Tax rates could be the main reason for Indonesia’s low and declining tax-to-domestic-gross-product (GDP) ratio from 13.61 percent in 2013 to 11.42 percent in 2018. Theoretically, as articulated by the so-called Laffer Curve, the relationship between tax rates and tax revenue can be illustrated by a bell-shaped curve. It correlates positively in the beginning, but after reaching a point, a higher tax rate can be counterproductive to tax collection. The latter is suggested as the phase Indonesia is currently in.

Add the fact that Indonesians’ income per capita has been growing during the same period, that rationale is not so wrong, as evidenced by Indonesia’s relatively wide “tax gap”, which is the gap between potential and realized tax collection. A wide tax gap represents that our tax collection is far from optimal.

Another supporting factor in regard to the above hypothesis is the fact that there are a substantial amount of Indonesian assets parked offshore. As we recall back in 2014, the estimated size of these assets was put at around US$250 billion. Based on high-level surveys conducted by international institutions, 14 percent of these asset owners state that tax advantages are among the reasons why they place the assets overseas.

In comparison with other countries, Indonesia’s corporate income tax rate is indeed the second-highest in the ASEAN-5 region while the personal income tax rate is quite moderate — still lower than the Philippines and Thailand.

If one digs into macrolevel data, this can also be confirmed by Indonesia’s relatively high savings rate, which is not accompanied by a similarly deep financial sector. Our primary income account, which is the flow of proceeds from business and financial activities, has also always recorded a high deficit. This is the rationale behind regulations that incentivize the repatriation of export proceeds to Indonesia.

However, viewing tax policy in a vacuum is not necessarily the best approach. If we take one step back, tax is just one element out of many that involve individual transfers to and from the government. Aside from paying tax, individuals also receive direct benefits. Social assistance in Indonesia is considered high among the ASEAN-5 region, with an increasing trend — growing from 0.4 to 4 percent of GDP between the 2013 and 2019 fiscal years.

Besides, the government has applied many incentive schemes as a means of reducing the tax burden for dedicated taxpayers. Based on Indonesia’s Tax Expenditure Report (TER), Rp 154.6 trillion ($10.66 billion) of taxes (1.17 percent of GDP) in 2017 was not collected because of incentives policy.

Putting all transfers to and from the government in one list, if we are to assume all Indonesian taxpayers as one individual for simplicity, their final income should be able to tell if that individual is a net payer or net benefit receiver.

Final income is, thus, gross income, deducted by direct taxes (e.g. personal income tax [PIT]), indirect taxes (e.g. value added tax [VAT], excise) and added indirect subsidies (e.g. tax incentives, subsidized goods), direct cash transfers (e.g. subsidized rice and other benefits for the poor) and in-kind facilities (e.g. health care).

In Indonesia’s case, using Indonesia’s socio-economic survey data, excluding PIT because of data availability issues, in 2017, half of the Indonesian population with the highest income had become net payers. This was seen as a major improvement from 2012 when only two out of 10 groups of population with the highest income were net payers. Using the fairness angle, these findings show that fiscal policy did play the income-redistribution role better. This means that the current decline in the tax-to-GDP ratio is in line with the agenda of improving fairness of fiscal policy and not a result of a high tax ratio.

The transfer to or from the government, if transformed into percentage of income terms, however, suggests room for improvement. In relative terms, the poorest benefited more but paid almost as much as the richest. Net transfers to the government made by the middle to rich income groups, which are less than 10 percent, have been quite insignificant compared to their income. Further room for improvement is demonstrated by the fact that those who benefited from this most were the middle income group. Their consumption has grown considerably compared to poorer and richer groups since 2010.

From the above developments, there are important points that should be taken into consideration for 2019-2024 tax reform. First, it is clear that tax reform goes beyond tariff adjustments. A lower tax rate does not necessarily support the overall fiscal policy objectives in terms of income redistribution.

In this department, among the desired responses from tax reform is improving the targeting of tax incentives. Based on the TER, nearly 40 percent of the incentives are dedicated to improving the welfare of the people, especially through VAT facilities. However, the effectiveness of this particular policy has not been reflected as evidenced earlier by the similar VAT burden carried by individuals across income groups. PIT effectiveness in reducing inequality, although already applying progressive-to-income rates, should also be investigated to identify if there is room for improvement, such as the need to adjust the degree of progressivity.

Second and last, tax reform should elaborate the importance of introducing tax policies all together as a whole package with the incentives policy. This approach is expected to give taxpayers a comprehensive perspective when examining tax policy. This model has been adopted by other countries in the ASEAN region such as in the Philippines, which has commenced the “Comprehensive Tax Reform Program”.

All those lessons learned should complement the other important components as suggested by the government, such as simplification of business procedures, orchestrated with the international tax system in this era of automatic exchange of information, and administrative reform in organization, human resources and business processes.

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Adelia Pratiwi is an economist at the Finance Ministry, Andi Kuncoro is a member of Pi Alpha Honor Society, Cornell University, New York, United States. The views expressed are their own.

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