Indonesia has the potential to be Asia’s economic star of the next decade. That its long-term future is sound and promising despite the challenges is confirmed by the views of some 500 prominent business leaders, polled in PwC’s APEC CEO survey 2013. Indonesia is emerging as one of their top investment destinations. Even so, Indonesia needs balance, coordination and focus if it is to optimise its potential.
Over the last decade, Indonesia’s tax system is much improved, both in revenue collection and in administrative processes. Yet its total tax take, about 12% of GDP, is lower than in other Asian economies. Indonesia continues to focus on ways to attract foreign direct investment. With this in mind, policymakers need to consider carefully whether raising taxes is the only, let alone the best, way to increase tax revenues.
Supply-side economists have long argued that high taxes discourage production. Tax cuts can thus result in the government collecting more revenues not less, as this is proven globally to encourage compliance. Any raising of Indonesia’s corporate income tax rate of 25%, its value-added tax (VAT) of 10%, or widening of its extensive tax net for withholdings, could thus render Indonesia a less attractive place for investors. What could help are further efforts to widen the tax base. Onerous administrative requirements could also be streamlined. These steps, properly managed, can raise compliance without overly hampering economic activity. The tax authorities are trying to do this by, among other measures, setting up an e-filing system for taxpayers.
A policy, whatever its intent, is only as good as its execution. Consistency of application is thus a chief virtue. In this light, the government’s efforts to simplify business regulations and relax restrictions on foreign ownership, along with Vice-President Boediono’s 2013 policy package to encourage investment, are commendable. Red tape remains a common barrier for investors. Regulatory and licensing rules are not always clear, nor easy to comply with. Businesses’ experiences are inconsistent. The myriad approvals, procedures and documentations, as well as lack of transparency, only add to the frustration. From tax holiday applications to large-scale business re-organisations, therefore, more consistency and coordination between government agencies would be much welcome.
A VAT was introduced to widen Indonesia’s tax base in 1983. Yet some of the regulations that accompanied it have had unintended consequences. When businesses look for where to base their services and expertise, costs are a chief consideration. Limitations on a zero-rating of VAT for exports have put Indonesia at a disadvantage to many of its neighbours. Unsurprisingly, few regional headquarters are set up in Indonesia. One way to improve this is to introduce a systematic and transparent way for taxpayers to provide feedback and suggestions to relevant authorities.
To gain the biggest edge, Indonesia should focus on its strategic advantages. Even if tax holidays are introduced for financial businesses, traction will likely be limited. Indonesia’s financial market is still in its infancy, and it lacks the infrastructure, specialist talent and supporting ecosystem of developed neighbours like Hong Kong and Singapore. To further mature and attract the interest of multinationals, it needs tax incentives for human capital development, infrastructure and strategic industries with large multiplier effects.
Taxes could also be better administered. Indonesia’s policy of self-assessment for tax relies heavily on tax audits to correct erroneous filings and collect underpaid tax. Under prevailing practice, a tax refund of any amount triggers a tax audit. This is inefficient. The forensic nature of audits, with tight deadlines for submitting documents, is cumbersome to taxpayers. Tax authorities’ efforts to clarify their focus are therefore heartening. A recent circular, for example, clarified the factors that may lead to transfer pricing audits.
Despite the challenges, Indonesia is moving in the right direction. Exciting developments abound. With greater balance, coordination and focus, we believe that its potential can be maximised on the world stage.
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