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Jakarta Post

Is tax holiday a panacea?

  • Subagio Effendi
    Subagio Effendi

    Doctoral candidate at the University of Technology Sydney-Business School

Sydney   /   Mon, January 7, 2019   /   05:03 pm
Is tax holiday a panacea? Providing fiscal incentives to investments that do not generate value-added and positive externalities may create distortions which lower economic efficiency. (Shutterstock/File)

The Indonesia government has released an expansion of the 16th economic policy packages regarding acceleration of business implementations in respond to the global economic turmoil and sustain the positive momentum of national economic growth up to the end of 2018.

The new policy packages comprising of expansion of tax holidays, relaxation of the negative investment lists, and foreign exchange control on the exports of natural resource products are believed to be the 'quick wins' policies to lessen the current account deficit problem and maintain a stable domestic currency until the end of the fiscal year.

A stable exchange rate is an essential factor in maintaining business certainty. However, the inconsistency of the goods and services’ trade surplus in the national current account balance has made the government and Bank Indonesia’s efforts to maintain the stability of rupiah more problematic.

According to Bank Indonesia (BI), the current account deficit (CAD) reached US$8.8 billion at the end of the third quarter of 2018, equivalent to 3.37 percent of the gross domestic product (GDP). It increased by 11.59 percent from the previous quarter's CAD of $8 billion or 3.02 percent of GDP.

Policies to reduce CAD must be carefully determined so as not to pose a counterproductive impact on the national economy. On condition that the domestic substitutions are not yet available, the government, certainly, does not want to limit the import of capital goods and industrial raw/supporting materials which hinder infrastructure development and real sector outputs.

Similarly, the government cannot reduce imports of fuel oil and staple foods which can drive inflation and reduce public welfare. As a result, policy options available to minimize CAD are limited. In addition to spurring the performance of exports of goods and services, the government can only limit imports of price-elastic consumption goods with a proportion of 9.22 percent of total national imports.  

Another policy option that can be made is to improve the performance of capital and financial accounts by attracting foreign investments to finance the current account deficit. According to BI’s report, until the end of the third quarter of 2018, the capital and financial accounts surplus reached $4.2 billion, equivalent to 1.61 percent of GDP, originating from foreign direct investments, portfolio investment in government securities and foreign loans of corporations.

Unfortunately, the capital and financial accounts surplus is insufficient to finance the accumulation of current account deficits and eliminate pressures on rupiah’s exchange rate.  

In line with the expansion of the 16th economic package, the government can further increase the capital and financial accounts surplus by optimizing the attractiveness of existing tax holiday program. The fiscal incentive aimed at improving direct investment and performance of pioneer industries has been revised with the Finance Minister’s Regulation Number 35/PMK.010/2018 and Finance Minister’s Regulation Number 150/PMK.010/2018 concerning Provisions of Corporate Income Tax Deduction Facilities.

A fundamental improvement considering that since the tax holiday facility was offered in 2011, the incentive has not produced a significant impact on the investment and performance of pioneer industries.

As reported by the Finance Ministry until 2017 the tax holiday is only enjoyed by five companies with a total investment value of Rp 39.4 trillion and an average period of tax holiday 7.2 years. Nevertheless, since the enactment of the new policy, eight investors have submitted tax holiday applications with a total investment plan reaching Rp 161.3 trillion.

The promising initial momentum can be further optimized by reducing the minimum investment threshold (i.e. mini tax holiday) and expanding the scope of pioneer industries to include agriculture, plantation, forestry and digital economy sectors following the new policy packages. However, in theory, the primary purpose of the tax holiday and other fiscal incentives is to improve economic efficiency by correcting market failures caused by positive externalities (spill-over benefits).

Providing fiscal incentives to investments that do not generate value-added and positive externalities may create distortions which lower economic efficiency. Therefore, the government needs to ensure that investments in the new pioneer sectors which receive tax holiday facilities have extensive economic linkages, generate value-added and high positive externalities, and have strategic values for the national economy.  

Another aspect that needs consideration is the harmonization of tax holiday facility with international trade provisions. Pursuant to the World Trade Organization’s Agreement on Subsidies and Countervailing Measures ( 1995 ), a facility/incentive from the government that is given specifically to a company or industry can be categorized as a harmful subsidy if it distorts international trade competition and causes material injury to the domestic industry.

The Trade Ministry reported that several Indonesian export products (e.g. uncoated paper, frozen warm-water shrimp, acrylic fibre yarn) had faced countervailing duty investigations from partner country’s trade authorities since the exporter firms are alleged to receive subsidies from the government. Hence, the tax holiday facility should be prioritized to industrial sectors that are oriented to fulfil the demands of the domestic market as import substitutions while still taking into account the market share of each industry.

With the appropriate promotion and provision of facilities, tax holiday can be a panacea in attracting foreign direct investments and maintaining global optimism to the national economy.

***

The writer is a doctoral candidate at the University of Technology Sydney-Business School, Australia.

Disclaimer: The opinions expressed in this article are those of the author and do not reflect the official stance of The Jakarta Post.