Can tax reform stimulate Indonesia’s economy?

Indonesia has unveiled wide-ranging measures designed to create jobs and stimulate economic growth, as discussions continue over the government’s proposed tax reforms.

On February 12 the government submitted a letter to the House of Representatives to officially start the deliberation process on its flagship omnibus bill, which combines multiple areas of legislation that will be agreed upon or rejected with a single vote.

Containing 174 articles and 15 chapters, the bill aims to replace or amend around 80 existing laws. It is central to President Joko Widodo’s plan to improve the investment climate and create more jobs.

The government hopes the legislation will cut red tape, often cited as a hindrance to investment and overall economic growth. The bill covers 11 areas and includes measures to strengthen intellectual property rights, ease labour laws and establish a land bank to allocate plots to investors.

See also: The Report – Indonesia 2019

Tax reforms

Another key feature of the omnibus bill is a proposal to reform the existing tax system, with the bill to revise up to seven related laws.

Measures include a phased cut in the corporate tax rate from the current level of 25% to 20%, new rules to tax electronic payments and efforts to increase tax collection from international digital companies operating in the country, such as Netflix and YouTube.

In addition, the reforms aim to reduce personal income tax for Indonesians and expatriates, relax rules on prepaid value-added tax payments and encourage the reinvestment of dividends.

Officials are hopeful these measures will incentivise large-scale investment in the country, while also broadening the tax base.

However, a World Bank report released on January 30 suggests that the reforms could end up lowering tax revenue. Analysis in the bank’s “Aspiring Indonesia – Expanding the Middle Class” report found that the government’s tax plans, if passed by lawmakers, would reduce the tax-to-GDP ratio by 0.5%.

Given that the current ratio – at 10.7% – is already one of the lowest in the region, the report raised concerns over tax collection, especially in the context of the country’s large-scale infrastructure plans.

“Without complementary revenue-raising measures, this will translate to less money being available to close the infrastructure and human capital gaps,” Rolande Pryce, the World Bank’s acting country director for Indonesia, said at the report’s launch in Jakarta.

“In the short term, the tax-to-GDP ratio might decline, but it will then slowly increase due to tariff changes and adjustments to tax brackets,” Sri Mulyani, minister of finance, told OBG. “In order to compensate for the initial tax loss, Indonesia will focus on compliance enhancement. In addition, we will continue to enhance the core tax system so that it can be implemented in full within the next few years.”

Indonesia collected Rp1332trn ($97.4bn) in taxes last year. While this was an all-time record, it was equivalent to 84% of the government’s target, leaving a shortfall of Rp245.5trn ($18bn), the highest such deficit in five years.

Supporting the aspiring middle class

The authorities have identified tax collection as an important tool for broader socio-economic development.

While noting that Indonesia has made strong progress in reducing poverty over the past 15 years – with the poverty rate now at less than 10% – the World Bank emphasised the importance of supporting the country’s “aspiring middle class”.

This group – estimated at around 115m people, or 45% of the population – is defined as those who are above the poverty line, but have yet to achieve full economic security. Significant investment in education, health care and infrastructure will be crucial in ensuring continued prosperity and moving these individuals into the middle class.

While the private sector is expected to play a role, public funding, much of which is derived from taxes, will be needed to realise these goals.

Investment key to economic plans

Tax reforms, along with those contained in the omnibus bill, are central to President Widodo’s plans to stimulate growth in the economy during his second five-year term in office, which began in October last year.

While growth has been consistent – at around 5% since 2014 – there are concerns that the expansion may not be enough to support Indonesia’s burgeoning population, estimated at around 265m.

Key to boosting growth is foreign direct investment (FDI), which dropped to $29.3bn in 2018 after five consecutive years of growth, then decreased further in 2019, down to $28.2bn.

On this front, however, 2020 started off strong, with the government signing $23bn worth of agreements with the UAE in mid-January.

The two parties signed 11 business deals and five memoranda of understanding, which included investment in the oil and gas, petrochemicals, maritime and telecoms sectors.

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