Broadening the tax base

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.