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Jakarta Post

Moral hazard in Indonesia'€™s tax incentives

Countries are competing against each other to attract investments

Suhut Sinaga and Kristian Agung (The Jakarta Post)
Jakarta
Tue, May 19, 2015

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Moral hazard in Indonesia'€™s tax incentives

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ountries are competing against each other to attract investments. Investors have many considerations before they decide where to locate their investments. One factor is fiscal policy, which includes the tax systems of the countries being observed. The more facilities and incentives are given, the more attractive the country is as an investment destination.

Nevertheless, the government should be careful not to destroy market mechanisms or even worse create a moral hazard.

The Indonesian government recently issued the new Regulation No. 18/2015 regarding tax allowances for investment in certain business sectors and/or certain regions.

 Indonesia is offering various types of tax facilities to attract more investors. Some of them are: tax holidays; tax allowances for investment in certain business sectors or regions; the simplification of calculations for income tax on income from businesses with certain gross income; income tax reductions for publicly listed companies; and tax reductions for resident corporate taxpayers.

Tax holidays are provided for pioneer industries. Corporate taxpayers that are newly established in Indonesia and conduct business in the scope of pioneer industries '€” i.e. basic metal industries, oil refineries, oil and gas source-based organic chemicals, machinery, renewable resource industries, or communications equipment '€” are eligible to apply for this facility.

The requirements include a minimum investment of Rp 1 trillion (US$77 million). The tax holiday consists of a corporate income tax exemption for 5 to 10 years, from the start-up of initial commercial production, a 50 percent corporate income tax reduction for two years after the tax holiday period ends, which may be extended again subject to some further consideration by the Finance Ministry.

Tax allowances are provided for investment in certain business sectors and certain regions. There are 66 business sectors and 77 business sectors in certain regions that are eligible for this allowance.

One of the consideration is to promote equality and acceleration of development among regions in Indonesia. High investment plans, being export-oriented and having a high number of workers and high local content are required.

The facility consists of an investment allowance at 30 percent of the total investment, accelerated depreciation, a lower income tax rate for dividends paid to non-residents, loss compensation for 5 to 10 years depending on the conditions of location, domestic worker numbers, expenses in economic and social infrastructure, research and development expenses and the utilization of domestic raw materials/components.
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The state should help those corporations that help themselves regardless of their size.

Simplification of the calculation of income tax is given to businesses with no more than Rp 4.8 billion of gross income within one fiscal year. The simplified formula is implementing a final income tax that is 1 percent of gross income.

Income tax reductions are provided for publicly listed companies. To be eligible, taxpayers should list a minimum of 40 percent of stocks, owned by at least 300 parties, where each owns less than 5 percent of all stocks. The corporate income tax rate reduction is 5 percent lower than the normal rate.

An income tax reduction is provided for resident corporate taxpayers with gross income up to Rp 50 billion per year. A rate reduction of 50 percent is imposed on taxable income from the part of the gross revenue of Rp 4.8 billion.

Korea'€™s development experiences showed that for economic development, the state should support political ideology and policies that help those who help themselves. It is strongly recommended that the government act discriminatively, in that it favor those who perform well in the market '€” not merely based on location, size, business sector, or just because it is weak or small. Be careful not to get trapped in egalitarianism. The government should strengthen the market'€™s discriminatory function and thereby provide motivation for economic excellence by helping to acknowledge differences in economic outcomes.

The state should help those corporations that help themselves regardless of their size. The size of a firm could be irrelevant to growth of the firm and a discriminatory policy should be adopted for economic development '€” industrial, corporate and regional development. Corporations can create successful know-how and synergy internally by exercising economic discrimination.

The government can improve upon the private market outcomes (development failure) by solving both market as well as corporate developmental failures through adopting the discriminatory institutional as well as policy regimes, which help those agents, corporations and individuals who help themselves. For economic development, the government should perform the role of the economically motivated discriminator just like the market, thereby supplementing the market. Industrial policy should reinforce the market discrimination.

Any political and socioeconomic regime seeking economic equality is not development friendly. Economic policies to differentiate incentives such as taxes and subsidies and financial support depend on performance: small and medium enterprise (SME) promotion, agricultural support, regional development, research and development support, educational support, etc.

Government overprotection of SMEs creates a moral hazard on the part of SMEs. Economic discrimination by the government with tax and financial supports to the self-helping and better-performing firms was the key factor of Korea'€™s economic success during the Park Chung-hee era. If you unconditionally support only small-sized firms, you will always only end up with more small firms.

I suggest Indonesia reform its corporate promotion policy in terms of helping only those who help themselves.

A tax holiday provided for pioneer industries is not appropriate. Only corporations can be the appropriate object of incentives. It is better to give incentives to corporations in many sectors (who perform well) than to all corporations in certain sectors (where it is difficult to discriminate those who perform well from those with poor records). When it is considered highly important to promote certain pioneer industries, Indonesia should embed additional requirements based on '€˜market performance outcome'€™ to give such incentives.

Tax allowances provided for investment in certain business sectors and certain regions, once again, are not appropriate.

There are some specific criterions that match the dictum of helping only those who help themselves. In my opinion, (tax) incentives would best be given to businesses that meet the following criterion of: export proportion (out of total sales); financial statement ratios (such as return on assets, returns on equity, etc.); and growth (of sales or income).

It may be good to give incentives to businesses that that meet the criterion of: minimum amount of investment; utilization of domestic raw materials; absorption of domestic manpower.

Incentives are not recommended to be given merely to those which meet the criterion of: particular industries; certain regions; size (or another subjective character such as being listed or not); expenses for infrastructure and research and development.

How would you know that the expenses are spent effectively and economically, not merely spent just in order to achieve the criterion for government incentives? And never give incentives which would discourage SMEs to grow in terms of gross income limitations.

One important thing is that the examination of business performance must be reviewed periodically in a transparent process. Who would evaluate those requirements?

The criteria for selective support should be '€œmarket performance outcome'€ rather than a subjective evaluation by government officials and/or professionals in advance before the market outcome.

Unfortunately, Indonesia'€™s current tax incentives are given subject to evaluation by Finance Ministry or Investment Coordinating Board officials in advance.
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The writer is an official of the directorate general of taxation. This is a personal view.

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