Raising revenue without tax hikes

Raising revenue without tax hikes

By J. S. Uppal and Sukanto Reksohadrodjo

YOGYAKARTA (JP): Now that the nation has completed the
momentous task of democratically electing the national
assemblies, the President and vice president, it has to face the
stark reality of the massive social and economic problems facing
the country. Among several difficult tasks for the new
administration, the priority is to raise sufficient government
revenue to cover mounting expenditure needed to deal with the
nation's problems.

During previous years, with high oil prices and the influx of
massive foreign funds, the government could ignore the problem of
high fiscal deficits. Now, particularly since the recent economic
crisis, when oil prices are not as high as before and foreign
capital is not as easily forthcoming, the country faces the grim
reality of serious shortfalls in domestic revenue.

Not before long, the nation will have to stand on her own feet
rather than depending on uncertain foreign loans. Indonesia's
external debt has reached a point where the nation has to
sometimes compromise its independence and borrow in order to act
on vital issues. Recently, there have been instances where
Indonesia had to accept dictates from lending institutions, even
when it was clearly not in the national interest. There is a
growing feeling among people that too much dependence on foreign
aid is robbing Indonesia of its economic independence and has
made the country a captive state quite easily manipulated by
lending institutions.

Central government revenues are comprised of oil and gas and
non-oil and non-gas earnings. Currently (1998-99) 75 percent of
total non-oil non-gas revenues come from taxes. The two major
taxes are income tax, both individual and corporate, and Value
Added Tax, which contribute 34 and 39 percent of tax revenues
respectively.

The position of Indonesian tax revenues in comparison with
some neighboring Asian countries can be seen from the following
table:

Table: Indonesian Tax Revenues Compared with Neighboring Asian
Countries

(Percent of GDP)

Indonesia: Total Tax Revenues (12.0), Income Tax (4.8), Value
Added Tax (3.2); Malaysia: Total Tax Revenues (20.2), Income
Tax (11.5), Value Added Tax (3.1); Philippines: Total Tax
Revenues (16.3), Income Tax (9.8), Value Added Tax (3.89);
Thailand: Total Tax Revenues (16.9), Income Tax (10.7),
Value Added Tax (7.61); S.Korea: Total Tax Revenues (17.10),
Income Tax (6.3), Value Added Tax (5.3).

Tax Rates (Initial and Maximum)

Indonesia: Income Tax (10.30), Value Addes Tax (10);
Malaysia: Income Tax (5.40), Value Addes Tax (NA);
Philippines: Income Tax (10.35), Value Addes Tax (NA);
Thailand: Income Tax (5.45), Value Addes Tax (15.00);
S.Korea: Income Tax (10.50), Value Addes Tax (10.16);

Note: Calculated from various sources. These figures should be
used for illustrative purposes only. Due to differences in tax
coverage and periods, these figures are not strictly comparable.

Why does Indonesia lag behind her Asian neighbors in
collecting tax revenues (called Tax Effort)? It is not that
Indonesian tax rates are so high they would discourage taxpayers
and investors. In fact tax rates in Indonesia are in general
comparatively lower, as figures in the above table show. It
should be noted that these are legal or nominal tax rates. If we
take real or effective tax rates (tax actually paid as a percent
of taxpayers total income), these figures become much lower.

To cite the case of income tax, while the top tax/nominal tax
rate is 30 percent, in real terms, we have estimated that it is
not more than 20 percent. It just means that high income earners
do not bear the legally mandated burden of taxes.

While statistical, information on the tax burden of different
income classes is not available, one could infer that the biggest
burden falls on the middle and lower classes, particularly in the
case of the VAT.

How do we account for this unfortunate situation? There are
two explanations. Firstly, in Indonesia only a small proportion
of the population is liable for taxes. It is estimated that
between 85 to 90 percent of people in this country do not fall
within the income tax net as most of them have incomes below the
income tax threshold.

The unfortunate part is that less than 1 million people, or
less than one half of one percent of the total population, are
even registered for filing tax returns. To make the situation
worse, from this small amount of registered taxpayers, only 55
percent even care to file tax returns.

