Indonesia can significantly increase its tax revenues

Purbaya Yudhi Sadewa, Jakarta

In the 2005 state budget, the Indonesian government plans to increase its tax revenue by Rp 25.9 trillion (US$3 billion) over its projected 2004 figure. This is a sizable amount but should be attainable. The government, however, does not expect the necessary improvements in tax collection efficiency.

The economic crisis that hit the country in 1997 has left the government with huge debts. Each year the Indonesian government has to pay a significant amount of interest and principal on its domestic and foreign debts, which has strained the state budget.

However, the government has to be careful in its efforts in increasing its tax revenues, given that too high a tax rate might hamper economic growth. As such, the government has tried to increase its tax revenues by broadening the tax base, and, most importantly, by increasing the efficiency of the tax collection process.

This strategy seems to have worked well, given that revenues from taxes have risen consistently, and the economy has picked up its growth rate steadily in the last three years. For example, in 2001, tax revenues only amounted to Rp 185.3 trillion, but for the year 2004 they are expected to reach Rp 272.2 trillion. Meanwhile, the tax to GDP ratio (a ratio often used as a measure of tax collection efficiency) rose from 11.9 percent in 2000 to 13.6 percent in 2004 (projected). Also, economic growth increased from 3.8 percent in 2001 to an expected 4.9 percent for 2004.

Tax revenues will still play an important role in the 2005 budget plan. The government expects to collect Rp 297.8 trillion from tax (up by Rp 25.9 trillion compared to the previous year), which is around 75.9 percent of the total government revenue planned for fiscal year 2005. The biggest component that contributes to government tax revenue is income tax (47.6 percent of total tax revenue), followed by value added tax (around 33.5 percent of total tax revenue) and by excise tax (around 9.7 percent). The government expects higher revenues in all the tax components next year.

The government's expectation of higher tax revenues in 2005 is reasonable enough. Economists at Danareksa Research Institute arrived at a calculation that suggests the Indonesian economy is currently in an accelerating phase, which should mean a faster economic growth pace in 2005. Business sales and profits are likely to grow at a faster rate too. This also means faster income growth; and, therefore, higher income tax revenue for the government.

I do not believe that the higher oil price will slow the economy, since the government is not likely to lift fuel subsidies next year. Danareksa's calculations show that the state budget is still in good shape, even if the average oil price rose from $24 per barrel (the budget's assumption) to $35 per barrel. Furthermore, the cost of removing the fuel subsidy would be greater than its benefits.

Removal of the subsidy would push up inflation, which would force the central bank to hike interest rates. As a result, interest payments on government debts would increase. At the same time, the cost to the central bank to pay Bank Indonesia promissory notes (SBI) interest would also increase.

However, a higher oil price might even push up tax revenue, as long as the subsidy is not removed. Higher oil prices mean higher tax revenue from oil and gas income tax. As such, provided that the world oil price does not increase too steeply, the prospects of the economy will remain bright in the near term.

Despite the expected increase in tax revenue, the government does not seem to expect a significant improvement in the efficiency of the tax collection process. The 2005 budget only expects a tax-to-GDP ratio of 13.6 percent, unchanged from the tax ratio in the previous year.

This figure is much lower than in neighboring countries. Thailand, for example, has successfully raised its tax collection rate from 13.6 percent of GDP in 2000 to 15.2 percent in 2003. Meanwhile, Malaysia has also pushed up its tax collection rate from 13.8 percent in 2000 to 16.0 percent in 2003. This data suggests that it is possible for Indonesia to reach a tax collection rate above 13.6 percent of GDP.

Strangely enough, the government does not seem to be ambitious about gaining a higher tax collection rate amid the overall tax reform, which is expected to be effective in 2005. The tax reform will include improvement of the tax administration and policies and amendments to the current tax laws. I believe that, in principle, the reform should bring about more efficient tax collection, without necessarily adding further to the burdens of taxpayers.

A lack of improvement in the efficiency of tax collection is bad news for business and the economy in general. It is not a secret that the current taxation system has many loopholes that can be manipulated by both tax officers and businesspeople alike for their own benefit. On many occasions the business community has accused tax officers of abusing their power, thus forcing companies to pay taxes far above their official rates, but quite a portion of those payments only end up in the pockets of tax officials.

Tax reform is expected to rectify this problem. And as a result, the tax collection rate should improve. The government has acknowledged this problem, and has exerted its efforts to rectify this problem by preparing an amendment to the tax laws, which includes income tax, valued added tax and the general provisions on taxation.

Apparently, however, the current government does not expect too much from the reform at least for next year, as reflected in its projected tax collection rate. Furthermore, many issues are yet to be solved by the current tax reforms. These include regulations on tax refunds, consistency in tax regulations and eliminating loopholes that may create "negotiations" between tax officers and taxpayers.

Against this backdrop, the target of the tax revenue in the 2005 budget is rather too pessimistic. Higher tax revenues can be reached, without additionally burdens on businesses and the economy if there is political will to resolve the problems in the current taxation system.

The writer is a Senior Economist at Danareksa Research Institute. This article is a personal view.