Taxing consumers in Batam

The government must strongly oppose an initiative by the House of Representatives to turn the entire island of Batam, about 30 kilometers southeast of Singapore, into a free trade zone, even in the face of threats by a number of investors to move their businesses off the island to other countries.

As a shortsighted initiative to gain votes in Batam during the upcoming presidential runoff, making the island a free trade zone, as proposed in a House-sponsored bill, could significantly boost local support for President Megawati Soekarnoputri.

However, such a step would be economically and fiscally ill- advised for the long-term good of the national economy, and could set a dangerous precedent that could trigger demands from people on other islands for similar tax facilities.

Putting Batam back under the national tax regime now would unlikely be met with as fierce an opposition as in the late 1990s. There was, after all, little protest when the government, after five postponements since 1998, moved earlier this year to impose in Batam a value added tax (VAT) and a luxury sales tax initially on motor vehicles, tobacco, cigarettes and liquor, and beginning in March, on electronic goods. And to our knowledge, not a single investor has left Batam simply because of the tax imposition based on Government Regulation No.63/2003.

People and investors in Batam seem to have increasingly realized that returning the island to the national tax regime would be aimed only at correcting a major mistake that has been overlooked since 1978, when the government began 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 duties, VAT and other indirect taxes normally levied on such transactions. However, the tax and duty exemptions in a bonded zone are effective or granted only to export transactions and do not apply to domestic sales or domestic consumption.

This means that industrial companies are entitled to such exemptions only if their imports are materials for their export goods, and if their products are entirely destined for the export market.

However, Minister of Industry and Trade Rini Soewandhi argued during the deliberation of the Batam bill on Monday that unlike other bonded zones in the country and overseas, Batam has also developed into a city of more than 500,000 people with a mixture of residential areas, industrial complexes and commercial centers. Hence, manufacture is only part of the mainstream economic activities on the island.

The best solution, therefore, is to restrict the free trade zone to major industrial areas/estates in Batam by classifying them as enclave bonded zones (isolated from residential and commercial areas), similar to other bonded areas such as the Nusantara bonded zones at Cakung in Jakarta and Belawan in North Sumatra. All of these bonded zones are located outside residential areas. Such a tax treatment is also applied in Singapore, Hong Kong and most other areas operating bonded zones.

Minister Rini said there were seven industrial areas in Batam that could be developed into enclave bonded zones (isolated from residential areas), and since only 40 percent of these industrial estates were currently being used there was still room for new industrial plants.

A continuation of different tax treatment for Batam not only could make the island a beachhead for smuggling but, as Minister of Finance Boerdiono said on Monday, it would also be unfair to people on other islands in the country. Why should the people of Batam enjoy such special privileges?

The government, however, should address the great concern among investors (as expressed in an essay on page 7) over the likely ramifications of bonded zones under an enclave system. What really worries investors, notably foreign manufacturers, is not the imposition of the taxes itself, but rather the integrity and technical competence of the bureaucratic machinery -- the tax and customs services -- and the other law enforcement agencies that will administer the taxes and duties and oversee the movement of goods from one area to another on the island.

It is therefore imperative for the government to develop an effective system to ensure the flow of goods into and out of the enclave bonded zones remains smooth, while domestic trade/consumption outside these bonded zones is properly taxed.