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Jakarta Post

Tax reform team: Aim higher, the force is with you

Between 2007 and 2015, the Indonesian economy grew by 14.3 percent while taxation revenue only grew by 12.3 percent. The best year for taxation was 2008 (partly due to the so-called Sunset Policy, a form of tax amnesty implemented that year) when revenue grew by 34.2 percent.

Glenn Polii (The Jakarta Post)
Jakarta
Mon, January 9, 2017

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Tax reform team: Aim higher, the force is with you Finance Minister Sri Mulyani Indrawati (left) and director general of taxation Ken Dwijugieasteadi attend a meeting with House of Representatives Commission XI in Jakarta on Oct. 12. (Antara Photo/M Agung Rajasa)

T

he newly established Tax Reform Team, a 100+ member team headed by the finance minister, set out a single measure of success: 15 percent tax-to- GDP ratio by the year 2020.

Yes, there are many grand expected outcomes, most of which are unquantifiable, such as creating a strong, credible and accountable DGT, but the ultimate expected result appears to be just that: an increase of four percentage points in the tax ratio from 11 percent in 2015 to 15 percent in 2020.

An increase of 1 percentage point in the tax ratio every year for four consecutive years really does not seem too much. Compared to previous targets, such as the 30 percent increase in taxation revenue in 2015, this target is rather “realistic”.

But is it really achievable? And more importantly, how do we know whether 15 percent is the right target?

Let us start with the first question and look for some clues from Indonesia’s past tax performances.

Between 2007 and 2015, the Indonesian economy grew by 14.3 percent while taxation revenue only grew by 12.3 percent. The best year for taxation was 2008 (partly due to the so-called Sunset Policy, a form of tax amnesty implemented that year) when revenue grew by 34.2 percent.

The outlier nature of this growth rate was highlighted by the fact that revenue collected the following year actually shrunk by 5.9 percent.

In an otherwise normal period, the lowest growth was in 2014, when taxation revenue only grew by 6.5 percent, much lower than nominal GDP growth that same year.

From this observation, it seems that over a medium-term period the best we can hope for is parity between (nominal) GDP growth and taxation revenue growth rates.

Now, if the Indonesian economy for the foreseeable future was expected to grow by 5 percent with 3 to 4 percent inflation and the tax ratio target was set at 15 percent, then this would imply that, by 2020, taxation revenue would have surpassed Rp 2.66 quadrillion (US$199.50 billion), or double the current 2016 revenue collection estimate, which is around Rp1.32 quadrillion.

In other words, between 2017 and 2020, tax collection would have to grow by an unprecedented rate of 19 percent every year.

This is double the GDP growth rate over the same period. Judging by Indonesia’s past performances, this phenomenal growth in taxation revenue is highly unlikely.

But let us step back and ask this question: is 15 percent tax-to-GDP the best ratio for Indonesia?

The 15 percent figure was decided by the Tax Reform Team after establishing a benchmark with Indonesia’s regional peers.

Here, from highest to lowest, the ratios for Indonesia’s neighbors (all in percentage, source the Heritage Foundation): Vietnam 18.9, Thailand 16.2, Malaysia 15.8, Laos 15.3, Singapore 13.8, Philippines 13.3 and Cambodia 12.4. (Yes, presently at 11 percent, Indonesia is the lowest after Myanmar’s 6.8).

So 15 percent is more or less the median figure in this benchmarking.

But still this does not answer the question: how do we know whether 15 percent is the optimum, or to borrow a phrase from the Tax Reform Team, the “best-fit” tax-to-GDP ratio for Indonesia?

The short answer is, we do not know. The DGT does not know. The Finance Ministry does not know and neither do the Tax Reform Team.

But this is only because no official estimate has ever been produced of the tax revenue potential that should be collected by the Indonesian government under the tax laws.

This amount is known as the tax capacity.

While there are many issues with estimating tax capacity and the final estimate will always involve significant uncertainty, nevertheless both the estimation process and the resulting figure could provide important insights and a rough measure as to how well the government is collecting revenue, as well as assisting in managing compliance risk and formulating enforcement strategies (Gemmel and Hasseldine, 2013).

Moreover, because tax capacity is the estimate for the maximum tax revenue that a country can achieve, it follows then that, although it might not be accurate, it is the true benchmark.

To use an analogy, if your smartphone is equipped with a battery capable of 24 hours of battery life, but your friends happen to have smartphones with 12 hours of battery life, do not take 10 hours as satisfactory.

Thus, the Tax Reform Team erred in setting its target by benchmarking Indonesia against its regional peers. Instead, it should have benchmarked Indonesia to its own tax potential.

Although the government itself does not have any estimate for this important figure, we know from external sources that the maximum tax potential is far higher than the current collection.

For example, a study by Fenochietto and Pessino (2013) published in an IMF Working Paper has estimated that Indonesia’s tax capacity stands at 28 percent of GDP.

At this point, we can understand that the Reform Team’s target of 15 tax ratio by 2020 really falls short of what Indonesia can achieve.

Although 15 percent seemed nice and good enough when compared to our neighbors, it is actually only 54 percent of Indonesia’s potential.

In conclusion, from a historical perspective, a 15 percent tax ratio by 2020 seems too difficult to achieve. But given the enormous tax potential still available for the government to tap, that 15 percent tax-toGDP is really only a half of what we could achieve.

This is tricky, but after all, this is what tax reform is all about: breaking the curse of history and building a better future — at least to a level where the government can seriously set its sights on what Indonesia can really achieve.

So, is the target 15 percent tax ratio by 2020 realistic? Perhaps. But does it really matter? The true objective lies twice as high. The journey to get there, though, does not have to be twice as long.

Finally, to the Tax Reform Team: Work hard, work smart and work boldly. Set your sights higher. The President, the finance minister, the media, the political powers and the people all stand by you.

Really, there is no better time for a radical tax transformation toward a much better Indonesia with much less poverty, much less inequality and more opportunity for all.

 

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