Chapter

Chpater 6: Implementing a Medium-Term Revenue Strategy New

Author(s):
Luis Breuer, Jaime Guajardo, and Tidiane Kinda
Published Date:
August 2018
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Author(s)
Ruud de Mooij Suahasil Nazara and Juan Toro

Ruud de Mooij and Juan Toro are affiliated with the IMF’s Fiscal Affairs Department. Suahasil Nazara is Chairman of the Fiscal Policy Agency, Ministry of Finance, Republic of Indonesia, and professor of economics, University of Indonesia. The chapter is based on a technical assistance mission by the IMF, which worked closely with the staff of the Ministry of Finance. Other members of the IMF team include Aqib Aslam, John Brondolo, Annette Chooi, Michael D’Ascenzo, Hui Jin, Narine Nersesyan, and Thomas Story. The work benefited from comments by the Indonesian government’s officials, as well as by IMF staff, including Michael Keen, Thornton Matheson, Debra Adams, and Christophe Waerzeggers. The views expressed in this chapter do not necessarily reflect those of the IMF or the Indonesian government.

Introduction

Indonesia needs to substantially increase its government revenue level in a sustainable manner to finance additional expenditures that are critical for economic growth and development. With a ratio of general government tax revenue to GDP of just over 11 percent, Indonesia is the lowest among the Group of Twenty (G20) countries and trails other emerging market economies. Empirical evidence suggests that countries with a tax-to-GDP ratio of less than 15 percent tend to grow significantly more slowly than countries beyond this tipping point because it impedes opportunities for productive government spending. Therefore, adopting a medium-term approach to raising revenue will be critical to achieving the revenue-level change that Indonesia needs.

This chapter outlines a medium-term revenue strategy (MTRS) for Indonesia that aims to raise tax revenue by 5 percentage points of GDP in five years. The MTRS approach was developed for the G20 by the Platform for Collaboration on Tax and frames the tax system reform in a comprehensive and holistic framework of four interdependent components: (1) building broad-based consensus in the country for medium-term revenue goals to finance needed public expenditures; (2) designing a comprehensive tax system reform covering policy, administration, and the tax legal framework to achieve these goals; (3) committing to steady and sustained political support (government-led and whole-of-government approach) of implementation of the strategy over multiple years; and (4) securing adequate resourcing—domestically and from capacity development partners and donors—to support implementation of the MTRS. Complete and sustained implementation of each of these components is critical for achieving the revenue objective. The chapter provides a detailed tax system reform proposal (the second key component of the MTRS approach) encompassing a combination of tax policy, administration, and legal reform. The full-fledged MTRS for Indonesia—which may need further refinement from the Indonesian government—is summarized in Table 6.1.

TABLE 6.1.Indonesia’s Medium-Term Revenue Strategy
Objectives
  • Increase tax-GDP ratio by 5 percentage points of GDP in 5 years—from 10.4 percent to 15.4 percent by 2022

  • Reduce tax distortions and strengthen progressivity (to be measured by distributional and economic impact study)

  • Reduce compliance costs and improve investment climate (to be measured by surveys)

  • Improve community perception of tax system fairness (to be measured by surveys)

Tax Policy Reform (3.5 points of GDP)Tax Administration Reform (1.5 points of GDP)Legal Framework Reform
Value-Added Tax (VAT)
  • Remove several exemptions.

  • Reduce the registration threshold.

  • Removal of the sales tax on luxury goods.

  • Increase (gradually) the standard rate by 2 percentage points

Excise Taxes
  • New excises on vehicles

  • New excises on fuel

Corporate Income Tax (CIT)
  • Replace the myriad of special regimes for corporate businesses with one single corporate income tax regime

  • Introduce alternative minimum tax

Personal Income Tax (PIT)
  • Broaden personal income tax base by including the middle class

  • Strengthen the progressivity of personal income tax

  • Reduce the threshold of the small and medium-sized enterprise regime

Property Tax
  • Allow higher rate, while reducing local transfers

Institutional Reforms in Tax Policy
  • Strengthen capacity for revenue analysis in the Tax Policy Unit of the BKF

Taxpayers’Compliance Manaaement

Launch a CIP with targeted, well-resourced, and supervised plans for:
  • Value-added tax

  • Employer withholding obligations

  • Ultra-high-wealth individuals

  • Wealthy Indonesians: high-income earners and high-wealth individuals and professionals

Underpin the CIP with five supporting initiatives:
  • Strengthening audit

  • Building a powerful data matching capability

  • National deployment of compliance risk management

  • Increasing efficiency of support and supervision

  • Leveraging the tax amnesty and automatic exchange of information intelligence

Institutional Reforms in Tax Administration
  • Grant greater autonomy within the auspices of the ministry of finance

  • Modernize human resources management (gradually), prioritizing policies in operational areas to support the CIP

  • Revamp and relaunch the code of conduct

  • Streamline organization following international trends

  • Deploy a program of information and communication technology (ICT) improvements to support the CIP, in anticipation of the full ICT redevelopment

KU P Charmes
  • Modernize General Provisions Procedures law (RUU KUP) to improve its structure by simplifying and clarifying provisions and procedures to ensure a proper balance between revenue collection and the rights of taxpayers.

  • Substantially relax the requirement for auditing all or most refund audits in favor of a more risk-based approach.

Substantive Law Chanaes
  • VAT Law (RUU PPN) to strengthen revenue performance through measures that improve value-added tax system design

  • Income Tax Law to simplify the law and eliminate distortions and broaden the base to include the middle class while improving progressivity

  • Eliminate the requirement to fill a tax return for employees whose only source of income is from a single job

  • Excise laws for revenue mobilization and addressing environmental externalities

  • Property tax changes to boost local revenue—enablingthe central government to reduce its transfers

Decrees & Reaulations
  • Strengthen the governance framework for tax system reform to ensure effective implementation of the MTRS

  • Provide authority to the Ministry of Finance to change internal structure, allocate staff, and regrade positions

Political SupportExternal Resources
  • Strengthen reform governance and management

  • Commit to multiyear budgets to secure reform implementation

  • Ensure government-led effort based on a whole-of-government approach

  • Involve a wide base of stakeholders to achieve a country-owned effort

  • Launch an”amnesty-like” socialization campaign for the MTRS

  • Identify capacity requirements to reform development and implementation

  • Identify available external support from capacity-development (CD) partners to fill capacity constraints

  • Formalize an agreement with capacity development partners to support the government-led MTRS

Note: CIP = Compliance Improvement Program; MTRS = medium-term revenue strategy.

The Need for A Medium-Term Revenue Strategy

As discussed in Chapter 5, “Supporting Inclusive Growth,” Indonesia needs to substantially increase its government revenue. Higher expenditures on infrastructure, health care, and education are urgently needed to lift economic growth, reduce inequality, and improve the well-being of Indonesians. The government has already attempted to improve spending quality by removing distortive subsidies and promoting efficiency. However, more fundamental reforms aimed at significantly improving revenue mobilization are clearly pivotal to the country’s objectives of raising expenditure levels. Increasing Indonesia’s very low tax-to-GDP ratio has therefore been a long-standing goal of the government. Nevertheless, achieving that goal has proved to be hard. Several tax system reforms have attempted to enhance revenue performance, and temporary increases have been achieved. However, they have not led to any fundamental and sustainable improvement, and the revenue ratio remains very low and, in fact, has been declining in recent years (Figures 6.1 and 6.2).

Figure 6.1.
Tax-to-GDP Ratio versus Real GDP Growth

(Percent)

Sources: IMF, World Economic Outlook, and IMF staff calculations.

Note: Tax revenues refer to general government.

Figure 6.2.
Tax-to-GDP Ratio in Indonesia and in Emerging Markets

(Percent)

Sources: IMF, World Revenue Longitudinal Database; and IMF staff calculations.

Note: Tax revenues refer to general government.