Also, there are huge tax arrears to be collected. For income
tax alone, Rp 6.236 billion was delinquent in 1997-98, which
constitutes 17 percent of the total tax collectible. The rate of
tax delinquency has increased in the recent times. This is
massive tax evasion indeed, which if not stopped, will make
Indonesian income tax ineffective.

Secondly, there is the problem of many tax loopholes used by
individuals and corporations to reduce their tax liability.
Interestingly, when the existing income tax and VAT were
introduced during 1985-86, there were only a few exemptions and
deductions. The filing of taxes was made voluntary, assuming
honesty on the part of the taxpayer. There was also a stipulation
of strict tax law enforcement through intensive audits. It is
pertinent to cite the potential effects of proper audits.

In June 1986, an independent task force of auditors consisting
largely of returnees from overseas training programs and
reporting directly to the Director General of Taxes launched a
special audit on two dozen companies reporting zero or negative
tax liability. These firms were assessed to owe Rp 87 billion in
taxes, fines and penalties. While this audit campaign cost only
Rp 250 million, it yielded a direct return of that was 340 times
the investment.

Later on, several loopholes were introduced. There were two
reasons for this. Firstly the tax department could not cope with
the need for intensive audits of large numbers of tax returns
found to be in non-compliance with the voluntary tax laws.
Rather than strict enforcement of taxes thorough audits, an easy
way out was adopted, by introducing a final withholding system of
various items of income which of course suited the upper income
class taxpayers. If you look at the list of final tax
withholdings, some of the items are bizarre: unheard of in
countries with reasonable tax systems.

For example if an employee has one job, there is a final
withholding of say 15 percent, no matter what his other sources
of income -- interest, dividends or rents -- may be. The
interesting part is that government pays the tax for government
employees. In this way, one can make a fortune with just one job
and pay no tax at all.

One can become super rich from other income sources such as
interest on deposits, stock dividends, rents and royalties, with
tax liability of only 15 percent as the final withholding
taxalthough if the total income of this tax payer was put
together, he may well be in the 30 percent tax bracket. These are
only a few examples of tax abuse.

There are several others showing how these tax loopholes have
seriously eroded the Indonesian Tax System and have made a mess
of it, as is the case with VAT which has also lost much of its
steam from various changes introduced since 1986 to lessen the
workload in the tax department and to please vested interests.
Indonesian VAT has lost its special feature of being a "Money
Machine" as originally stipulated.

Fortunately, however, as a silver lining in the otherwise dark
clouds hovering over the Indonesian skies, there exists a big,
untapped potential in the tax system. Even with the existing
legal tax rates, the government can raise needed tax revenues by
following a two-pronged strategy: to make modifications in the
tax laws to reduce tax loopholes which have reduced tax revenues
and diminished tax equity.

Secondly, the tax administration needs to be strengthened to
enforce proper tax compliance. It suffers from a lack of
coordination between different agencies, for example between the
tax and excise and customs departments. Also the tax department
lacks much needed independence to interpret and enforce tax laws
without any outside interference.

The legal setup of the American Internal Revenue System would
be a good case study to make the Indonesian tax department
independent of any politically motivated intervention in
enforcing the collection of tax liability, particularly from the
politically and economically powerful classes. Consider the
independence and power vested in the American tax agency: the
Internal Revenue System. There are recent well-known instances
where IRS did not even spare the President and Vice President of
the United States from accusing them of tax irregularities.

The idea of making tax agencies independent, though common in
Western developed countries, is being increasingly adopted in
other elsewhere to deal with the serious problem of tax abuse by
powerful people. It may also be prudent to invest funds to update
computer technology in the tax department to develop an elaborate
tax database so that no item of income received by any taxpayer
escapes the eyes of the collectors.

Indonesia does not need to increase tax rates. Merely by
removing the abuse of tax loopholes and illegal tax evasion
practices, the government can collect sufficient tax revenues to
decrease the fiscal deficits and to run the nation.

Dr. J. S. Uppal and Dr. Sukanto Reksohadrodjo are professors
of economics at the State University of New York at Albany, New
York, USA and Gadjah Mada University, Yogyakarta, Indonesia. This
article is a part of their continuing research on Tax Reform in
Indonesia under the USAID-funded project, Sustainable Indonesian
Growth Alliance, based at Gadjah Mada University, Yogyakarta.