Another tax reform

The amendments to five tax laws approved on Monday by the House of Representatives are designed mainly to improve the efficiency of tax administration, make tax burdens more equitable, increase tax compliance, broaden the tax base and support the decentralization of political and fiscal power to the provinces.

Though the amendments are not as extensive as the overall tax reform launched in 1983 when the government fundamentally changed its taxation system to a self-assessment system that minimized the discretionary power of tax officials in determining the amount of tax obligation due, the latest changes are still quite significant. Moreover, the latest amendments are the second set of improvements effected since the first major amendments in 1994.

Significant changes effected by the latest amendments are broadening of the income tax brackets and differentiating income tax rates between individual and corporate/institutional taxpayers. Under the old laws, corporate/institutional income tax brackets and tax rate structure were the same as for individuals. Even though the highest individual income tax rate was raised to 35 percent from 30 percent, lower and upper-middle income tax payers will benefit from the changes.

Previously, taxable income of up to Rp 50 million per year (US$5,500 at the current exchange rate) was subject to the highest rate of 30 percent, but now taxable income up to Rp 200 million is subject to only 25 percent tax. The highest rate of 35 percent is applied to personal income in excess of Rp 200 million.

These changes, and the raising of the non-taxable income level, were necessary to institute a more equitable distribution of tax burden and to reflect the general increase in the cost of living and sharp erosion in the value of the rupiah since the 1997 financial crisis.

Another major improvement, which is designed to expand the tax base, is the broadening of the definition of corporate or institutional taxpayer to include social and political organizations even though their articles of incorporation designate them as non-profit organizations. The impact of this amendment is the netting of numerous foundations, claiming to be non-profit, social-oriented organizations, but which in reality are often among the most prosperous enterprises, such as the foundations formerly chaired by former president Soeharto.

The business sector also gets a boon from the amendments. The applicable highest tax rate for businesses and other institutional taxpayers is only 30 percent, as against 35 percent for individual taxpayers. The amendments grant tax allowances, allow accelerated depreciation and carry-over of losses (for compensation) for up to 10 years.

Improvements to the efficiency of tax administration will be realized by simplification of procedures for refunds of excess income tax and value added tax payments and imposition of severe punishment for tax officials who erroneously calculate tax obligations. Similarly, the law on tax collection by distress warrant was amended to encourage tax compliance.

A completely new stipulation, obviously designed to support decentralization of political and fiscal power to the provinces, is the allocation of 20 percent of individual income tax receipts to regional administrations. But a more significant benefit of this provision is the encouragement it will provide for local administrations to attract more investments. In the past there was no incentive for local administrations to woo businesses as all receipts from income tax and value added tax went directly to the central government.

However, at the end of the day, the benefits of the latest tax law amendments will be determined by the level of compliance, which is still the lowest among ASEAN countries. Latest estimates put the tax ratio (the proportion of tax collected against the potential tax revenues) at less than 50 percent.

Tax compliance is not solely a matter of law enforcement. Though this factor is necessary to discourage tax evasion and to establish justice in tax collection, the government will never have enough manpower to register and audit all taxpayers. The degree to which taxpayers freely respond to their statutory duty to declare their income will depend on the credibility of the government and how the people view spending and management by the government. Hence, good governance, which is one of the priority objectives of the present government, is crucial for enhancing tax compliance.