The Indonesian government initiated a new reform effort in 2016 with better features than in previous attempts (see discussion below), but some critical weaknesses pose risks to its ambitious targets. The establishment of a reform governance framework and reform agendas, and the allocation of dedicated resources to implement the reforms, are critical to the success of complex and comprehensive tax system reforms. Also, it is notable that the sponsorship of the reforms at the highest level of government is a significant strength, with the Minister of Finance championing them as co-chairperson of the Steering Team, along with the Coordinating Minister for Economic Affairs. However, the approach to tax system reform lacks an overarching coherence, which poses a significant risk of failing to achieve a large step increase in the tax-to-GDP ratio. The current reform agenda does not identify and quantify the specific policy and administration measures that are needed to achieve and sustain the ambitious revenue target for 2020. Nor are the most important reforms singled out for close and active management by the reform team.

Adopting an MTRS approach to frame the tax system reform will increase the likelihood of achieving and sustaining the much-needed increase in the tax-to-GDP ratio.1 The core elements needed for effective implementation of an MTRS are outlined in Box 10 of the June 2016 platform paper to the G20, reproduced here as Box 6.1. As explained in the platform paper, the strategy would help the authorities credibly commit to sustainable implementation, requiring holistic, synergic, and steady development of the core elements. Box 6.1 illustrates key priorities that should be addressed in developing each of the MTRS’s four interdependent components.2

A comparison of current reform initiatives in Indonesia with the MTRS reveals similarities and key differences. To some extent, Indonesia is already undertaking revenue mobilization efforts—most notably the tax system reforms—along the lines of the above elements of the MTRS (or parts of them).3 However, many of these efforts do not have the same reach, rigor, synergy, and sustainability as the MTRS approach. Box 6.2 elaborates on the enhancements that are required to address the weaknesses of the current tax system reform approach to transition those efforts toward an MTRS approach.

Core Elements of a Medium-Term Revenue Strategy, as Set Forth in the Platform Paper to the G20

  • A social contract on the level of revenue mobilization effort for the medium-term (5–10 years) with due consideration to the poverty and distributional implications of the associated measures

  • A comprehensive reform plan for the tax system, reflecting country circumstances and the state of institutional capacity:

    • A redesign of the policy setting to meet the revenue goal.

    • A reform of the revenue agencies to properly administer the policy setting and to achieve a high level of taxpayers’ compliance to meet the revenue goal.

    • A strengthening of the legal framework to enable the policy redesign and administration reform, including by balancing revenue agencies’ powers and taxpayers’ rights.

  • A country’s commitment to a steady and sustained implementation, notably by securing political support and resourcing.

  • Secured financing for the capacity development effort (technical assistance and training) to support the country in overcoming domestic constraints to formulate and implement a medium-term revenue strategy effectively.

Figure 6.1.1.
Key Medium-Term Revenue Strategy Interdependent Components and Underlying Priorities

(Percent)

Source: Authors.

Enhancements to the Current Tax System Reform Effort in Indonesia under the Medium-Term Revenue Strategy

Setting revenue and other goals

  • Revenue goal to finance expenditure needs: The specified revenue mobilization effort (an explicit target of raising the tax-to-GDP ratio by the end of 2020) needs to be linked to a complementary medium-term expenditure strategy to enhance stakeholder support for the proposed tax reforms.

  • Consultation: Efforts to achieve far-reaching and active stakeholder involvement need to be enhanced, notably to develop a country-owned revenue strategy.

  • Other objectives: Intended tax system reform needs to define clear criteria (or objectives) to ensure high-quality measures in tax policy, tax administration, and tax legal framework.

Comprehensive tax system reform to achieve goals

  • Tax system reform scope: To achieve the goals, the reform effort needs greater attention to addressing weaknesses in tax policy and legal frameworks, beyond reforms to the revenue agencies (Directorate General of Taxation and Directorate General of Customs and Excises).

  • Specific revenue-raising initiatives: Specific reform initiatives in tax policy (a revenue package) and tax administration (well-targeted plan to improve taxpayer compliance) need to be identified to achieve the goals.

  • Quantification: A realistic assessment needs to be conducted of how much revenue policy and administration measures can generate to achieve the overall revenue objective. More broadly, the impact of reform efforts needs further quantification to show how they will contribute to achieving the goals.

  • Revenue agencies’ transformational initiatives: These initiatives need to be prioritized and actively managed, with clearly empowered and accountable people, specific implementation plans, and resources allocated to achieve their outcomes. This groundwork will avoid implementation failure, as operations tend to be prioritized. In addition, synergies between two agencies (Directorate General of Taxation and Directorate General of Customs and Excises), which are both under the Ministry of Finance, must be identified and realized.

  • Good practices: Changes inconsistent with international trends need to be discarded in the current reform strategy (for example, the expansion of local tax offices, which will not streamline the Directorate General of Taxation organization, and the untargeted efforts on massive registration of taxpayers—”extensification”—which yields low returns).

Sustained political commitment from formulation to implementation

  • Whole-of-government approach: Broad buy-in and country ownership of the reform are crucial and need to be further nurtured across several ministries and entities of the government.

  • Resources: The resource commitment to finance the information technology and communication system revamping needs to be complemented to finance the deployment of other transformational reform components; it seems unrealistic that it will be accommodated within existing budgets, or the upgrades will not be properly financed.

  • Reform governance: While Decree 928 was issued for 2017, a medium-term revenue strategy requires a multiyear commitment. Fully functioning governance is crucial, with regular meetings to assess progress, monitor milestones, ensure allocation of resources, and make timely decisions.

Coordinated capacity development support from formulation to implementation

  • Aligned support: Good collaboration between the Indonesian government and capacity development partners needs to be aligned under the government-led medium-term revenue strategy, including by determining the overall envelope of capacity development support and each capacity development partner’s role in implementing the medium-term revenue strategy.

The rest of this chapter formulates a full-fledged MTRS that addresses the above weaknesses, notably related to the tax system reform component. The next section discusses the first component of the MTRS: setting the revenue objective derived from expenditure needs. The subsequent two sections describe the two substantive elements of the tax system reform (second component of the MTRS), distinguished by tax policy reform and reform of the revenue administration. The following section then elaborates on the sustained political commitment, specifically management of the revenue strategy (third component of the MTRS), and coordination of capacity development partners in providing support (fourth component of the MTRS). The contours of the MTRS described here serve as a starting point for the government to lead a country-owned revenue strategy. The government’s own MTRS should be published as a government document that highlights Indonesia’s revenue mobilization effort with a steady and sustained implementation reform path, a plan of collaboration with capacity development partners supporting this effort, and alignment of the whole of government with full implementation.4

Setting Revenue Mobilization Objectives

Indonesia needs to substantially increase its government revenue to finance additional expenditure priorities to boost economic growth. Chapter 5 discusses in detail the rationale for the increased expenditure. Despite efforts to make existing expenditure programs more productive and efficient, spending gaps are present in several areas and equate to 5 percentage points of GDP. The spending gaps will have to be financed by additional tax revenue because additional debt is constrained by the government’s commitment to following a fiscal rule that prevents increases in debt levels. Moreover, there is room to increase taxation revenue, which has been declining in recent years (Figures 6.1 and 6.2). Given the very low current spending levels on infrastructure and health care, and the low tax-to-GDP ratio, the social benefits of higher spending are likely to significantly outweigh the cost of financing enhancements through taxation.

In choosing between taxation options, it is important to select measures that will generate the best possible outcome. Otherwise, welfare losses induced by higher taxation could more than offset the benefits of the higher spending. Hence, although raising revenue is the MTRS’s primary objective,5 the choice of reform measures for achieving this goal should be guided by clear principles of good taxation:

  • Efficiency: Additional revenue will be raised in a way that is least distortive to the economy. For instance, taxation should not induce large distortions to investment and saving decisions, consumer choices, or employment behavior. Taxes might, however, be used to deliberately discourage certain behaviors that are socially harmful, such as air pollution or tobacco consumption.

  • Equity: Revenue will be raised in a manner that is perceived to be fair and equitable. It is important to note, however, that what ultimately matters for equity and fairness is the combined impact of taxation and expenditures. Reductions in inequality, for instance, might best be achieved in Indonesia through public spending, even when financed by proportional or even regressive taxes.

