T

he Indonesian government finally launched last week a tax incentive scheme, which provides an income tax holiday from between five to 10 years and tax allowances to projects in high-priority sectors and in remote areas, in a bid to ramp-up investment in infrastructure and resource-based manufacturing industries.

The tax holiday facility will be given to manufacturing projects in base metals, oil refining, petrochemicals, machine tools and renewable energy with a minimum investment of about US$117 million.

Tax allowances — reductions of taxable income up to 30 percent of total investment carried over six years — will be offered to selected labor intensive projects in remote areas with a minimum investment of Rp 50 billion (US$6 million)

A joint ministerial team, comprising officials from the Industry Ministry, the Investment Coordination Board and the Finance Ministry, will review investment proposals case by case and decide whether they qualify for the tax incentives.

Public debates over the role of tax holidays in attracting investment have taken place on and off since 2007, but the then chief economics minister Boediono argued against such a facility, pointing out that investors looked primarily at the quality of the overall investment climate — political and macroeconomic stability, policy consistency, legal certainty. After all, tax is paid out of profits, and anyway most new investment ventures lose money during the first few years after start up.

But we reckon the government finally went ahead in offering such tax incentives mostly because several other ASEAN countries, such as Malaysia, Singapore and Thailand, also provide such facilities to woo investors to high-priority areas or sectors. It would, however, be a big mistake if the government thinks that reform measures to improve good governance are no longer so urgent and imperative, now that tax incentives have been made available.

Instead, we still think that tax holidays and tax allowances will be rendered meaningless in attracting investment if the government cannot make significant improvements in good governance practices in tax administration, customs services, licensing bureaucracy and other components of regulatory and legal frameworks.

Indeed, tax holidays have never ranked prominently in the list of grievances aired by domestic and foreign investors in opinion surveys. Businesspeople often complain about tax issues, but they are not related to the absence of tax holidays; instead, their complaints primarily concern inefficient and corrupt tax administration and taxation regulations, which put taxpayers at a great disadvantage vis-à-vis tax officials.

Our corporate income tax, which is 25 percent flat, is already competitive. Tax holidays have a negligible impact on investors’ decisions when such basic issues as the effectiveness of the judiciary and the ability to uphold and enforce contracts still rest upon shaky ground, as they do here. It is these non-economic factors, in addition to excessive red tape, and not tax policies, that have been the main concerns for businesses.

The Doing Business 2011 report by the World Bank that rated 183 countries according to their performance of 11 requirements for the ease of doing business, ranked Indonesia 121st. Even among ASEAN countries, our performance was among the worst, better only than the Philippines.

The government is well advised to realize that tax holidays and tax allowances for investment are no substitute for good governance and sound macroeconomic policies.