Urgent fiscal policy tasks for RI

By J. S. Uppal and Sukanto Reksohadiprodjo

YOGYAKARTA (JP): The revival of the Indonesian economy from its recent crisis will depend on whether the government takes immediate and important steps to deal with the crucial fiscal policy issues highlighted in this article. Any further neglect will be harmful for economic stability and financial sustainability.

Economists sometimes make budgets sound technical, using theoretical jargon. Governments often use different accounting tricks to make them politically acceptable.

The term used to describe the latter way to present a budget is called "budget trickery", and the government of Indonesia has been doing exactly that for many years. While the government's budget has been clearly in the red, it has been presented to the nation as a balanced budget as per constitutional requirements.

Rather than simply taking the difference between domestically raised resources from taxes and oil/gas revenues and total government expenditure as a true indication of the budgetary condition -- surplus or deficit -- the government covers up the actual yearly deficit by ever-increasing foreign borrowing.

As a cash flow device this may be justified, but it also reflects the reality of the government's chronic inability to raise sufficient domestic revenues to meet its expenditure.

While the magnitude of the real deficit depends on how one calculates and presents it -- there are different figures ranging from 4.5 percent to 7.5 percent of the gross domestic product (GDP) -- there is no denying the fact that the nation is in a state of fiscal distress.

The government revenues, particularly tax yields, are lagging seriously behind mounting government expenditure and the nation is increasingly dependent on foreign borrowing to make ends meet.

The tax system is riddled with many budget loopholes designed ostensibly for administrative purposes, but really to benefit upper-income people.

The tax system has thus been seriously eroded. The tax base has been narrowed further by massive tax evasion through concealing incomes through noncompliance.

We discussed the sad state of Indonesian taxes in an article in The Jakarta Post on Oct. 27. Suffice to say here only 1 percent of our population is even registered as income tax payers, and only about half of them even care to file tax returns for paying income tax based on voluntary compliance .

A massive amount of tax liability stands uncollected and the rate of tax delinquency has recently increased. Value-added tax (VAT), dubbed the "money machine" due to its high revenue potential, has lost much of its steam as a result of changes introduced after lobbying by businesspeople.

Against this shortfall in tax revenue, government expenditure continues to increase. Without drastic cuts in routine and development expenditure, including reducing subsidies on basic goods introduced to help the poor, public outlays will continue to grow.

Since the recent popularly-elected government has been espousing the cause of poor and needy, it cannot easily reduce subsidies or trim down the size of the government work force to reduce government expenditure.

This means that unless the government raises tax revenues by a substantial amount, it will continue to face serious fiscal distress with a continuing dependence on foreign borrowing.

There is a serious need for the nation to ponder over this vital question. How long and how much can it depend on capricious and uncertain foreign borrowing just to keep its government running?

The government should not lose sight of some serious implications of the continuing budget deficit: inflation, an adverse balance of payments and depreciation of the foreign value of money. All these factors can also lead to the downgrading of the credit rating of the country's bonds and other commercial papers in the world markets. There is an urgent need to restructure the Indonesian tax system and scrutinize thoroughly government expenditure.

In a hurried attempt to pacify the demands for autonomy from the provinces on the eve of the last elections, the government passed laws aiming at political and fiscal decentralization starting in 2001; not too far away from now.

The legislation contains only very broad outlines of the fiscal relationship between the central and local governments. The sources of self-raised revenues for the local governments have been mostly left undefined.

There is a broad provision for 25 percent of the central government resources to be allocated to local governments, without any specific formula for intergovernmental resource distribution.

Some resource-rich provinces will be able to claim as much as 80-85 percent of their income from their natural resources. Resource-poor provinces have been assured balanced development, however there is no mention where the resources are going to come from.

Most of the central government's present functions, along with its financial resources and personnel, will be transferred to local governments, but no details have been worked out as yet in this respect.

People will be able to elect local officials who will raise the people's hopes and expectations for a better life and more control over their local affairs. But they will not know where the necessary resources will come from.

In short, in 2001 when the decentralization process will start, Indonesia will find itself in serious financial chaos if all the necessary details are not worked out well in advance.

Fortunately, however, Indonesia can benefit from the experience of other federal systems with varying amounts of administrative autonomy.

Regions in the United States have a high level of autonomy, so much so that each of the more than 85,000 local governmental units -- states, cities, towns, villages, school districts -- have their own taxing and spending powers.

On the other hand, Canada, India, Australia and other democratic federal governments have well-defined and clearly demarcated taxing and expenditure powers, vested in different jurisdictions.

However, all these federations have a well laid out mechanism for the distribution of central resources amongst local governments. Indonesia can pick and choose from these federations, depending on its region's political and economic environments.

Indonesia should start right away to formulate policies to deal with the forthcoming decentralization. Otherwise, it faces impending chaos.

J. S. Uppal Ph.D and Sukanto Reksohadiprodjo Ph.D are professors of economics at the State University of New York, Albany, New York, and Gadjah Mada University, Yogyakarta, respectively. This article is based on their continuing research for the Sustainable Indonesian Growth Alliance, a United States Development Agency (USAID) and Gadjah Mada University Project.

Window: People will be able to elect local officials who will raise the people's hopes and expectations for a better life and more control over their local affairs. But they will not know where the necessary resources will come from.