  • Ease of administration and compliance: Indonesia reduced the average amount of time that businesses spend preparing, filing, and paying taxes from 266 hours in 2010 to 221 hours in 2016 (World Bank 2017). Despite this reduction, Indonesia still lags its regional comparators—Korea (188 hours), Malaysia (164 hours), the Philippines (86 hours), and Singapore (67 hours).

To achieve the MTRS’s revenue target, tax policy, tax administration, and legal measures are needed. These reforms will work in tandem, and there will be important interactions between them. For example, improvements in value-added tax (VAT) compliance (tax administration) will be supported by a faster refund system, elimination of VAT exemptions, and simplification of the law (tax policy). Good-quality legal tax provisions—comprising tax laws, regulations, decrees, and circulars—are essential to provide certainty to taxpayers and to minimize the costs of compliance. The next two sections develop a set of concrete reforms in the areas of tax policy and tax administration.6 The revenue implications of these measures are quantified using historical data, international comparative evidence, or empirically validated model simulations—although some of these calculations might need further refinement when the government’s own MTRS is formulated. From this quantitative analysis, it appears that tax administration measures can potentially generate 1.5 percent of GDP in revenue over the next five years. Tax policy reforms can potentially generate the additional 3.5 percent of GDP to meet the MTRS’s overall revenue objective.

Tax System Reform: Policy

Although the basic structure of Indonesia’s tax system is appropriate, there are severe weaknesses in its design that reduce its revenue productivity. Tax revenues are generated primarily from income taxes, the VAT, a handful of excises (mainly on tobacco), and a property tax. Headline rates for the corporate income tax (CIT) (25 percent), personal income tax (PIT) (top rate of 30 percent), and VAT (10 percent) are broadly in line with regional peers. However, a closer inspection reveals inherent weaknesses in the tax policy framework, in that design elements of all the major taxes severely undermine the basic principles of a good tax. For instance, the myriad of special regimes, exemptions, and tax incentives in each of the major taxes causes weak revenue performance in Indonesia compared with other countries. In addition, they create an uneven playing field, thereby inducing welfare losses, inequities, and complications in administration and compliance.

This MTRS explores revenue options in all major taxes. First, revisions to the VAT law and the income tax law provide opportunities to enhance revenue mobilization, and are currently under discussion. Second, Indonesia does not exploit excises that are common in other countries, such as on vehicles and fuel, representing significant untapped revenues. Understandably, excises on fuels will be politically challenging given that Indonesia has been struggling recently to remove fuel subsidies to allow domestic prices to align with international oil prices. Third, increases in the property tax can boost local revenue—enabling the central government to reduce its transfers. In choosing options for reform, the MTRS introduces a high-quality reform package aimed at improving revenue mobilization while strengthening efficiency, equity, and the ease of administration and compliance.

The tax policy reform package developed in this section is expected to increase revenue by 3.5 percent of GDP in five years. In quantifying impacts, the analysis relies on several technical reports (Arnold 2012; Sugana, Zolt, and Gunadi 2013; IMF 2014; World Bank and Ministry of Finance 2015; IMF 2016; Hamilton-Jart and Schulze 2017). Figure 6.3 summarizes the revenue effects from reform measures in the VAT, income tax, excises, and property tax. There is some front-loading in the first year of the MTRS (1 percent of GDP), which mainly comes from the introduction of the vehicle excise. Reforms to the VAT and the income tax are smoothed over the entire MTRS period, with revisions in the VAT law assumed to be implemented in 2020 and 2022.

Figure 6.3.
Projected Revenue Increases from Tax Policy in the Medium-Term Revenue Strategy

Source: IMF staff calculations.

To facilitate transparency and good governance in tax policymaking, the Indonesian government should also start publishing an annual tax expenditure study to assess the revenue forgone from preferential tax arrangements that deviate from the benchmark system. The study should be integrated into the regular budget cycle to inform Parliament and other stakeholders in making well-informed decisions.

Value-Added Tax

Indonesia’s 10 percent VAT rate is in line with that of other countries in the Association of Southeast Asian Nations (ASEAN), but is relatively low in a wider international context (Figure 6.4, panel 1). Since 2014, VAT revenue has declined as a share of GDP, driven in part by increasing weaknesses in its design. The number of VAT-exempt activities is long, while the VAT registration threshold (another form of exemption) is exceptionally high—at 40 times GDP per capita, one of the highest in the world (Figure 6.4, panel 2). The combination pushes too many businesses outside the scope of the VAT. Although the direct revenue loss from exemptions is likely modest, exemptions create two major problems: First, they lead to cascading effects because exempt suppliers are unable to claim VAT credits on their inputs. This distorts production patterns and reduces welfare—both outcomes that the VAT principally aims to avoid. Second, they lead to breaks in the VAT chain, which reduces voluntary compliance—another key attraction of the VAT. Indeed, the very high VAT compliance gap that has been estimated for Indonesia is in part due to the myriad of exemptions and the excessively high registration threshold.7

Figure 6.4.
Comparing Features of the Indonesian VAT System

Sources: IMF, Fiscal Affairs Department Rates Database; and IMF staff calculations.

Note: ASEAN = Association of Southeast Asian Nations; BRICS = Brazil, Russia, India, China, South Africa;

Dev. Asia = developing Asia; EMDEs = emerging market and developing economies; PPP = purchasing power parity;

VAT = value-added tax. Data labels in panel 2 use International Organization for Standardization (ISO) country codes.

1Comparator economies = Bangladesh, Brazil, Egypt, Iran, Mexico, Nigeria, Pakistan, Philippines, Russia, Thailand, Turkey.

Revisions to the VAT law currently under discussion should be guided by the removal of distortions and an increase in revenue productivity. The new VAT structure should be broad-based, with a single rate (including for tobacco) and with zero rating of all exports (including services and supplies to special economic zones). Social objectives or certain industrial policies should no longer be accommodated via special VAT treatment, but instead should be achieved by using other instruments—such as expenditure policy—that are more effective and efficient for that purpose. The following concrete reforms should be part of the VAT revision in the coming years:

  • Removal of exemptions: Exemptions for mining, agriculture (including plantation and forestry products), tourism, domestic transportation, employment services, fee-based financial services, art, entertainment, electricity, and water can be eliminated. Article 16b of the VAT law, which enables the issuance of regulations that impose VAT exemptions, should be phased out during 2018 and 2019 so that no new exemptions can be introduced without parliamentary approval. A short list of “standard exemptions” can remain, such as for margin-based financial services, education, and health care. Estimates of the revenue effect of removing exemptions vary, but are generally modest and are unlikely to exceed 0.2 percent of GDP.

  • Reduction of the registration threshold: The increase in the VAT threshold in 2014 from Rp 600 million (about US$45,000) to Rp 4.8 billion (about US$350,000) reduced the tax base. Reversing this change is expected to raise revenue by 0.2 percent of GDP.

  • Removal of the sales tax on luxury goods (STLG): The STLG is another example of inconsistent Indonesian tax policy in the sense that, while the VAT applies generally at each stage of the value-added chain, the STLG is a one-time sales tax applied to luxury goods. The STLG in 2015 raised only 0.15 percent of GDP, 90 percent of which came from vehicles. Such small revenue is not worth the complexity and administrative efforts the STLG creates. Therefore, the STLG can be repealed, and all goods should be subject to the normal VAT rate. Vehicles should instead become subject to a specific excise (see the “Excises” section).

  • A gradual increase in the standard VAT rate: Raising the VAT rate in the current system runs the risk of magnifying existing distortions induced by the large number of exemptions. Therefore, the VAT rate can be increased, but only after several exemptions have been removed and the VAT registration threshold has been reduced. An increase in the VAT rate by 1 percentage point has been estimated to increase revenue by approximately 0.4 percent of GDP. An increase in the VAT rate to 11 percent in 2021 and to 12 percent in 2022 is expected to boost revenue by 0.8 percent of GDP by the end of the MTRS period.

