka_ WT/TPR/S/237 29 September 2010, p. 123.