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Indonesia: Selected Issues

Author(s):
International Monetary Fund. Asia and Pacific Dept
Published Date:
February 2017
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Deepening the Growth-Enhancing Fiscal Strategy1

This paper applies the analytical framework developed in an IMF cross-country study on fiscal policy and long-term growth to the case of Indonesia.2 The general theme is one of structural fiscal reforms that expand and improve the efficiency of public expenditures, financed by additional revenue mobilization, leading to productivity gains and faster and more inclusive growth.

A. Macroeconomic Stability as a Prerequisite for Sustained Growth: Keep the Prudent Fiscal Rule While Building Buffers

1. Indonesia’s fiscal rule remains an important policy anchor. The fiscal rule limits the general government deficit to no more than 3 percent of GDP and debt to no more than 60 percent of GDP (Figure 1). Driven by the strong fiscal discipline and fast economic growth, Indonesia’s general government debt has been successfully curbed from about 90 percent of GDP in 2000 to below 30 percent in 2015. Though rigid, the rule also supports external market funding for Indonesia while its domestic investor base develops, and promotes macro stability, a pre-requisite for sustained growth.3

Figure 1.Indonesia: General Government Gross Debt

(In percent of GDP)

Sources: World Economic Outlook; World Bank; Indonesian authorities; and IMF staff estimates.

2. Although there is modest fiscal space in the near term, a countercyclical buffer within the rule is desired in the medium term. Indonesia’s low debt and deficit levels, small gross financing needs, and other macro indicators suggest modest fiscal space in the near term. This supports a slightly larger fiscal deficit of about 2¾ percent of GDP in 2016. However, in the medium term, aiming for a deficit target of 2¼ percent of GDP would provide a countercyclical buffer of ¾ percent of GDP under the fiscal rule, and boost the economy’s resilience to shocks.

3. Deepening the authorities’ growth-enhancing fiscal strategy would require structural fiscal reforms to promote higher medium- and long-term growth. This strategy will increase revenue and expenditure each by about 3 percentage points of GDP over the medium term, with the budget composition more effective in promoting sustainable growth. Revenue mobilization is slightly greater than expenditure expansion, to generate the countercyclical buffer.

B. How Can Fiscal Structural Reforms Promote Growth: Improve Efficiency and Expand Growth-Enhancing Expenditures

4. For Indonesia, the most effective fiscal policy to promote growth is to increase spending with higher efficiency on infrastructure, health, and education. IMF (2015a) provides a menu of structural fiscal policy options to promote medium- to long-term growth: encourage labor supply, enhance investment in physical capital, support human capital development, increase total factor productivity and promote technological progress. For emerging economies, the most relevant policies would be to protect and increase the public capital stock, provide more efficient public infrastructure, provide access to education for disadvantaged groups, and expand access to basic healthcare (Table 1). In the context of Indonesia, this would mean an expansion of public expenditure on infrastructure, health, and education, while improving efficiency in those areas.

Menu of Options: Structural Fiscal Policies for Medium- to Long-Term Growth 1/
Structural Fiscal PoliciesAdvanced

Economies
Emerging

Economies
Low-Income

Economies
Policies to encourage labor supply
Reduce labor taxes, especially at low income levelsXXXXXX
Redesign unemployment benefits, including by tightening eligibility and shortening durationXXXXXX
Provide in-work benefits and tax creditsXXXXXX
Increase use of active labor market programs (ALMPs)XXXXXX
Stimulate labor force participation of:
Women, including through individual taxationXXXXXX
Older workers, by restricting early retirement and providing tax incentivesXXXXXX
Low-skilled workers, through targeted ALMPs and use of in-work benefitsXXXXXX
Policies to enhance investment in physical capital
Design a system that taxes excess returns on capitalXXXXXX
Provide well-designed tax incentives that reduce the cost of capitalXXXXXXX
Protect or increase the public capital stockXXXXXXXXX
Enhance the productivity of public investment by strengthening the investment processXXXXXXX
Policies to support human capital development
Provide access to education for disadvantaged groups by:
Spending more at lower levelsXXXXXXXXX
Increasing cost-recovery for tertiary educationXXXXXXXX
Conditioning cash transfers on school enrollmentXXXXXXXX
Expand access to basic healthcare by:
Reducing user charges for low-income householdsXXXXXXXXX
Addressing supply-side barriers in less developed areasXXXXXXX
Conditioning cash transfers on preventive health visitsXXXXXXX
Policies to increase total factor productivity and promote technological progress
Grant tax credits or deductions for R&DXXXXXX
Increase public R&D spendingXXXXXX
Provide more efficient public infrastructureXXXXXXXXX
Source: IMF 2015a.

