THE NEW INDONESIAN TAX REFORM INITIATIVES ...kokyo/sympojuly05/papers/july05...THE NEW INDONESIAN TAX REFORM INITIATIVES: MEDIATING TWO COMPETING PROPOSALS Mohamad Ikhsan Ledi Trialdi

THE NEW INDONESIAN TAX

REFORM INITIATIVES: MEDIATING

TWO COMPETING PROPOSALS

Mohamad Ikhsan

Ledi Trialdi

Syarif Syahrial

Jakarta, June 2005

TABLE OF CONTENTS

1. INTRODUCTION ...................................................................................1 1.1 Background ................................................................................................ 1.2 Objectives .........................エラー! ブックマークが定義されていません。 1.3 Methodology.....................エラー! ブックマークが定義されていません。 1.4 Proposed Tax Reform Gapsエラー! ブックマークが定義されていません。 1.5 Organization of Study......エラー! ブックマークが定義されていません。

2. REVIEW OF TAX PRINCIPLES AND GOALS.....................................4 2.1 Economic Efficiency.................................................................................4 2.2 Equity or Fairness ...................................................................................6 2.3 Tax Administration .................................................................................8 2.4 Taxation and Growth...............................................................................9

3. ESTIMATION OF TAX POTENTIALS................................................11 3.1 Individual Income Tax in Indonesia: Potential Revenue and

Its Distribution ....................................................................................11 3.2 Assessing the Potential of Corporate Income Tax................................17 3.3 Assessing the Potential of Value Added Tax (VAT) .............................18

4. GAPS ANALYSIS: PERSONAL AND CORPORATE INCOME

TAXES...................................................................................................22 4.1 Number of Tax Brackets and Top Marginal Tax Rates .......................22 4.2 Taxable Objects and Gross Income Deduction .....................................29 4.3 Tax Administration ...............................................................................32

5. GAPS ANALYSIS: VALUE-ADDED TAXES.......................................34 5.1 Taxation on Services Export .................................................................34 5.2 VAT on General Mining Goods .............................................................35 5.3 VAT Rate on Specific Goods ..................................................................36

6. SUMMARY OF RECOMMENDATIONS.............................................38

REFERENCES .........................................................................................43

Institute for Economic and Social Research Faculty of Economics University of Indonesia

New Tax Reform Initiatives In Indonesia

1. INTRODUCTION

Nowadays, the Indonesian government has faced the real challenge

to assure its fiscal sustainability in the near and longer future. The

continual decline of revenue from oil and gas can no longer be prevented. At

the same time, the government’s commitment to gradually lessen the

budget reliance on foreign debt also gives rise to the worsening government

budget funding. Moreover, those funding problems are complicated by the

considerable needs for fund to support, particularly, the ongoing

decentralization process as well as the completion of the economic recovery

process. By considering the above factors, as a result, efforts should be made

particularly to mobilize funding and increase the efficiency of expenditure.

At the revenue side, the Indonesian government has no other choice

but to effectively mobilize revenue from taxes. Taxes have a great potential

to be the main source of government funding. New tax increases can be

achieved through improved taxation administration or by expanding the tax

basis or by increasing rates. Nonetheless tax implementation up to 2003

shows that there is still the opportunity to increase national revenue

without having to increase current rates. There are a number of indicators

that illustrate this, including:

1. Tax Ratio in Indonesia is still relatively low compared to other countries.

The Indonesia non oil and natural gas tax revenue ratio for 2003 is still

as much as 11.9%, far lower than many countries with per capital

incomes lower than Indonesia, like India (11.49%), Pakistan (13.76%),

Srilanka (19.8%) and other developed countries like Philippines (11%),

Thailand (16.5%), Korea (16.07%) and Malaysia (18.5%).

2. The filing ratio, i.e. the ratio between taxpayers that actually pay taxes

and registered taxpayers who are unable to afford the three main taxes,

individual income tax, commercial income tax and added value tax. For

the three types mentioned especially for income tax, the amount of

actual taxpayers compared to those registered shows a decrease in the

last year.

3. Realization of tax revenue for all types of taxes: income tax and VAT is

still below potential. The Administration efficiency ratio (AER) – the

ratio of actual tax revenue to potential is still quite low. The 1998 IMF

1



study show that the AER for individual income tax was the lowest

compared to two other types of taxes. This illustrates that not only the

amount of taxpayers is low, but also that many taxpayers do not pay the

required amount.