Income Tax

Income taxes currently raise about 5 percent of GDP in Indonesia, which is close to levels in other large emerging market economies. Yet, there are two key weaknesses in Indonesia’s income tax. First, the myriad of special regimes for businesses of different sizes or in different sectors has created an uneven playing field. For instance, there is excessive discrimination between firms as a result of sector-based final tax regimes, the overly generous presumptive taxation of small and medium-sized enterprises (SMEs), and preferential treatment of selected businesses. This system has created several arbitrage opportunities for businesses and induced organizational and allocative distortions, including significant misallocation of capital and labor. This is reflected in lower productivity than what could otherwise be achieved through a more neutral system. Second, the Indonesian income tax deliberately excludes a large share of the population from the tax base, including the rapidly growing middle class. For example, the nontaxable income threshold in Indonesia is quite high, about 90 percent of the country’s per capita income. In 2016, the decision was made to increase the threshold further to boost consumption. However, it has become so high that it forgoes significant opportunities to tap an important and growing revenue base (Kharas 2017). In addition, both the revenue productivity and the progressivity of the PIT could be enhanced by bringing more middle-class families into the tax base. The following reforms to the income tax would boost revenue, enhance tax neutrality, and strengthen its progressivity:

  • Structure of the corporate income tax: In the new tax law, one uniform CIT rate should apply to all corporate income (except for shipping, which is commonly treated separately). Final withholding schemes on deemed profits should thus be abolished, the 50 percent discounted rate for medium-sized businesses should be removed, and corporations should no longer be eligible for the small business regime, even if their turnover is less than the new SME threshold. Also, discretionary tax incentives in the CIT should be phased out. The precise revenue implications of this package are hard to predict without access to taxpayer data and a corporate sector microsimulation model. Yet, any revenue gains from these base-broadening measures could be used to reduce the headline CIT rate at the end of the MTRS period as part of an efficiency-enhancing reform. Although the current CIT rate of 25 percent is close to that of Indonesia’s peers (Figure 6.5), a slight reduction will mitigate outward profit shifting by multinational firms and may help attract foreign direct investment.

  • Structure of the personal income tax: In advanced economies, the middle class typically bears a large share of the PIT burden. Indonesia deliberately eliminates the middle class by imposing a relatively high basic exemption threshold (Figure 6.6, panel 1). Together with the rate structure, this renders the average PIT burden on middle-class families much lower than in other countries (Figure 6.6, panel 2). The new income tax law should aim to gradually expand the PIT base and strengthen its progressivity. The base would best be individual income instead of family income. Progressivity can be strengthened by replacing the basic tax deduction with a nonrefundable tax credit, calibrated to leave taxpayers in the first bracket (subject to a 5 percent rate) unaffected. The basic tax credit should be held nominally fixed over the coming years, so that an increasing share of people will gradually enter the PIT base. The top PIT rate of 30 percent might remain unchanged, but the level of income at which this rate applies can be significantly reduced to further strengthen progressivity. The new rate structure should also be adjusted in such a way that revenue from the PIT will increase by 0.3 percent of GDP in 2022.

Figure 6.5.
Distribution of Statutory Corporate Income Tax Rates

(Percent)

Sources: IMF, Fiscal Affairs Department Rates Database; and IMF staff calculations.

Note: ASEAN = Association of Southeast Asian Nations.

1Comparator economies = Bangladesh, Brazil, Egypt, Iran, Mexico, Nigeria, Pakistan, Philippines, Russia, Thailand, Turkey.

Figure 6.6.
Personal Income Tax Thresholds as Multiples of Per Capita GDP and Relative Progressivity of Personal Income Tax Schedule

Sources: International Bureau of Fiscal Documentation; and IMF staff calculations.

Note: Data labels in panel 1 use International Organization for Standardization (ISO) country codes.

  • Small business regime: The gross turnover threshold for Indonesia’s special SME tax regime is exceptionally high by international standards, meaning that too many medium-sized businesses are subject to the 1 percent final turnover tax. This has several disadvantages: (1) it creates distortions in firm behavior (for example, it discourages firms from growing, or encourages them to split into multiple small firms); (2) it creates large horizontal inequities (for example, between firms with different margins on turnover); and (3) with a low rate of 1 percent, the inclusion of many medium-sized enterprises comes at the expense of revenue. A special SME regime should remain part of the new income tax law, but be applied only to unincorporated firms with limited ability to keep proper books and records. The special regime thus serves the purpose of reducing the compliance burden on very small firms. The new threshold under the MTRS can best be aligned with the VAT threshold and set at Rp 600 million. This reform to the SME regime is likely to yield some additional revenue, which is conservatively estimated to be 0.1 percent of GDP. However, behavioral responses may generate additional revenue and enhance productivity by eliminating distortions.

  • International taxation: Indonesia has already adopted measures to comply with minimum international standards on base erosion and profit shifting and automatic exchange of information (AEOI). Moreover, it has implemented other anti-avoidance measures, such as controlled foreign corporation legislation and restrictions on interest deductibility. Further strengthening of these measures is underway, for instance, with respect to transfer pricing regulations, provisions against treaty shopping, the definition of a permanent establishment, and a general anti-avoidance rule. While these measures are important for protecting the CIT base and for Indonesia to comply with internationally agreed-upon standards, their potential revenue impact should not be overestimated. For instance, the adoption of anti-avoidance measures can at best capture a fraction of the revenue loss from base erosion and profit shifting; and experience with the Foreign Account Tax Compliance Act in the United States suggests a very modest revenue gain of about 0.004 percent of GDP per year (Byrnes and Munroe 2017), implying that revenue effects from AEOI are likely small, especially in the short to medium term. Another issue relevant for Indonesian international taxation rules is the country’s double tax agreements. Thus far, these treaties have been guided by the assumption that Indonesia is receiving investment from other countries, rather than investing abroad. However, more and more Indonesian companies are expanding their business opportunities abroad so that outbound investment has become more important. This changes the perspective on double tax agreements. Indeed, different guidelines for double tax agreements are needed, which may also be used as a pathway to reforming other aspects of the domestic tax system.

  • Alternative minimum tax: To provide an effective safeguard against tax avoidance and tax evasion by corporations, an alternative minimum tax (AMT) in the CIT has been proposed. The AMT would be based on a 1 percent tax on turnover. A corporation would thus pay the maximum of either the ordinary tax liability under the CIT or the AMT. One possible disadvantage of the AMT is that it will impose a tax on loss-making companies. To address this possibility, it would be accompanied by a generous carry-forward period of 10 years. Thus, the difference between AMT payments and regular CIT liability would be creditable against future CIT liabilities. The carry-forward provision would also help smooth volatility of tax revenues in the budget. The AMT has an expected revenue yield of 0.2 percent of GDP.

Excises

Excise revenues in Indonesia, almost exclusively from tobacco, currently stand at 1.2 percent of GDP, which is low compared with other countries. Average excise revenues in ASEAN countries are 2 percent of GDP, typically generated by excises on a wider set of products, including fuel and vehicles. In Thailand, excise revenues are about 4.6 percent of GDP; in other emerging market economies, the average excise-to-GDP ratio exceeds 2 percent (Figure 6.7). These comparative statistics indicate that Indonesia could expand its excises beyond tobacco—for which a clear road map has already been developed and a reform program is underway—to contribute to the MTRS’s revenue mobilization objectives. Moreover, some excises can serve other social purposes, such as regulating undesirable behaviors that lead to pollution or traffic congestion. Two new excises are particularly attractive as part of the MTRS:

Figure 6.7.
Excise Revenues: Indonesia versus Emerging Market Economies

(Percent of GDP)

Sources: IMF, World Revenue Longitudinal Database; and IMF staff calculations.

Note: EM = emerging markets.

  • Vehicle excise: Vehicles are currently subject to the STLG. The STLG was introduced initially to enhance the progressivity of the revenue system by taxing luxury goods that are disproportionately consumed by rich households. The revenue, however, comes almost exclusively from vehicles. It appears, however, that the sales price of vehicles is often significantly undervalued and misreported, which has eroded the base of the STLG. Indeed, STLG revenue performance as a share of GDP has declined in recent years. Following international practice, the STLG on vehicles can better be transformed into a specific vehicle excise, independent of price. As outlined by the World Bank (2015), the amount of excise due on the sale of each new vehicle can be based on the engine size of the vehicle. The vehicle excise base can be expanded compared with current STLG treatment by also covering vehicles that are currently exempt, such as pickups and other trucks. The introduction of the vehicle excise is expected to raise additional revenue of 0.6 percent of GDP. To prevent a decline in this share over time, the specific excise rates should be adjusted yearly for inflation. The reform has specific appeal in the context of the MTRS because a significant part of the revenue will be spent on new infrastructure projects that will benefit vehicle owners.