5. Indonesia has room to increase efficiency and spending in these key growth-enhancing expenditure areas compared with peers. Constrained by its revenue mobilization capacity, Indonesia’s spending in these areas is generally low compared to peers. As described below, there is also room to improve the efficiency of spending.

Infrastructure

6. Indonesia’s infrastructure spending is low compared to peers. Total infrastructure spending was 2.5 percent of GDP in 2015, compared to the EM Asia average of 5.1 percent of GDP. Indonesia’s access to infrastructure is particularly low in electricity, road transportation, and health facilities (Figures 2 and 3).

Figure 2.Public Capital Investment

(In percent of GDP)

Sources; World Economic Outlook, World Bank; Indonesian authorities; and IMF staff estimates.

Figure 3.Measures of Infrastructure Access

(Most recent year)

Sources: World Bank; OECD; and IMF staff estimates.

Figure 3: note Units vary to fit scale. Left hand axis: Public education infrastructure is measured as secondary teachers per 1,000 persons; Electricity production per capita as thousands of kWh per person; Roads per capita as km per 1,000 persons; and Public health infrastructure as hospital beds per 1,000 persons. Right hand axis: Access to treated water is measured as percent of population.

7. Infrastructure development is highly decentralized and suffers from limited implementation capacity and relatively low efficiency. Of the government’s US$480 billion infrastructure investment plan for 2015–19, only about 30 percent will be executed through the central government. Starting in 2017, 20 percent of the central government transfers to regions via general allocation fund (DAU) and revenue sharing will be earmarked to infrastructure. The non-central-government channels—state-owned enterprise (SOEs), public private partnerships (PPPs), and sub-national government (SNG)—seem to involve more risk and entail less capacity to develop, plan and implement investment projects efficiently. Based on IMF (2015b), an indicator for physical access to infrastructure shows relatively low efficiency in Indonesia’s public investment. The resulting efficiency gap between Indonesia and the most efficient countries with comparable levels of public capital stock per capita is 56 percent, much wider than the average gap of emerging market economies (41 percent), emerging and developing Asia (50 percent), and all countries (41 percent) (Figures 4 and 5).

Figure 4.Physical Infra st ra ctu re Frontier

Sources: World Bark, OECD, and IMF staff estimates.

Figure 5.Physical Infrastructure Efficiency Gap

Sources: World Bank; OECD; and IMF staff estimates.

8. The expansion of infrastructure spending should be accompanied with improved public financial management (PFM). Scaling-up of public investment often goes hand in hand with a decrease in investment efficiency and an increase of integrity issues. Therefore, better management is required to improve efficiency. The government could consider the following reforms: (i) streamline the annual budget process; (ii) develop a multi-year pipeline of high-quality projects by investing in project development; (iii) encourage use of multi-year contracting and carry-overs, both at the central and local levels of government; (iv) improve timeliness and content of information flow to SNGs on special purpose grants (DAK) and line ministry’s own investment plans; (v) develop a wide-ranging capacity building plan in the PFM area for SNGs, jointly by Ministry of Finance (MOF) and Ministry of Home Affairs (MOHA); and (vi) simplify and reduce the reporting burden of SNGs. More importantly, there are currently five central agencies with some mandates on public investment: MOF, MOHA, the National Development Planning Agency (BAPPENAS), the Committee for Accelerated Infrastructure Delivery (KPPIP), and the Evaluation and Monitoring Team for State and Regional Budgets Realization (TEPRA). These central agencies need to coordinate more closely and develop a Single Window monitoring system of line ministry and SNG public investments. At a later stage, PPP and SOE project monitoring could be integrated with the above reforms.

