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he increase in non-taxable income was approved by the government and the House of Representatives last June. The non-taxable income, which was at Rp 24.3 million (US$1,825) for an unmarried taxpayer, is to be raised to Rp 36 million.

There are two main considerations underlying this policy. First is the increase in regional minimum wage for 2015. This year, the average increase in regional minimum wage is 11 percent. Second, the government wants to boost people'€™s purchasing power, given the gloomy economic performance that started in 2014.

For the past five quarters the Indonesian economy grew at only 5 percent on average, which is lower compared with the growth from 2009 to 2013, which was 6 percent on average. External conditions are considered to be the major cause.

The global uncertainty, which started with the end of the quantitative easing in the US at the end of 2013 and was further followed by the possibility of a rise in the US Federal Reserve funds rate, has made the situation even more vulnerable to reverse capital flows from the emerging economies.

Worse still, Indonesia'€™s major trading partners, such as China and Japan, are not better off, which affects the demand for our exports. China, which used to grow in double digits, is currently at its slowest pace with gross domestic product (GDP) growth at only 7 percent in the first quarter of 2015.

As for Japan, despite the implementation of a very profound economic stimulus policy, its economic outlook is also not yet promising. Furthermore, the eurozone is currently still in a slow pace of economic recovery and could even suffer a contraction.

The current slowing of economic growth contrasts with the new government target of 7 percent growth in 2019. High growth is necessary to absorb the unemployed and to escape the middle-income trap.

The government has made efforts to achieve high growth, one of which is by boosting infrastructure spending. Government spending on infrastructure has exceeded its spending on subsidies for the first time in 10 years.
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Caution has to be shown since massive increase in aggregate demand will further lead to inflation.

This year the government allocated Rp 290 trillion for infrastructure spending, which is a significant increase compared to the Rp 170 trillion from the previous year. Unfortunately, Indonesia is still facing issues in budget realization, particularly in capital spending, which has always been lower than the budgeted total.

Even up until the end of May this year, the capital spending realization still reached only 7.5 percent of the total, down from 11.1 percent in the same period last year.

In facing the economic downturn, the government has two fiscal tools: fiscal expansion and tax incentives.

Fiscal expansion has been done by the current administration through massive spending on infrastructure and regional transfer funds, though it turned out that the budget realization is not happening as quickly as expected while the downturn has to be tackled immediately, so the government needs a rapid solution and tax incentives are seen as a virtuous solution.

Giving tax incentives during an economic slow down is a common policy. China responded to the subprime mortgage crisis in 2008 by giving tax incentives through cutting the tax rate in almost all of its exported commodities and increasing the tax rebate and special tax incentives targeted to industries with high value-added exports.

Therefore the increase in the non-taxable income is quite appropriate given the current condition.

When taxable income is decreased, it will lower the tax burden of the people and their disposable income gets larger.

The increase in disposable income will lead to increases in both consumption and investment.

Particularly for developing countries such as Indonesia, marginal propensity to consume is higher compared with developed countries.

The increase in consumption will further increase the GDP, but caution has to be shown since massive increase in aggregate demand will further lead to inflation.

In addition, if people choose to save their money rather than spend it, the loanable funds will get larger and banks will be able to provide more credit to people for investment '€” the higher the investment made, then the higher the GDP becomes.

An increase in consumption and investment will increase the demand for output in the economy, which means more workers will be needed and more jobs will open up.

In addition, the ones who benefit the most from the increase in non-taxable income are mostly the ones at the bottom of income distribution: mostly lower-salaried workers.

Empirical studies show that the lower income people tend to consume more basic goods, such as food and clothing.

So another implication of this policy would be the increase in demand for particularly basic goods. It is expected that local entrepreneurs will be able to tap into this opportunity.

Also, since the ones who benefit are the ones at the bottom of income distribution, then it will help mitigate the inequality issue in this country.

Aside from the positive impact from this tax policy, the government also has to be very cautious about the possible decrease in tax revenues.

Moreover, last year, the government experienced a shortfall in tax revenues. The government only obtained Rp 1,143 quadrillion, less than the target of Rp 1,246 quadrillion.

This year the government aimed to obtain Rp 1,489 quadrillion in tax revenues, which is quite a remarkable increase. But an increase in non-taxable income, which will strength the consumer'€™s purchasing power, can also lead to an increase in value-added tax revenues because of increased consumption.

In the end, the decision is made and hopefully the multiplier effects from increase in the non-taxable income can compensate the possible shortfall in the tax revenue.
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The writer works at the Fiscal Policy Agency of the Finance Ministry. This is a personal view.