  • Fuel excise: Indonesia currently imposes no net tax on gasoline, while diesel is still subsidized. This practice contrasts with other ASEAN countries and the BRICS (Brazil, Russia, India, China, South Africa), where gasoline and diesel are subject to specific excises. For example, the average net tax (composed of VAT and excise) on gasoline in ASEAN countries is equivalent to Rp 2,682 per liter, while the BRICS average is equivalent to Rp 3,476 per liter (Figure 6.8). A net tax on gasoline similar to the average in ASEAN will generate expected revenue of 0.4–0.5 percent of GDP; bringing the diesel excise to the ASEAN average will add another 0.2–0.3 percent of GDP. Fuel excises have several merits for Indonesia. First, they provide a powerful tool for internalizing the cost of environmental damage caused by emissions of carbon dioxide and local air pollutants in prices, as well as costs attributed to road congestion, accidents, and noise. Thus, the excise can support Indonesia’s environmental objectives under its National Medium-Term Development Plan and contribute to achieving the Paris Agreement pledge by 2030 to lower greenhouse gases by 29 percent below “business-as-usual” levels. Second, because fuel consumption and road use are closely connected, the fuel excise acts as a user charge to finance infrastructure investment. In the MTRS, the fuel excise could gradually be implemented over the next five years, to reach a revenue target in 2022 of 0.5 percent of GDP.

Figure 6.8.
Fuel Taxes in ASEAN and BRICS

Source: IMF, Energy Subsidy Database.

Note: ASEAN = Association of Southeast Asian Nations; BRICS = Brazil, Russia, India, China, South Africa; net tax = consumer price minus supply cost.

Property Tax

Recurrent property taxes are generally considered the most growth-friendly because they distort business and consumer decisions less than do other taxes. They are also perceived as fair because of the relatively close link between the tax obligation and the benefits that the taxpayer derives from local public services. By its transparency, a higher recurrent property tax rate can induce greater political accountability and improve the quality of the overall public financial system (local and central) by reducing reliance on intergovernmental transfers and encouraging fiscal responsibility on the part of local governments. Property transfer taxes (or stamp duties) are generally easy to collect, but create larger distortions in property markets and are therefore less efficient.

In Indonesia, revenue from property taxes is low and there is scope for an increase. Since 2012, the land and building tax has been largely devolved to local governments, in line with international practice. Current revenue from the recurrent property tax is about 0.3 percent of GDP, which is low compared with ASEAN averages, large emerging markets, and advanced economies (Figure 6.9) for the following reasons. First, property values used for the assessment of the property tax are considerably below market value, which results in a narrow base. Second, the law does not allow municipalities to set rates higher than 0.3 percent of the assessed value, which is also low in an international context.

Figure 6.9.
Tax-to-GDP Ratio for Recurrent Taxes on Immovable Property

Sources: Organisation for Economic Co-operation and Development; and IMF staff calculations.

Note: ASEAN = Association of Southeast Asian Nations.

To boost revenue from property taxes and improve their efficiency, the MTRS should contain at least the following three reform measures:

  • The maximum allowable rate of the recurrent land and building tax should be increased from 0.3 percent to 1 percent: This increase will enable local governments to mobilize an additional 0.1 percent of GDP during each of the first three years of the MTRS. Central government transfers can then gradually be reduced by 0.3 percent of GDP as local governments receive more fiscal autonomy. Local governments can also use the increase in the land and building tax to recover revenue losses from reforms of other local taxes, such as the 10 percent turnover tax on hotels and restaurants (which will be moved into the standard VAT regime).

  • Properties should be revalued: An accurate property register should be developed, accompanied by an efficient system of valuation. With the central government issuing guidelines regarding the initial appraisal and subsequent mass adjustments, local governments should be responsible for the assessment, as they are now. Revaluation closer to market values will broaden the property tax base in many districts as another way to boost local tax revenue.

  • The maximum allowable rate of the property transaction tax (stamp duty) can gradually be reduced: Currently, the stamp duty rate is 5 percent. This tax, however, is relatively distortive and reduces the number of transactions in property markets. Because the recurrent property tax is more efficient, encouraging local governments to shift from the property transaction tax toward the recurrent property tax will enhance efficiency.

Tax System Reform: Administration

An effective and efficient tax administration is crucial for strengthening Indonesia’s tax system. Although the DGT’s performance has improved in some areas in recent years, potential remains for significantly increasing tax collection through further improvements in tax administration. To this end, the MTRS should include a targeted set of initiatives aimed at strengthening the DGT’s capacity to do the following:

High-Risk Areas of Noncompliance

  • Employer withholding: Only 20 percent of businesses file their employer withholding tax returns on time, and only 5 percent make timely payment of their withheld taxes.

  • Value-added tax:The overall value-added tax compliance rate declined from 53 percent in 2013 to 45 percent in 2015. The rate of on-time filing of value-added tax returns declined from 64 percent in 2014 to 52 percent in 2016.

  • Professional services providers: Only about half of individuals who provide professional services file their income tax returns on time, while fewer than one in four professional services corporations meet their filing obligations.

  • High-wealth individuals: About 2,000 Indonesian individuals own about US$230 billion in assets; their complex tax affairs provide opportunities for aggressive tax planning.

  • Reduce noncompliance and tax evasion: As illustrated in Box 6.3, high non-compliance risks are present in the Indonesian tax system. Large numbers of businesses and individuals fail to comply with their tax obligations. Among the major taxes, filing compliance with the VAT and employer withholding is the poorest. Other areas of high risk of noncompliance include high-wealth individuals and professional services providers. Poor compliance has not only resulted in large losses of tax revenue, but has also created unequal competition between those taxpayers who comply with the tax rules and those who do not. Even worse, the failure of some individuals and businesses to pay their fair share of taxes threatens to undermine Indonesians’ confidence in the fairness of the tax system and the integrity of its administration. Increasing taxpayers’ compliance by a large margin would mobilize substantial additional revenues. Based on the estimates below, it is expected that tax administration reforms could increase the tax yield by up to 1.5 percent of GDP over the next five years. To achieve this increase, a comprehensive compliance improvement plan should be implemented, along with major institutional changes to sustain the revenue gains over the medium term.

  • Pursue institutional reform to increase the productivity of the DGT’s workforce: Routine tax administration suffers from low productivity. For instance, low compliance with the obligation of all employees to file a tax return has led the DGT to allocate a disproportionate number of its staff (more than 50 percent) to enforcing taxpayers’ routine registration (that is, extensification) and filing obligations. This work suffers from low productivity because it is carried out manually and in an untargeted manner, reflecting weak information systems and, until recently, the absence of risk-based approaches. Thus, the DGT allocates far too many of its staff members to routine support (Figure 6.10, panel 2) and supervision tasks and far too few to auditing compared with regional peers (Figure 6.10, panel 1). For similar reasons, the DGT’s auditor program is plagued by low productivity. At present, about 80 percent of the DGT’s audit resources are allocated to examining refund cases that generate only 20 percent of the additional revenue from audit, while only 20 percent of the DGT’s audit resources examine the more productive nonrefund cases that generate 80 percent of the audit results. This misallocation is due mainly to the legal obligation that requires the DGT to audit almost all refund claims, regardless of their revenue risk. As a result, the DGT gives insufficient attention to potentially large amounts of unreported taxes by most taxpayers who do not claim a refund.

Figure 6.10.
Allocation of Tax Staff to Verification and Support Functions

Source: Authors’ calculations.

Note: Data labels in figure use International Organization for Standardization (ISO) country codes.