Health

9. There is a need to expand insurance coverage and health facilities. Health spending is low in Indonesia compared to peers (Figure 6). The authorities have made a commitment to expand the coverage of public health insurance to 100 percent by 2019. At present, about 60 percent of the population is covered, and the bottom one third of the population (the poorest 92 million) are included with waivers of health insurance premium. Essentially, the government is subsidizing the premium for the poor. Many of the uncovered 40 percent of the population are self-employed middle-income individuals, who have reportedly purchased private health insurance. Indonesia also has room to increase public spending on health infrastructure and open up the health sector to the private sector and foreign investors. Although the central government is legally required to allocate at least 5 percent of its budget expenditure on health, the rule mostly ensures that health spending in percent of GDP remain broadly constant. Based on the experience of Thailand when implementing universal health coverage, it is expected that the share of public spending in total health care spending would then rise from 40 percent now to 60 percent over the medium term. In the event, the ratio of public health spending to GDP would reach 2.1 percent of GDP in 2021—0.6 percentage points of GDP above the baseline.

Figure 6.Public Health Expenditure

(In percent of GDP)

Sources: World Economic Outlook; World Bank; Indonesian aurhorities; and IMF stalt estimates.

Education

10. There is room to improve spending efficiency in education. Although Indonesia’s public education spending is lower than the average level in EM Asia (Figure 7), the near-term priority should be to improve spending efficiency. Similar to health, the central government is legally required to allocate at least 20 percent of its budget expenditure on education. However, without strong links to educational outcomes, much of the annual increases are spent on teachers’ compensation, especially those through the certification programs. Therefore, the teachers’ compensation system could be reviewed to identify inefficiencies, while the link between compensation and outcome could be strengthened. As the efficiency issue is addressed, education spending could be further expanded from general primary and secondary education to other areas, such as early childhood, vocational, and tertiary education.

Figure 7.Public Education Expenditure

(In percent of GDP)

Sources: World Economic Outlook; World Bank; Indonesian aultiorilies; and IMF stall estimates.

11. International experience suggests that preserving and increasing expenditure in these key areas are an integral part of a successful reform strategy for resource-revenue dependent economies. For example, one successful factor for Malaysia to unlock its long-term growth potential as part of its fiscal adjustment in the early 1980s was to maintain health and education expenditure at a steady level of 1.5 percent and 5 percent of GDP, respectively, which bolstered human capital to support the successful transition to a manufacturing-based economy during the same period. These are still well above Indonesia’s 2015 spending levels for health and education (1.3 percent and 3.5 percent of GDP, respectively). Similarly, when Chile implemented its massive fiscal consolidation in the late 1970s, it actually increased public spending on primary and secondary education, as well as primary health care.

C. Fiscal Space for Pro-Growth Reforms: Adopt a Growth-Friendly Revenue Strategy

12. Relatively low capacity in revenue mobilization has constrained the government’s ability to expand growth-enhancing expenditure priories (Figures 8 and 9). General government revenue has trailed behind peers, with the gap widening after 2008. Although the sharp decline in oil-and-gas revenue accounted for the majority of the shortfall, non-oil revenue in percent of GDP remains weak around its 2004 level. As a result, Indonesia’s public expenditures in the above growth-enhancing areas are below their peers.

Figure 8.General Government Revenue

(In percent of GDP)

Sources: World Economic Outlook; World Bank; Indonesian authorities; and IMF staff estimates.

Figure 9.Indonesia: Composition of General Government Revenue

(In percent of GDP)

Sources: World Economic Outlook; World Bank; Indonesian authorities; and IMF staff estimates.

13. Low tax productivity also points to substantial scope for mobilizing non-oil revenues (Figures 10 and 11). Indonesia’s C-efficiency ratio is about 0.6, which means the authorities only collect 60 percent of total VAT revenue compared to the benchmark that taxes all consumptions at a uniform rate of 10 percent. In addition, CIT productivity defined as the ratio between CIT revenue in percent of GDP and the top CIT rate is low. Many factors could explain such low tax productivity, including numerous lower-rate regimes, exemptions, and weakness in tax administration. Therefore, Indonesia has significant potential to mobilize major non-oil tax revenue through streamlining exemptions, removing differentiated tax rates, and improving tax administration.

Figure 10.Value-Added Tax Collection Efficiency 1/

Sources: IBFD database; IMF, Government Finance Statistics; and IMF, World Economic Outlook database.

1/ VAT Collection Efficiency = VAT Revenue in percent of Consumption/VAT Rate.

