Taxing interest incomes

The higher targets for income tax and value added tax for this fiscal year are indeed an uphill task for the directorate general of tax as the most optimistic prediction places economic growth only slightly above last year's expansion of between 4.5-4.9 percent. Quite a number of analysts even foresee the economy to remain stagnant, equaling last year's growth rate.

As the target for state receipts from personal and institutional taxpayers was increased by 30 percent and those from value added tax (VAT) by almost 36 percent, the government has either to raise tax rates or broaden the tax base. These measures are, among other things, the essence of a series of new tax regulations that were issued last month to become effective as from this month.

Two of the rulings that will have far-reaching impacts on the public and the domestic economy are the raising of income tax rates on interest earnings from bank savings by 5 percentage points to 20 percent, and the broadening of the categories of taxable goods under the VAT Law to include farm produce, livestock and fish.

Collecting tax on interest accrued from bank savings is administratively much easier to facilitate as the directorate general of tax can ensure compliance through commercial banks which can be charged with withholding tax due on interest earnings accrued to their depositors.

Administrative problems were the main obstacle that prompted the government to temporarily exempt farm produce, livestock and fish from VAT when this tax was launched for the first time in 1984. However, as the government has increasingly been hard pressed to raise more revenues to meet its budget needs, it has now been considered the appropriate time to collect VAT from those commodities. Yet the government is pragmatic enough not to collect VAT from producers given the complex administrative problems. It has instead established supermarket chains as the point of collection in order to simplify supervision. This way VAT collection would also not place an additional burden on lower income groups who mostly buy from traditional markets. The kind of people who usually buy groceries from supermarkets -- middle and top-income groups -- are not likely to feel that it is a great burden to pay an extra 10 percent (the VAT rate).

We don't think the sharp rise in income tax on interest earnings from bank savings would dampen people's propensity to save. Nor would it set off a new wave of capital flight. After all, the 20 percent rate is flat in the sense that the rate is not progressive according to the amount of interest earnings. Some taxpayers may complain about the inequalities as big and small depositors bear the same tax burdens. True, the tax rate should ideally be progressive as it is layered with regard to income tax. But then the administrative and collection problems caused by such differentiation would be counter-productive in view of the limited capacity of resources of the tax office.

The most significant impact of the higher tax rate may be the movement of deposits away from banks to other investment instruments such as shares. Big depositors may also decide to withdraw their savings and plough them into businesses which will be beneficial in spurring economic expansion. Investment in shares or directly in businesses will generate income that is subject to tax anyway. Hence, in so far as tax collection is concerned, the withdrawal of deposits from banks will cause changes only at the point of income tax collection.

The directorate general of tax is, however, required to conduct a more effective supervision to ensure that banks in charge of withholding income tax from interest earnings accrued to their depositors fully comply with the new tax ruling. For the keen competition to attract big depositors may tempt some banks to collude with depositors in cutting down their tax burdens. We reckon though this is not so difficult a task as all big banks, which account for more than 85 percent of the banking industry's assets, are now controlled by the government through the Indonesian Bank Restructuring Agency (IBRA).