Compliance Improvement Program

To bring the high rates of noncompliance that plague Indonesia’s tax system under control, the DGT needs to implement a special compliance improvement program. The program would include specific plans aimed at improving taxpayers’ compliance in four key areas that have high risks of revenue leakage:

  • Value-added tax: The VAT provides an important revenue stream, contributing almost 40 percent of total DGT collections, equating to 3.4 percent of GDP. However, VAT compliance rates are low and declining, from 53 percent in 2013 to 45 percent in 2015. The rate of on-time filing of VAT returns has also declined, from 64 percent in 2014 to 52 percent in 2016. Tax arrears have increased 20 percent. Tax yield could be increased significantly if the VAT compliance rate were increased to the levels of regional comparators, such as Thailand (about 80 percent VAT compliance). A compliance improvement plan for the VAT could focus on promoting and enforcing VAT registration, filing, correct reporting, and payment. In addition to increasing attention to monitoring and enforcing these core tax obligations, a small number of high-risk sectors and high-risk activities should be identified and targeted for closer attention.

  • Employer withholding: Employers play an important role in Indonesia’s tax system, but many are not complying with their obligation to withhold and remit taxes on their wage payments. About 2.4 million employers withheld and remitted Rp 114 trillion to the DGT in 2015 on behalf of their employees. This represents 10 percent of total DGT tax collections. Employers also paid Rp 36 trillion in social security contributions. However, many employers are failing to comply with their obligation to file their withholding returns and remit the taxes withheld from employees on a timely basis. Only 20 percent of businesses file their employer withholding tax returns on time, and only 5 percent make timely payment of their withheld taxes. This failure is putting large amounts of tax revenue at risk, requiring immediate and stepped-up attention to bring this under control. The DGT could implement an intensified compliance program to ensure that businesses meet their employer obligations. By providing employers with the necessary tools, education, and support, the DGT could help them comply with their obligations. Specific support can be given to businesses at critical points in their business life cycle, such as when they hire their first employee. The DGT should also strengthen its data matching and intelligence to identify employers who are at high risk of not complying, followed by enhanced audit and reviews when risks are confirmed.

  • Wealthy individuals: This group includes professional services providers, high-income individuals, and high-wealth individuals (HWIs). Their perceived behavior has a powerful impact on community views about the fairness of the tax system. International experience suggests that these groups pose a substantial compliance risk. In Indonesia, only about half of all individuals who provide professional services file their income tax returns on time, and fewer than one in four professional services corporations meet their filing obligations. HWIs are an important and difficult group to manage because of the complexity of their affairs and the opportunities and incentives they have to engage in international tax planning. Building high-quality third-party data and analytic capabilities would be critical to strengthening oversight of this group.

  • Ultra-high-wealth individuals (UHWIs): This group is separated from the HWIs because of specific patterns of noncompliance. The number of UHWIs in Indonesia was estimated to be almost 2,000 in 2016. They owned about US$230 billion in assets, up by almost 10 percent compared with 2015 (Wealth-X 2017). The DGT could materially improve oversight of the 1,000 wealthiest individuals by establishing a dedicated UHWI team in the Large Taxpayer Office, LTO—currently the HWI team. The unit should identify and profile the top 1,000 investors and business operators and identify better ways to meet their service needs to mitigate the material compliance risks that some UHWIs present. Initially, the unit should focus on building strong relationships and ensuring premium support for compliance with all core tax obligations. Potential noncompliance should be identified by maximizing the use of available data and should be addressed through personalized approaches reflecting the circumstances of each taxpayer. Strong cooperation from all government and nongovernment data holders is required to support UHWI compliance improvement.

The compliance improvement program will provide a systematic approach to increasing taxpayer compliance. For each of the four high-risk areas, a separate plan will be prepared to identify the specific risks across the key compliance indicators (registration, filing, payment, reporting). The plan should also provide customized treatments for mitigating the risks (including a mix of taxpayer services, enforcement programs, and legislative changes), set targets for the number and types of treatments that are to be delivered by the field offices, and include a monitoring and evaluation system to track the plan’s delivery by the operational tax offices and assess its impacts on improving compliance. Furthermore, the plan should be underpinned by the following five initiatives to enhance the DGT’s capacity to identify and deal with noncompliance and tax evasion.

  • Strengthening audit: Audit workforce numbers are low by international standards. A significant increase in audit staff is required, probably an almost doubling of the existing numbers. This increase will be difficult to deliver in the short term without risking quality. A national audit taskforce should be established to ensure that a steady stream of trained auditors is available to all regions over the next two years, including elite auditors working with human resources staff and others. Improved recruitment and training and the development of a national training curriculum are also required, including master class training to build specialist-development programs that strengthen the LTO and Medium Taxpayer Office (MTO) skill sets. The national audit taskforce is a prerequisite for effective deployment and retention of skilled resources and for supporting a sustainable long-term audit capability. Audit can also be strengthened by joint audits among relevant authorities. For example, recent collaborations between the DGT and the DGCE have resulted in a better understanding of taxpayers’ behavior in respect of import, export, and tax filings.

  • Data-matching capability: Self-assessment systems depend upon a comprehensive set of high-quality data for effective management, and investing in good data will pay dividends in the long term. Modern tax administrations use data to reduce compliance burdens through better targeting of services, prepopulating tax returns, and better risk management. These activities make it easier for taxpayers to comply and reduce costs for compliant taxpayers. Strengthening access to data, and improving its quality, is also critical for supporting better detection of noncompliance, including by matching data from third parties to data reported by taxpayers on their tax returns. Currently, the DGT uses 67 data sets, which will need to be reorganized into a smaller number of high-priority databases. A pilot program can be conducted with the objective of developing a longer-term comprehensive data-improvement methodology. Based on the lessons learned from the data-improvement pilot, the data-improvement methodology can be progressively deployed across all required data sets, with the aim of progressively completing the core set within three years. Because of joint audits, immediate data matching between the DGT and the DGCE has resulted in better profiling of taxpayers. Both institutions are able to better identify the risk profiles of their clients, whether they are importers, exporters, or taxpayers.

  • Compliance risk management (CRM): CRM approaches are critical for supporting improved taxpayer compliance. Initially, they can focus on improving case selection. As the processes mature and the data sets improve, they can be expanded to include greater environmental scanning to detect and analyze system risks. The DGT’s first-generation CRM system, which is under pilot in 16 district tax offices, is consistent with international CRM case selection approaches. National deployment is a high priority to better target resources to higher-risk cases. The CRM includes modules to support work in each of the core tax functions (registration, filing, correct reporting, payment) and has the potential to materially improve productivity.

  • Efficiency of support and supervision: Successful revenue administrations respond quickly to changing organizational priorities, and ensure that staff are assigned the highest-priority work. Lower-value activities, such as the current extensification work and the auditing of low-risk refunds, are inefficient uses of resources. Indeed, refund audits should focus on high-risk cases, while extensification should target individuals and businesses with significant tax potential. The large amount of resources currently consumed by these activities could be reallocated to more productive activities. Being more responsive to a changing risk landscape is critical to supporting the compliance improvement program. Barriers to efficient staff assignment, work allocation, and risk-based compliance management should be systematically identified and removed, and the DGT should diagnose the barriers and garner support to enable more timely administrative responses, in line with international good practice.

  • Tax amnesty and AEOI intelligence: The international momentum on full disclosure and exchange of information for tax purposes is building up through initiatives such as the Organisation for Economic Co-operation and Development’s (OECD’s) Common Reporting Standard (CRS) and Automatic Exchange of Information (AEOI). Ahead of the introduction of the CRS, Indonesia held a tax amnesty to encourage investors to repatriate undeclared foreign assets; the amnesty also covered domestic assets.8 This effort has generated revenue and provided valuable data. CRS and AEOI commence in 2018 and will increase the sharing of financial data on citizens between governments. Together with the tax amnesty data, there is better information than ever before and a valuable opportunity to strengthen compliance by HWIs and UHWIs. Yet international experience highlights the risk to revenue and community confidence if amnesty is not followed by credible actions to strengthen enforcement. Such actions include keeping amnesty participants in the system and compliant, and dealing firmly with nonparticipants. The DGT should thus develop a plan to ensure that the information from the tax amnesty and AEOI are exploited.