Figure 11.Corporate Income Tax Productivity 1/

Sources: IBFD database; IMF, Government Finance Statistics; and IMF, World Economic Outlook database.

1/ CIT Productivity = CIT Revenue in percent of GDP/CIT Rate.

Tax Policy Reform

14. Tax policy reform should be predicated on increasing revenue from the most “growth-friendly” taxes. The most growth-friendly tax is property tax, followed by indirect taxes, labor income tax, and corporate income tax (IMF, 2015a). This is also consistent with how “mobile” the tax base is: property tax has the least mobile tax base, therefore raising property tax revenue has the least negative impact on growth. In contrast, CIT has the most mobile tax base, which is at the core of international taxation issues. However, property tax is administratively challenging and therefore not a good source of short-term revenue gains. Therefore, indirect taxes that are both growth-friendly and easy to administer, especially VAT and excise taxes (including environmental tax), would be the most suitable tax instruments to raise significant revenue in the near to medium term.

Value-Added Tax

15. The VAT rate could be gradually increased with base-broadening to raise revenue. The present statutory VAT rate of 10 percent is low compared to major emerging economies and the OECD, although it is in line with regional practices (Figure 12). At the same time, there are many exemptions on intermediate inputs, which result in cascading effects.4 These exemptions distort the Indonesian market and, due to the cascading effect, result in somewhat higher VAT revenue. For example, VAT exemptions of some services (such as hotel, restaurant, and transportation) mean that these service providers can pass along the VAT on their inputs to their customers through higher prices. If the products are then used by business customers in further production, the VAT is charged on the output but credits could not be claimed for the earlier VAT paid on inputs. Revenue losses from VAT exemption of final consumption are about 0.8 percent of GDP, while cascading tax collected on intermediary consumption is about 0.9 percent of GDP. Therefore, to raise revenue, any VAT rate increase should be accompanied by the removal of exemptions on both intermediate and final consumptions. For example, increasing the VAT rate in stages to 15 percent (maximum allowed in the current legislation) while removing exemptions, could increase VAT revenue by at least 1.8 percentage points of GDP in the near to medium term.

Figure 12.Value-Added Tax Statutory Rate

(In percent)

Sources: KPMG; IBFD; IEO; IMF staff estimates.

16. There is room to improve VAT administration. Indonesia has a complex VAT return, requiring itemization of transactions that can amount to millions between taxpayers each month, compared to the dozens of aggregated items required in other countries. Moreover, the refund procedure is excessively long. Regular taxpayers (instead of fast-track taxpayers) are audited prior to receiving a refund payment. Refund requests from about 2,000 bonded zones and 600 bonded warehouses—that are effectively zero rated—have risen significantly. As a result, refunds to regular taxpayers can suffer long delays.

Excise Tax

17. Excise reforms could generate additional revenue of about 1 percent of GDP in the near term.

  • The vehicle tax could be rebased on CO2 emissions. The current ad valorem Sales Tax on Luxury Goods (STLG) on motor vehicles is inefficient, as the producers could easily understate the value. It could be replaced with a more efficient excise tax on motor vehicles based on CO2 emissions, which could generate additional revenue up to 1 percentage point of GDP.

  • Tobacco excise could be streamlined and increased. Although Indonesia has the highest prevalence of smokers among ASEAN, the tax burden is below the regional average (Figure 13). An increase in the tax rate, while simplifying the present 13 tiers of specific rates, will be able to boost the revenue in the near term. The authorities already have plans to increase tobacco excises and streamline the tiers.

Figure 13.Smoking Prevalence and Tobacco Excise Tax Burden

(In percent)

Source: APTF ASEAN excise tax study group, 2013, discussion paper

  • Environmental (fuel) taxes could be introduced. Currently, retail prices for gasoline and diesel in Indonesia are low compared to other ASEAN countries, which suggests that there is room for raising taxes to compensate for their negative externalities (Figures 14 and 15). In the near term, an environmental tax of Rp 1,000/liter for gasoline and Rp 500/liter for diesel would generate an estimated 0.3 percent of GDP of new revenue. This action would also support Indonesia’s Paris Agreement pledge to lower greenhouse gases by 29 percent below “business-as-usual” levels by 2030.

Figure 14.Gasoline: Retail Price and Net Tax

Sources: KPMG; IBFD; IEO; IMF slaff estimares.

