Hiking taxes may be catastrophic

By Christopher Lingle

UBUD, Bali (JP): Like many other governments in crisis-torn East Asia, the Indonesian government is struggling under the weight of large budget deficits. In searching for ways to reduce the shortfall in public sector revenues, the government has announced plans to plug part of the hole in its finances by raising taxes.

Unfortunately, raising taxes during a recession might be the worst possible solution for restoring balance to the public treasury. If this is a response to demands by the IMF and World Bank, hiking taxes might be more catastrophic than meeting the conditionality requirements set by international institutions after the onset of the crisis. It is hard to imagine a worse course of action than raising taxes when unemployment is rising and economic growth is slowing.

Consider the political costs and economic consequences from increasing the overall tax burden. The political ramifications for Indonesia might be substantial given the prevalence of wasted resources and misdirected public funds due to KKN. If more money is taken and squandered, outrages among an informed citizenry might spark a tax revolt.

In the case of Japan, the imposition of a consumption tax is widely viewed as the final straw that brought on the current recession by reinforcing negative forces in its economy. And in the US, an economic slowdown brought about by higher levies cost George Bush his re-election bid when he broke his famous "no new taxes" pledge.

Yet now, authorities in Jakarta have announced plans to increase taxes on some specific commodities (cement, tires and soft drinks) that is expected to yield about Rp 2 trillion, about US$2.75 billion. To their credit, the targets for higher taxes were selected with the aim to minimize collateral damage to the rest of the economy. There is also some discussion about raising import duties on sugar from the current level of 25 percent, albeit the motivation mostly reflects protectionist instincts rather than revenue generation.

There are many better ways to reduce public-sector budget deficits that could provide larger amounts of funds more quickly or outflows could be reduced. On the one hand, improving collection procedures to reduce leakages due to tax evasion can generate additional funds.

On the other hand, increasing efficiency and reducing mismanagement of state companies could lighten the burden on the state treasury. A concerted effort to halt unnecessary expenditures on government schemes would be highly beneficial.

In all events, the amount raised by the proposed new taxes is trivial compared to losses registered by state-owned companies arising from mismanagement. For example, the state electricity company is expected to lose almost Rp 14 trillion in the coming fiscal year. Additionally, there are reports of billions of dollars in losses by major state companies such as Pertamina because of poor management. And then there are enormous amounts of government revenues lost to theft and fraud as indicated by the siphoning off of as much as Rp 784 billion of funds that were available for reforestation.

Rapid steps could be taken to privatize state-owned assets along with a more concerted effort to sell off distressed assets held by IBRA. Besides the immediate injection of funds from sales, the conversion to private enterprises will result in them becoming net taxpayers rather than being a drain on government financial resources.

Another improvement would arise from increasing user fees and prices of goods sold by state enterprises. Note that such steps can actually decrease the overall tax burden. Reductions in public subsidies should bring down the amount of tax revenues required for government operations.

Even more important, is that gains would occur even if direct income transfers to poorer families were made in amounts that exactly offset subsidies that might have been paid to unprofitable state firms. Payments to the financially weakest sector of the community would shield them from increased prices and so minimize political opposition to such a plan.

Net gains from increased efficiency that would lessen the burden on the environment because of more prudent use of natural and human resources. This is because higher prices for previously subsidized goods or services would encourage households and businesses to choose more economically. When governments fix artificially low prices, distortions are shifted to other sectors of the economy. Removal of subsidies on electricity or petrol will benefit the environment by inducing conservation. Consumers will choose more sensible usage given their budgetary constraints.

The decision to rely upon higher taxes for deficit reduction indicates an outmoded mindset. Perhaps things might be different if political choices were made solely on the basis of equity and fairness or service to the community. Few citizens in Indonesia or the rest of Asia believe that story.

A superior approach to reducing public sector deficits is to rely upon restoring economic growth that will bring about revenue increases without imposing new taxes or increasing rates on existing levies. Globalization has revealed that high economic growth is a matter of choice for policy makers.

Governments must take the initiative to implement policies and support institutional arrangement that provide incentives for private entrepreneurs to undertake risks. In the end, only private sector actions can provide a sustainable source of job opportunities and additional wealth for a community. It is time to unleash more of these forces and allow greater scope for market transactions. In so doing, entrepreneurs can better discover what their fellow citizens most want to have and on the basis of those prices they will be willing to pay.

Raising taxes will only place more money into a system that seems to be irredeemably tainted by mismanagement and corruption. The choice of which path will bring better results should be clear.

The writer is an independent corporate consultant and adjunct scholar of the Centre for Independent Studies in Sydney. His e- mail address is CLINGLE@ufm.edu.gt.