Hiking taxes may be catastrophic

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.