Figure 15.Diesel: Retail Price and Net Tax

Sources: KPMG; IBFD; IEO: IMF staff estimates.

Corporate Income Tax

18. There is room to simplify the current CIT regime. At 25 percent, the current statutory CIT rate is generally in line with the OECD and major emerging economies (Figure 16). Therefore, a significant reduction of the statutory rate is not advisable, as large countries like Indonesia have little to gain but more to lose from a much lower rate. Though excessive borrowing from related parties (tax-base erosion) may be a concern, addressing the issue through reduced corporate tax rates is unlikely to be effective. Other approaches, such as tightening thin capitalization rules could be considered. On the other hand, there are numerous low-rate CIT regimes: a 1 percent tax on gross revenue for small and medium enterprises (SMEs) below an annual turnover of Rp 4.8 billion; a rate reduction of 50 percent up to their taxable income corresponding to gross turnover of Rp 4.8 billion for medium-sized enterprises up to an annual turnover of Rp 50 billion; and a reduced rate of 20 percent for publicly listed companies. Therefore, there is room to consolidate all the regimes for companies above the SME threshold of Rp 4.8 billion, and apply a single and modestly lower CIT rate in a revenue-neutral manner.

Figure 16.Corporate Income Tax Statutory Rate

(In percent)

Sources: KPMG; IBFD; IEO; IMF staff estimates.

19. The international taxation aspect of the CIT could be strengthened through anti-avoidance measures and the G20/OECD BEPS project. Anti-tax avoidance regulations could be strengthened, such as those on permanent establishment, transfer pricing, thin capitalization, and controlled foreign corporations. As a G-20 country, Indonesia has agreed to implement the G20/OECD BEPS project. Implementation of the BEPS project outcomes will need to be carefully thought through in order to adapt them to Indonesia’s own capacity and circumstances.

Property Tax

20. Property tax could be gradually increased while the administration capacity is enhanced. Recurrent property tax in the form of “land and building tax” has been decentralized. The central government sets the maximum rate that municipalities are allowed to adopt, with the current rates ranges between 0.1−0.3 percent of the assessed value. Total revenue was only about 0.6 percent of GDP in recent years, compared to the worldwide average of 1 percent of GDP. Therefore, there is potential to increase such revenue by about 0.2 percentage points of GDP in the medium term, by increasing the maximum rate set by the central government. Also, as capacity to register and assess property values is strengthened over the medium term, additional property tax could gradually replace the distortive central-government transaction tax and local government stamp duties, which are 2.5 percent and 5 percent of the property transaction values, respectively.

Personal Income Tax

21. The base of the top PIT rate could be broadened. The PIT rate structure in Indonesia is comparable to regional peers. The top PIT rate is 30 percent for income over 15 times GDP per capita. The threshold seems a bit high compared to OECD (3.8), Singapore (4.9) and Malaysia (3.1). Given that raising PIT rate is less growth-friendly, one potential revenue-neutral improvement is to lower the threshold of the top rate by about half to 7 times GDP per capita while lowering the top rate slightly, which will broaden the tax base for the top 3 percent of the income distribution.

Revenue Administration Reform

22. Three critical components of growth-friendly revenue administration reform could be pursued: (1) improve tax collection efficiency; (2) strengthen the business environment; and (3) strengthen the institution of tax administration.

23. Improve tax collection efficiency. The following four reforms could be considered.

  • Strategies to boost compliance for a few major taxes. For each tax, the strategy could divide the taxpayers into segments and for each segment: (1) identify and rank the main compliance risks that the segment poses for a particular tax; (2) develop treatments for mitigating the compliance risks; and (3) provide a set of performance criteria and indicators for measuring the impacts of its treatments. In the short-term, the strategies could be developed for the VAT and employer withholding of personal income tax, focusing on large taxpayers and top-end of medium taxpayers in major centers.

  • Extended audit coverage through more specific-issue audits based on risk. By focusing on a limited number of issues, specific-issue audits could be completed much faster than traditional comprehensive audits, thereby allowing greater coverage of the taxpayer population. Numerical target could be adopted; for example, specific-issue audits could comprise at least 50 percent of all audits conducted in one year.