The compliance improvement plan and its supporting initiatives have the potential to increase tax collections by 0.3 percentage point of GDP per year, adding up to 1.5 percentage points of GDP in 2022, if effectively implemented (Figure 6.11).9

Figure 6.11.
Projected Revenue Increases from Compliance Improvement Program in the Medium-Term Revenue Strategy

(Percent of GDP)

Source: IMF staff calculations.

Note: UHWI = ultra-high-wealth individuals.

Institutional Reforms

The MTRS should include several institutional reforms aimed at making the DGT a stronger, more credible, and more accountable organization. These objectives require reforms to the DGT’s autonomy, budgetary arrangements, organizational structure and office network, and information systems. Implementation of these reforms in the right order and in a smooth fashion is crucial to supporting the much-needed improvement in taxpayer compliance and, consequently, to raising collection performance. It will also help sustain the revenue gains from these efforts.

  • Autonomy and budget flexibility: The DGT should be provided additional flexibility in managing and organizing its workforce. However, it should remain an integral directorate within the Ministry of Finance (MoF). Greater flexibility will be achieved by vesting the minister of finance (instead of other government agencies) with final approval authority over key aspects of the DGT’s organization, management, and human resources policies. For instance, the authority to approve a change to a job-grading classification, the internal structure of the DGT, or employee allocation within the DGT should be with the MoF rather than with the Ministry of Administrative and Bureaucratic Reform. The MoF can give the DGT greater flexibility in its operational decisions and monitor delivery against a small set of performance measures. This would allow the DGT to move funds between the major budget categories needed to enhance delivery. For instance, substantially increasing the auditor workforce requires reallocating existing staff from nonaudit to audit positions as well as seeking additional budget resources to create more auditor positions.

  • Organization: Changes in the DGT’s organization are necessary to curb corruption and enhance the productivity of its staff. The DGT’s organizational reform agenda should therefore be better aligned with good international practices and standards regarding staff integrity. For instance, surveillance of local counties that lack a physical DGT presence can be improved by periodically dispatching tax officers or by adding supervision functions to customer service centers. At the same time, more complex technical functions such as tax audit and debt-collection enforcement can better be centralized to achieve the critical mass needed to provide stronger technical backing to these complex functions. Integrity measures are required to create greater awareness among DGT employees about the directorate’s own Code of Conduct and by publicizing to staff the nature and consequences of misconduct. Alongside these integrity measures, human resources planning and development initiatives are needed to formulate well-founded internal staff structure and staff allocation proposals for the new priority work areas in the MTRS, such as the compliance improvement plan.

  • Information technology (IT): Improvements to the IT system should be prioritized to support compliance management. A new computer system (the core tax administration system) could strengthen compliance and improve tax officer productivity. To achieve the best results, the new IT system will be combined with the redesigning and simplification of core tax administration processes, including registration, filing, and payment. The new system’s key compliance and productivity-enhancing features will include (1) strengthening risk management, case selection, and data-matching capacities to better target the DGT’s enforcement activities on highest-risk areas and minimize burdens on compliant taxpayers; (2) improving case and workflow applications to allocate work to tax officers in an efficient manner and help them keep track of all actions taken and pending; (3) replacing the current fragmented local-level databases with national databases to develop a whole-of-taxpayer picture of taxpayers’ affairs across income sources, tax types, and location; and (4) deploying the new system initially toward the large and medium taxpayer offices to strengthen control of the most important revenue sources, before extending the system to larger numbers of small taxpayer offices.

Implementation of these reforms in the right order and in a smooth fashion is crucial to supporting much-needed improvement in taxpayer compliance and DGT staff productivity. This will help sustain the revenue gains from the MTRS.

Sustained Political Commitment and Coordinated Capacity Development Support

Tax system reform is not easy because there are multiple stakeholders, interests, views, and perspectives that need to be aligned. The numerous actors make it necessary to manage the strategy well to achieve the key objectives as part of a nationally owned effort. This section discusses six important areas of MTRS management, which are all essential to making the MTRS successful. These areas are governance of the reform, analysis to inform the public debate, mobilization of stakeholder support, communication strategy, resource commitment to ensure implementation of reform efforts, and priorities and timing. Apart from managing the internal process of the MTRS within Indonesia, it is also important to coordinate capacity development partners’ efforts that support the MTRS, both in the analysis of tax system reforms and in the implementation of MTRS initiatives. These are also discussed in this section.

  • Governance with whole-of-government commitment: Governance arrangements for tax system reform, such as the organization and management of the tax reform process, are critical to the success of the MTRS. The MTRS should be a whole-of-government strategic priority, meaning that it should be embraced by a broad spectrum of stakeholders from the public sector (various ministries and agencies) and be underpinned by clear accountability among them. Leadership of the tax reform agenda should rest with the MoF, with political backing from the president and the entire cabinet. The leadership should be supported by a reform steering committee and a tax reform executive team. At various levels, there should be effective collaboration with other government agencies to reflect the whole-of-government approach. The modus operandi of the tax reform teams should be characterized by regular meetings at each level, high levels of collaboration, prioritization of key issues, effective escalation, prompt decision making, clear accountability, and evaluative monitoring of progress. Once the tax reform strategy starts to be implemented, monitoring should be facilitated by quantification of the key performance indicators (including revenue performance). This will allow the steering committee to take timely action if objectives are not met.

  • Analysis: To provide an appropriate information basis for decision makers, it is critical that the tax reform teams have access to evidence-based, quantitative analysis of the tax system reform. Quantification should inform decision makers about the impact of alternative reform options on total revenue, income distribution, and the economy. Quantification will help structure, discipline, and rationalize the debate on tax reforms, both in administration and policy. Otherwise, discussions might become dominated by vague statements or loose hopes and beliefs, with significant risk of failure. Quantitative analysis also supports the transparency and accountability of the reform process and ultimately helps build trust in government. The quantitative analysis of tax reform should be the responsibility of the MoF, most naturally in the tax policy unit of the Fiscal Policy Agency. The unit should be granted access to anonymized taxpayer data from the DGT to perform adequate tax policy analysis and develop microsimulation models to assess the revenue and distributional impacts of reform. The tax policy team should also have sufficient dedicated economists and statisticians to develop and use these simulation models for analyzing reforms in all major taxes: PIT, CIT, VAT, and excises. Collaboration with external experts and development partners can help build capacity to develop and use these models.10 One key ingredient of the analysis is the ability to link tax reform to different macro- and microeconomic variables in the economy, which is imperative to show how different tax reforms (both administrative and policy) contribute to the improvement of growth, poverty, or inequality, and at the same time to the improvement of the business climate and firm profitability.

  • Stakeholder support: To make tax reform politically feasible and to secure the support of key stakeholders in society, a community-owned strategy is needed. Indeed, successful reform of the tax system will require not only parliamentary approval, but also broad support from both the public sector and the private sector. The former includes key parliamentary committees and advisors to the president; the latter comprises tax professionals’ organizations, industry associations, and civil society organizations. Effective engagement and consultation with these private sector organizations will help secure country ownership of the MTRS initiatives. These consultative processes should distinguish lobbying (which may have negative impacts on the design of the measures) from genuine professional and community input. The involvement of key stakeholders should be formalized so they engage in regular and genuine participation in tax reform governance and activities. As stressed earlier, a good analysis of how tax reform benefits different stakeholders is essential. It is quite natural that a particular tax reform would result in a certain group in the community paying higher taxes, or at the very least being exposed to the tax system radar. Potential backlash from different groups must be anticipated.

  • Communication: Communication is an essential part of comprehensive tax reform. For the internal government, communication can be a significant coordination problem if a coherent whole-of-government approach is not in place. For stakeholders, communication can be quite complicated because different stakeholders may have different motivations and objectives. The MTRS provides an opportunity for the government to strengthen the social contract with its stakeholders. For it to be embraced as a country-owned strategy, its communication and socialization should be a priority across government. The highest level of government should therefore lead the effort to open and inform the national dialogue that determines society’s expectations for the higher level of public services it will enjoy. Government leaders should mobilize representatives from the public sector, the private sector, and business associations along with religious leaders, community representatives, and the mass media to build broad consensus for key elements of the MTRS across multiple stakeholders and the wider community. The communication campaign should clearly link the need for additional revenue to the government’s specific commitments to building human capital and infrastructure and to reducing inequality. Such a narrative will position the MTRS as a government-led and country-owned strategy. The Indonesian campaign for the 2016 tax amnesty provides a good example of how such a communication strategy can be implemented.

