Consumption tax in Batam

President Megawati Soekarnoputri should be hailed for her political courage to impose domestic-consumption tax on Batam island, the bonded zone near Singapore, only a few months before the presidential election in early July.

Such a painful, fiscal measure certainly will set off protests, both from general consumers and investors. In fact it was such strong opposition that had prompted the government to postpone five times the implementation of the 1998 policy, to levy value-added tax and luxury-sales tax on domestic consumption on Batam island.

The President deserved full support for her politically unpopular, yet economically sensible fiscal measure. She braved local protests and took the risk of losing political support from voters, but her decision to push ahead with the long-postponed measure -- to put Batam under the country's tax regime -- was a long-sighted move.

This move corrected a major mistake that had been overlooked since 1978, when the government started an aggressive campaign to promote Batam as an industrial bonded zone, to attract foreign investors.

A bonded zone is an economic concept, designed to boost exports by allowing industrial firms to bring in capital goods and raw materials without paying import duty, value-added tax (VAT) and other indirect taxes normally levied on trading transactions. However, the tax and duty exemptions in a bonded zone are effective or granted only to export transactions, and not for domestic sales or domestic consumption.

This means that industrial companies are entitled to such exemptions only in so far as their imports are meant as inputs for export goods and their products are entirely designed for the export market.

By imposing VAT and luxury-sales tax on domestic sales (consumption), the government also puts Batam under its national trade regime. As long as Batam remains a bonded zone as it is now, it should be treated equally with other bonded zones, like the Nusantara bonded zone near Jakarta's Tanjung Priok seaport.

Hence, tax and duty exemptions are applied only to export and export-related transactions and not to domestic sales. The different tax treatment has so far made Batam a bastion for the smuggling of goods to other islands.

Further postponing the collection of VAT and other indirect taxes and duties from domestic consumption on Batam is also not fair to the people in other areas of the country. Why should the people in Batam enjoy such a special privilege of not paying taxes on their domestic consumption?

The tax imposition, we think, should not erode Batam's comparative advantage to attract investors, especially because the taxes are being imposed gradually, first on motorcycles, automobiles, cigarettes and liquor, which are hardly manufactured on that island.

What will greatly concern investors, notably foreign manufacturers, is not the tax imposition itself but rather the integrity and technical competence of the bureaucratic machinery -- tax and customs services -- that will administer the tax and duty collection.

Different from other bonded industrial zones in the country which are entirely isolated from residential areas, Batam island is also a large city complete with a municipal administration and a wide mixture of many residential areas, trading centers and industrial complexes.

The government therefore will require special bureaucratic procedures or safeguards to ensure that the tax and duty exemptions are granted only to enterprises which produce for export sales, and that all sales for domestic consumption are subject to taxes.

But businesses will be greatly worried if this procedure requires all companies -- even including export-oriented manufacturers -- to pay up-front duties and taxes on their imported inputs, because then they would have to routinely haggle with the poorly paid, highly venal tax and customs officials to get their tax and duty refunds.

The government, therefore, would be well advised to set up an expedient bureaucratic system with an effective oversight mechanism, both to administer the tax and duty exemptions for export transactions and to collect taxes on domestic consumption.

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