Broadening the tax base

Easing the tax burden is, theoretically, one of the policy instruments usually employed by a government to reinvigorate a slumping economy. The rationale is that a lighter tax burden will increase the amount of disposable income of taxpayers, thereby bolstering their purchasing power and consequently strengthening private consumption so as to encourage economic activity.

This popular line of economic reasoning should be quite relevant to Indonesia as its economic growth is projected to be 1.5 to two percentage points lower than the original estimate of four percent to five percent made at the outset of the 2001 fiscal year in January. Such a populist program would also be quite attractive as a political instrument for a government like that of Abdurrahman Wahid whose popularity and credibility is declining sharply.

The government is nonetheless being compelled to pursue the unpopular measure of stepping up its tax collection campaign, which in many other countries would be the surest path to political suicide. In fact, tax and excise duties are one of the five main policy instruments being employed by the government to raise additional revenue so as to cover its budget deficit, which for the current fiscal year is estimated to be about Rp 30 trillion (US$2.7 billion) larger than the original projection of Rp 53 trillion.

There are, however, several factors and conditions in Indonesia that still allow for a more concerted tax effort without causing more suffering for the people at large, who have been groaning under the strain of severe economic hardship since the crisis broke out in late 1997.

First of all, the government will focus its tax campaign on direct taxes, notably income tax. Even in this sector, the main objective is to broaden the tax base, not to raise tax rates, by registering potential taxpayers who have hitherto remained outside the tax net. Different from indirect taxes which squarely hit all taxpayers irrespective of their income levels, the impact of direct taxes is discriminative in that the tax rate is progressive in line with the level of income.

Most studies by domestic and international analysts have concluded that there are still tremendous opportunities for raising income tax revenues in the country due to massive tax evasion and the high incidence of tax fraud. The incidence of noncompliance in respect of personal and corporate income tax has been estimated at 50 percent.

The tax directorate general recently validated the conclusion of the studies, disclosing that only around one million of the country's 210 million people have been issued with personal tax identification numbers. Worse still, only about 50 percent of this small number actually file annual income tax returns.

The number is certainly quite small even though it does not include several million paid employees who pay their income tax through their employers (pay-as-you-earn system).

The government, therefore, is quite justified in stepping up its effort to register more potential taxpayers. Given its recent success in netting hundreds of potential taxpayers in the elite Pondok Indah residential area in South Jakarta, the tax office is expected to stage similarly vigorous campaigns in other high- income residential areas not only in the capital city but also other major cities throughout the country.

However, simply registering potential taxpayers will not automatically raise tax revenues if the tax administration system is not capable of detecting all the income actually received, both from within the country and from overseas, by taxpayers. In this connection, we think, the government needs to improve the mechanisms whereby tax officials are authorized to cross-check information on taxpayers' incomes and expenditures in cooperation with other institutions such as banks, the electricity and telecommunications companies, and the motor vehicle registration office.

But law enforcement, though necessary to minimize tax evasion and tax fraud, is not sufficient to ensure tax compliance as there will never be enough tax auditors to examine all taxpayers. Tax compliance involves the willingness of taxpayers to pay taxes and this, in turn, is influenced partly by their perception of the integrity of tax officials and the government's credibility in general. Efficient and transparent tax administration is also crucial for minimizing the cost of tax compliance. Taxpayers will be discouraged from registering if their tax identification numbers make them subject to uncertainties concerning questions of tax law, and costly objections, appeals and tax-rebate procedures.