  • Resources: The MTRS will require large investment in certain areas, for example, to revamp the DGT’s IT systems, develop new training programs, or attract qualified staff in priority areas. The budget for the entire reform effort (including for the tax reform team) therefore needs to be clearly identified, based on the MTRS’s holistic approach. The MoF’s budget should clearly distinguish funding allocation for MTRS activities from other transformational activities and business as usual. In this way, MTRS activities can be more effectively monitored, there will be clearer accountability, and benefit realization will be more transparent. Given the medium-term time-frame of the MTRS, the funding envelope should be a sustained commitment to delivery over a five-year period.

  • Priorities and timing: All reforms cannot be done at the same time. Determining when to launch a certain reform is important. Reforming the tax administration can be progressed through government regulation, presidential instruction, or MoF regulations. Although this can make tax administration reforms easier, if the government is committed to progress it, their revenue impact might take some time to bear fruit because they require major changes in how people work and in administrative processes. Experience indicates that revenue effects occur with a significant time lag and depend very much on implementation. Reforms in tax policy may have a much faster impact after a new law is passed. However, revisions to VAT law and income tax law may require long deliberations within the Parliament. Such debate is best started at the beginning of an administration rather than at the end, to reduce the political weight of the reforms. Implementation of the reforms can still be realized within the MTRS period. Other tax policy reforms, for example, on excises, need parliamentary consent although the final product is a government regulation. Once established, changes in excise rates can be pursued rather quickly. Good command over choosing priorities and timing is pivotal for the tax reform to succeed.

External Support

External support from Indonesia’s key development partners is important for implementing the MTRS.11 This includes analytical support in shaping, designing, and analyzing the reform package, and operational support in implementing the strategy. To maximize the use of partners’ funding and to avoid duplication of effort, donor partners will be asked to endorse the MTRS in formulating their assistance programs for the revenue area. The MTRS will also provide the framework for coordinating assistance from other donor partners that may wish to support the strategy, including the OECD, the Asian Development Bank, and other organizations.

Conclusion

This chapter argues that Indonesia needs to substantially increase its revenue mobilization effort to finance public investments that are critical for economic growth and development. However, boosting tax revenue in Indonesia has proved to be very hard. Although a tax system reform effort is now underway, the risk of another failed attempt is high. To increase the likelihood of success, this chapter argues that a different approach is needed along the lines of the medium-term revenue strategy, or MTRS, developed by the Platform for Collaboration on Tax. It aims to help the Indonesian government formulate an ambitious but realistic plan for tax system reform for the next five years, to increase the tax-to-GDP ratio by 5 percentage points.

The reforms in the MTRS are guided by generally accepted principles of efficiency, equity, and ease of administration and compliance. A combination of tax policy and tax administration measures is identified to achieve the MTRS revenue target. Tax administration measures can potentially generate 1.5 percent of GDP in revenue over the next five years, provided that a comprehensive compliance improvement program is swiftly implemented and institutional reforms are successful. Tax policy reforms should generate another 3.5 percent of GDP, including through the introduction of new excises and through major revisions to two laws (VAT and income tax).

The MTRS aims to strengthen reform governance by means of a multiyear commitment, with an appropriate mandate and monitoring to ensure effective implementation. Wide representation of government entities is needed to ensure a whole-of-government approach, while systematic and formalized involvement of broad stakeholder groups would create country ownership. A strong expression of government commitment should be demonstrated by launching a socialization and communication campaign to develop country ownership of the strategy.

Although the MTRS developed in this chapter provides the contours of a reform strategy for the Indonesian tax system and its management, the authorities are encouraged to refine its content to take into account stakeholders’ views. This effort should lead to a government-led and country-owned strategy to provide a sustainable base for implementation over the coming five years. The ultimate reward for the Indonesian people can be large: a significant and sustainable boost in economic growth that leads to higher welfare for the Indonesian people and a major reduction in inequality. It should be an effort worth pursuing.

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Adopting an MTRS is a key recommendation for enhancing countries’ revenue mobilization efforts in the report on “Enhancing the Effectiveness of External Support in Building Tax Capacity in Developing Countries,” prepared by the Platform for Collaboration on Tax (IMF, OECD, UN, World Bank 2016), which was submitted to G20 finance ministers in July 2016 (https://www.imf.org/external/np/pp/eng/2016/072016.pdf). In its July 2017 update to the G20 report (http://documents.worldbank.org/curated/en/487521499660856455/Update-on-activities-of-the-platform-for-collaboration-on-tax), the platform further develops the MTRS approach in a Concept Note and a two-page note, annexes 2 and 3 in the July 2017 report to the G20.

The MTRS Concept Note published in the July 2017 update to the G20 explains in details how these four interdependent components should be developed.

Indonesia’s Ministry of Finance (MoF) has issued several decrees to organize the reform and its contents: MoF Decree 928 of December 2016 established the Tax Reform Team for 2017, comprising a governance structure of four bodies: (1) the Steering Team, (2) the Advisory Team, (3) the Observer Team, and (4) the Executive Team. Subsequently, MoF Decrees 360 and 361 were issued in May 2017, setting the reform agendas in the taxation and customs areas, respectively, notably for the Directorates General of Taxation and Customs and Excises (DGT and DGCE).

The document should be updated on an annual basis to monitor implementation progress and evaluate outcomes. Where needed, the government should modify the strategy.

The MTRS may also enhance the quality of the existing revenue system, independently of revenue goals. For instance, the envisaged reforms to the value-added tax law and the income tax law will aim to reduce tax distortions and enhance tax progressivity, and improvements in the institutional framework of the DGT will aim to achieve a more equitable tax system and lower compliance costs for taxpayers.

Although legal aspects of tax system reform are important, this chapter does not separately discuss them; rather, it integrates those into the discussions about tax policy and tax administration.

Eliminating exemptions may require modifications to the policymaking process. Requests for exemptions come from different sectors for different reasons. A typical request for exemption is made by claiming that a particular good is of significant strategic importance for the economy and hence should be VAT-exempt. Exemption requests are often made for agricultural products, with the aim of helping farmers receive a better price and a higher income. However, the actual beneficiaries of these exemptions are often the middlemen rather than the farmers. Another kind of request for VAT exemptions aims to favor certain domestic activities over their VAT-free international counterparts. To effectively avoid such exemption creep in the VAT, only the minister of finance (who is primarily responsible for taxation) should be able to propose certain exemptions and a cost-benefit assessment should be made to assess the implications before a measure is sent to Parliament.

Indonesia offered the tax amnesty between July 2016 and March 2017. About 970,000 taxpayers participated in the program. Total assets declared amounted to about 39 percent of GDP, about a quarter of which were foreign assets.

This increase is based on the following assumptions: (1) for the VAT initiative, the VAT compliance rate is estimated to increase gradually from 45 percent to 65 percent; (2) for the employer obligations initiative, the compliance rate is assumed to increase by about 25 percent; (3) for the audit improvement initiative, the revenue impact is based on the proposed increase in the number of auditors and improved productivity; and (4) for UHWIs and HWIs, the revenue increase assumes gains from identifying people outside the tax system, and from improved audit results from enhanced use of AEOI data and tax amnesty data.

The Indonesian government should start publishing an annual tax expenditure study to assess the revenue forgone from preferential tax arrangements that deviate from the benchmark system. The study should be integrated into the regular budget cycle to inform Parliament and other stakeholders in making well-informed decisions.

The major technical assistance and financing vehicles for Indonesia are the Australia Indonesia Partnership for Economic Governance (AIPEG), the Indonesia Public Financial Management Multi-Donor Trust Fund (PFM-MDTF), the World Bank Fiscal Reform Development Policy Loan (WBDPL), and the Australian Government Partnership Fund (GPF).

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