Caveats within Susilo's tax amnesty plan

David E. Sumual, Jakarta

In an apparent effort to reform the overall tax system that discourages investment, the Susilo Bambang Yudhoyono administration has revealed its plan to draft a tax amnesty law as one of its first 100 days' actions. Nonetheless, the finance ministry did not elaborate further whether this intended tax amnesty also involved a reprieve for the criminal aspect of tax evasion.

The criminal aspect of tax amnesty is of importance, as it would involve the moral hazards problem and the people's sense of fairness. The moral hazards problem arises when people expect to be offered another amnesty, and would lower their compliance to pay tax in anticipation of the future tax exemption. Those honest taxpayers would also react negatively to the fact that evaders were being given concessions and they may choose not to comply in the future.

At a time when the government is considering reducing fuel subsidies next year, people may also react negatively like when the government announced the release and discharge policy at the same time when it announced fuel price hikes last year.

The general public may perceive this preferential treatment as unfair as those tax evaders are no longer subject to criminal punishment while, at the same time, the additional burden of higher fuel prices is imminent.

Given these tricky situations, it is important for the government thus to distinguish the taxpayers' character. As such, the government must give the right message, that amnesty does not tolerate those tax evaders who try to manipulate their tax reports. In other words, the tax amnesty program only gives a chance for the people who may have made an honest mistake on their taxes to clear their profile, without fear of prosecution.

And, at the same time, the program should not let lawbreakers off scot-free or not be open to those already under prosecution for tax manipulation. This is particularly true, as some studies have showed that the primary reasons for Indonesian businessmen to evade taxes are actually the choking bureaucracies and the unscrupulous tax officials seeking to extort money from them for personal gain.

To avoid moral hazards, tax amnesty has to be a one-off occurrence to give just a one-time opportunity to make up for past mistakes. In fact, it should be made clear that this is their only chance, since there would be no guarantee that this policy would ever be offered again in the future. The amnesty period that waived all penalties and the accrued interest on the owed taxes should be thus predetermined for the specific taxable periods.

Nonetheless, after the amnesty ends, an eligible taxpayer who fails to apply should face additional penalties, as well as criminal charges. Moreover, the law enforcement must be then intensified and be tougher than ever to give an important signal to the non-compliers that they will be punished severely when they are caught.

Besides moral hazards, a tax amnesty of course incurs real costs in the short term, in the form of penalties or interest that should have to be forgone to make voluntary disclosures attractive to past evaders.

However, there is a tradeoff coming forward as some additional tax is likely to be collected if those past evaders are successfully brought into the tax system and begin paying the correct tax.

Both the tax revenue and number of taxpayers that are currently only around 1 percent of Indonesia's population, would in turn get a boost as exemption gives people in the underground economy incentives to go legitimate.

Having said that, the massive informal economy in Indonesia that must hide to survive and thus cannot use legitimate channels for finance can be reduced. Furthermore, in the longer term, an amnesty also allows the tax authority to reduce its administrative procedures, thereby saving in administrative costs.

Worldwide comparative studies on tax amnesties have actually shown that the cost/benefit outcomes of amnesties are highly variable. In developed countries, the government tax amnesty had played a major part in the improvement of their fiscal conditions. The impact of tax amnesty measures in Italy for instance is reportedly around 1.5 percent of its GDP in 2003.

According to the U.S. Federation of Tax Administration, the U.S. has also offered exemption over the last two decades and was successful in bringing millions of individuals and businesses onto the tax rolls for the first time.

In contrast, the Philippine experience, however, showed that tax amnesties have not worked so well. The main reasons for the Philippine's failure may relate to its undeveloped tax system, its tax reform that in nature was still partial and a lack of law enforcement.

Learning from the Philippines experience, the "time factor" is very important, as everything that is done in a hurry would be likely to fail. As such, the government must ensure that the overall tax administration is ready before the implementation of tax exemption measures.

Improving transparency and efficiency of the tax office by cutting bureaucracy is thus a must. The online system that is equipped by computer tracking and a data mining system should also be in place, in order to make it easier to hunt down delinquent taxpayer accounts.

Moreover, improving tax administration should, of course, be directly linked to the tax officials' salaries. By raising the salaries of tax officials, there is less justification for them to be corrupt.

However, this improved tax system will not work without a better judicial system. By having well functioning law enforcement agencies, shock therapy to arrest corrupt tax officials or well-known figures that manipulate tax will not face public suspicion of being merely theatrical. With the improved tax administration, an amnesty could therefore be an effective transition tool before increasing enforcement activity or making significant tax reform.

The writer is an analyst of Danareksa Research Institute This article is a personal view and it is intended only to enhance public debate.