Most people think that this policy will hurt their perception of tax fairness, as applying VAT on basic necessities will weaken their purchasing power while discouraging production and consumption.

This argument is very reasonable, as shown in the bill on the general provisions on taxation (RUU KUP), which plans to expand the list of taxable items under VAT to include inelastic goods and services. These are the goods and services that people will always consume, regardless of price.

In addition to basic necessities and educational services, the bill also plans to tax health services, social services, financial services, insurance services and public transportation services. Since VAT is a consumption tax, the additional burden imposed on these basic goods and services could have the simultaneous effect of raising the prices of other goods, which could lead to inflation, declining aggregate purchasing power and consumption to damage economic growth in the long run.

However, the government is conveying a bigger plan through the bill. The government has explicitly stated that the enforcement/enactment of VAT on the importation and/or delivery of certain taxable goods and the delivery of certain taxable services that were previously not subject to VAT was intended to reduce the regressive nature of VAT.

By imposing a multiple rate system to replace the single rate scheme for VAT, the government is trying to restore a perception of tax fairness among the public. According to the government, the idea is to impose a lower VAT rate for the delivery of certain taxable goods and services that the majority of people need, and impose a higher VAT rate on certain goods and services that are specifically consumed by people of the high-income group.

At first glance, the idea seems reasonable enough. When viewed as a whole, however, it has many shortcomings. First, increasing the VAT rate from 10 percent to 12 percent will definitely increase the burden on general consumption. Even a potential mix combining the lowest VAT rate of 5 percent and the highest VAT rate of 15 percent still leaves the question as to how this multiple VAT rate will be applied in reality.

For example, how will the government determine which goods and services are specifically consumed by the rich? If only certain groups can access and obtain higher quality goods and services, won't this be a disincentive that will only widen the inequality gap?

Then, considering that VAT is an administrative tax that requires proof of collection through a tax invoice, how will the government efficiently share the task of collecting VAT, especially for small traders or small and medium enterprises (SMEs) with limited administrative resources?

Second, offering VAT as a remedy for the government's failure to implement fairer income tax as a tool for redistributing wealth seems hasty. The new VAT concept seems to be taking the place of “income tax responsibility” to burden the rich and help the poor. The concept has the vital goal of changing the initial nature of VAT from regressive to more progressive, despite the fact that the most effective way to redistribute wealth is to tax income, not consumption.

VAT reform is no easy task. To implement a multiple VAT rate efficiently, the goods and services subject to the different rates must be specifically determined and may require long discussion, especially for similar goods and services. In addition, there remains the potential for dispute if sorting the goods and services subject to different rates is open to multiple interpretations.

Singapore has faced this difficulty, which has led to delaying the implementation of a multi-rate system on its goods and services tax (GST). In 2019, Singaporean Minister of Finance Heng Swee Keat said that a tiered GST that imposed higher rates on luxury items than on daily necessities was a less efficient way to help lower-income households.

Reflecting on this statement, strengthening digital VAT administration is the key to pursuing this multi-rate policy. The Taxation Directorate General’s e-Faktur online tax invoicing system must be overhauled by first integrating each VAT rate with the categories of goods and services in the system. This way, taxable entrepreneurs (PKP) would be easier to check on the rates of the goods and services that imply to their transaction.

Second, taking sides with SMEs or small traders in the VAT system, the government needs to increase the turnover threshold to be assigned as PKP. The government also needs to expand the qualifications of retail traders.

These two solutions are necessary to lift the compliance burden on SMEs and small traders and help simplify their VAT reporting. Under the existing system, the PKPs with retail trader status could submit simpler monthly VAT returns. The government could also give VAT for PKPs with low turnover.

However, the mandates of wealth redistribution, protecting the consumption baskets of the poor and achieving other social objectives cannot be realized with a multi-rate VAT alone. Another measure is needed, such as implementing VAT exemptions for basic needs, although this can sometimes be a blunt instrument as it will also benefit the not poor who also consume these goods.

Another solution is to provide a VAT discount or cash transfers for the poor (BLT) for affected consumers who meet certain income criteria. In this, the taxation office’s information system is key. Aside from using the Social Affairs Ministry database (Bansos Data), offering VAT discounts to taxpayers can use the data on personal income tax returns.

Taxpayers with a certain gross income, for example, can be given a VAT discount if they have duly reported their income taxes. So this policy will not only maintain the purchasing power of affected consumers, but also persuade taxpayers to report their income tax returns.

Again, redesigning a VAT system is never easy. The government’s aim to incorporate wealth redistribution means that implementing the new VAT system will need to focus not only on items that are taxable under VAT, but also on the actual consumers of these goods and services. The government must also provide the entire infrastructure for the VAT system so it runs efficiently.

Implementing the new VAT system must go hand in hand with a more modern tax information system. Don't allow the complexity of this new system create a burden that will open opportunities for or incentivize the one behavior we all don't want: tax evasion.

***

The writer is an analyst at the Prodeep Institute. The views expressed are personal.

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