  • External information for data matching and pilot for risk-based case selection. Rather than obtaining extensive information from multiple sources, the data matching project could identify two or three high priorities for exchange of information targeting the highest risk areas. For example, priority may be given to receiving data on payments of investment income to individuals from financial institutions, real property purchases from property registers, and automobile registrations from the motor vehicle department. This information would then be used to pilot more targeted case selection.

  • Moving the Extensification program towards a targeted campaign. The program could focus on a few high risk sectors in the informal economy and on increasing registration and filing of registrants with significant tax potential. Project-based approaches—which target compliance activities on those sectors and individuals that pose the highest risk to tax collection—have succeeded in improving compliance in the informal economy in some countries.

24. Strengthen the business environment. The following reforms could be considered.

  • Priority regulations to remove ambiguities and inconsistencies with the tax laws. There are reports of many instances where the tax laws and regulations are unclear and inconsistent, causing uncertainty for taxpayers on the tax treatment of their investments. Removing ambiguities in the tax laws and ensuring that the laws are applied in a consistent manner could significantly improve the investment environment and support growth. Therefore, a comprehensive review of tax legislation and regulations could be conducted to remove ambiguities and inconsistencies.

  • Expanded number of taxpayers eligible to receive VAT refunds without a prior audit. As mentioned above, taxpayers have to wait a considerable time in many cases before receiving VAT refunds for excess input credits, which increases the financial cost of tax compliance. Under current practices, only a very small number of taxpayers are entitled to a refund without a prior audit. The Directorate General of Taxes (DGT) could revisit the criteria for ‘golden’ and ‘low risk’ taxpayers so that more taxpayers could receive a refund without an audit.

  • In priority areas, guidance on audit techniques and technical issues, and implementation of a process for ensuring consistent application. There are reports of frequent inconsistent interpretations of the law and application of audit techniques by auditors, which could create uncertainty and increase compliance costs. Addressing these problems would require the DGT to issue enhanced guidance on the application of the tax laws and audit techniques. As part of this effort, an up-skilling program could be introduced, focused initially on auditors and making it mandatory for auditors to follow the published guidance.

Strengthen the Institution of Tax Administration

25. Strengthening DGT through incremental reforms in the near term is one of the priority areas. An effective management and ministerial performance agreements could be considered to ensure that tax administration reforms support Indonesia’s growth efforts. Consideration could be given to making the Director General subject to a performance agreement that includes a small set of performance measures based on tax administration results and taxpayer satisfaction. The performance measures should not include (or give undue weight to) a revenue collection target. The authorities’ efforts to improve social trust is well placed and should be an integral part of the reform efforts—establishing a consultative forum with business representatives to discuss areas of concern in the tax administration may further expand these efforts. Other key actions could include putting in place a strong reform-management team, establishing a comprehensive tax revenue strategy comprising actions in the short- and medium-term on both tax policy and administration, and exploring avenues to grant the DGT additional management and administrative flexibility to facilitate its modernization.

26. The authorities should be cautious on the reform toward a semi-autonomous revenue agency (SARA). Although the revenue administration reform bill submitted to the parliament envisions a SARA down the road, there is no “one-size fits all” arrangement for tax administration. Tax administration may be part of the Ministry of Finance, partially autonomous, or fully autonomous—and the institutional setup tends to reflect characteristics of individual countries. In today’s context, the risks of establishing SARA appear to outweigh its potential benefits. A structural institutional change will necessarily lead to considerable transition costs as staff is separated from their original workplace and new systems are put in place. These, in turn, could be significant and can overwhelm other reform efforts to improve tax administration and tax policy—at a time when revenues are already significantly below the level needed to support the authorities’ growth-enhancing spending priorities.

D. Growth and Equity: Have a Balanced Mixture of Revenue and Expenditure Reforms

27. The above mixture of revenue and expenditure reforms will ensure a balanced approach to promote growth while maintaining or improving equity. On the revenue side, although raising property tax could be highly progressive, the reliance on increasing indirect taxes (VAT and excise) for revenue mobilization tends to be regressive, as increasing the more progressive PIT could have a negative impact on growth. However, much of the regressivity from the revenue side could be offset by the strong equity-enhancing expenditure policy. Increasing expenditure on public health and education will provide more equitable access for the poor, which promotes both growth and equity.

28. A better targeted and more efficient social assistance policy will also enhance equity. Indonesia has an array of social assistance programs lacking coverage and adequacy, and a large share of poor and vulnerable households are not receiving all the benefits they are eligible for. The authorities have already stated their intention to replace general price subsides, including energy subsidies, with more targeted cash transfers. An integrated database for social assistance (PBDT) has been developed, which covers the bottom 45 percent of the income distribution. This is a right step forward, which will enable the authorities to reduce and consolidate various social assistance programs into better-targeted and more efficient programs in the next few years. In the medium term, once the administrative capacity has been well developed, the authorities could also consider the introduction of a means-tested Guaranteed Minimum Income program.

E. Prioritization and Implementation of the Strategy

29. The above reform strategy could be implemented in stages. The above measures and their fiscal impacts are summarized in Table 2, which are expected to increase potential growth to 6 percent by 2021.5 Clearly, not all the reforms could be taken at the same time. In the near term, the priorities could be improving the quality of spending, raising revenues through higher excises (tobacco excise, environmental tax on fuel products, etc.), starting the phased move to a risk-based tax administration regime, and preparing to upgrade the key tax laws. At the core of the fiscal strategy is the revenue strategy which will enable growth-enhancing expenditure policy. Therefore, the design of the revenue strategy could be started right away, which will set the stage for the expansion of expenditure gradually over the medium term.

Table 2.Indonesia: Menu of Policy Options in Growth-Enhancing Fiscal Strategy(In percent of GDP)
Policy OptionsEstimated Fiscal Impact by 2021Details of the Policy
Total revenue policy 1/3.0
Value-added tax1.8Increase rate from 10 percent to 15 percent while removing exemptions.
Excise taxes1.0Increase vehicle and tobacco excise rates and impose environmental tax on fuel.
Personal income tax0.0Remove exemptions and lower top rate in a revenue-neutral manner.
Corporate income tax0.0Remove exemptions and lower statutory rate in a revenue-neutral manner.
Property tax0.2Increase rate and gradually replace transaction tax with recurrent property tax.
Total expenditure policy 2/2.7
Health0.6Implement universal health coverage while improving efficiency.
Education0.8Increase education expenditure toward EM average (4.8 percent of GDP) while improving efficiency.
Social Assistance0.1Consolidate poorly-targeted programs.
Infrastructure1.3Increase investment expenditure toward 5 percent of GDP while improving efficiency.
Other expenditure−0.1Cut nonpriority expenditure.
References

    Anderson, Derek, BenjaminHunt, MikaKortelainen, MichaelKumhof, DouglasLaxton, DirkMuir, SusannaMursula, and StephenSnudden, 2013, “Getting to Know GIMF: The Simulation Properties of the Global Integrated Monetary and Fiscal Model,IMF Working Paper No. 13/55 (Washington: International Monetary Fund).

    International Monetary Fund, 2015a, Fiscal Policy and Long-Term Growth (Washington).

    International Monetary Fund, 2015b, Making Public Investment More Efficient (Washington).

Prepared by Hui Jin (FAD), with original inputs from Holger van Eden, John Brondolo, Peter Barrand, Narine Nersesyan, Irena Jankulov Suljagic, Thornton Matheson, Ruud De Mooij, Victoria Perry (all FAD).

International Monetary Fund, 2015, Fiscal Policy and Long-Term Growth.

Unlike the European fiscal rules, there is no escape clause in the 3 percent deficit rule in Indonesia. As over half of the government debt is held by nonresidents, the fiscal rules play a key role in enhancing international investors’ confidence.

Cascading refers to a situation where tax is applied on taxes, thereby exacerbating the economic distortions caused by the tax. This arises when tax is charged on inputs into VAT-exempt goods and services. No refund could be collected for the tax paid on the inputs used in their production. A portion of the tax paid on inputs—the magnitude of which will depend on factors such as the relative elasticities of demand and supply and the ratio of taxed to untaxed inputs—is then passed on to consumers through higher prices. When an exempted item is used as an input into production, the input tax “sticks,” with tax applied on top of the tax.

The medium-term growth forecast is based on the global integrated monetary and fiscal model (GIMF) in Anderson and others (2013). This forecast is also similar to the experience with other emerging economies which have implemented growth-friendly fiscal reforms analyzed in IMF (2015a).

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