4. The elasticity of tax collection for all types of tax is till greater than one,

in fact for certain taxes like added value tax, import duty, excise duty

and land and construction tax, elasticity is still greater than two. This

shows that the in actuality the tax potential is yet to be reached.

5. The distribution of tax revenue is still concentrated on too few tax

payers. For example, in 2002, 1% of registered individual tax payers

contributed to about 50% of PIT revenues while 2% of registered tax

payers contributed to more than 80% of corporate income tax revenues.

Those figures revealed a significant potential for tax revenue expansion

through tax base expansion rather than an increase in tax rates. The

high level of concentration of tax revenue also shows the high level of

tax revenue vulnerability. It also calls for a broader tax revenue basis.

All five indicators mentioned above illustrate once more that without

increasing rates and by increasing the capacity of tax administration and

expanding the tax base, tax collection/revenue will increase.

The need to reform the tax system in Indonesia is also raised from

business competitiveness perspective. With a more integrated world

economy, a tax system plays one of the main indicators for investment

climate. As a result, tax competition among countries – particularly

developing countries – is intensified in order to attract more investors –

both domestic and foreign ones – to put their portfolio in their countries,

Realizing those demands, the Indonesian government through

Ditjen Pajak (DJP) has initiated the introduction of a new stipulation

proposal for the Indonesian tax reform. At the same time, the government’s

proposal has been challenged by the KPEN team (i.e., Kadin) that also has

proposed its own version proposal. Indeed, both proposals seem to focus on

similar efforts to expand the fiscal base and improve the tax administration.

However, in implementation, their ideas are somewhat different.

Therefore, there need some studies that provide a proper recom-

mendation to fill such gaps along with estimations of tax potentials in those

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respective taxes in Indonesia. In principle, regardless of the different

proposals for the Indonesian tax reform, the new tax system should be able

to meet the main principles and goals of taxation more appropriately. Based

on this consideration, accordingly, this study attempts to evaluate the main

different ideas from both parties and eventually comes up with some

recommendations.

This paper is orginzed as followed. Following this introductory

section, Section 2 presents a literature review that covers the basic

principles and goals of taxation. This principles allow us to evaluate the on

going tax reform in Indonesia. Section 3 specifies estimation methods to

calculate tax revenue potentials in Indonesia, as well as provides its

estimation results. Respectively, tax potentials that are estimated in this

study are personal income tax, corporate income tax, and value-added tax

(or VAT). In Section 4 and 5, gaps arising from tax reform proposals of

Ditjen Pajak and the KPEN team are analyzed and evaluated. The analysis

eventually results in some recommendations that are summarized in

Section 6.

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2. REVIEW OF TAX PRINCIPLES AND GOALS1

The main purpose of taxation is to generate sufficient revenue to

finance public sector activities. Lack of sufficient revenue often results in

large budget deficits. In normal economic condition, deficits generally have

undesirable macroeconomic consequences such as crowding out private

investment and increasing inflation. Moreover, in many countries, this

condition pushes the respective government to raise funds from foreign

loans. This is certainly not an effective solution, especially in the long run,

because such kind of funds, soon or later, must be returned through

government’s own source revenue.

Despite the fact that tax revenue can be used to anticipate current

year (short-run) shortfalls, tax reforms should be undertaken to achieve

long-term objectives. Frequent tax changes may increase enforcement and

compliance costs as well as efficiency costs. Businesses usually make

production and location decisions on the basis of a particular tax structure.

Moreover, behaviors of some other taxpayers are also affected by tax

changes. They can change their behavior temporarily or even permanently

due to tax changes.

Apart from the discussion above, tax design in one country must at

least satisfy three main criteria, namely economics efficiency, tax equity or

fairness, and simple and feasible tax administration. In addition, economic

growth objective usually needs to be accompanied by tax design in certain

ways.

2.1 Economic Efficiency

In economic terms, the amount of taxes themselves is not a cost.

Taxes are simply a means of transferring resources from private to public

use. E onomic costs are incurred only when the amount of resources available for society’s use, whether for public or private purposes, is reduced by taxes (Bird, 2003).

c

Both administration and compliance costs are considered economic

costs resulted from taxation. The former arises when taxes are collected,

1 Most part of this section is taken from Bird (2003), Tanzi (2001), and Stiglitz (2000)

4



while the later is born by taxpayers (or other parties that withhold

taxpayers’ obligation) when they meet their tax obligations. Compliance

costs include the time and financial costs of complying with the tax law. In

this respect, there can be a tradeoff between administration and compliance

costs, particularly in the self-assessment tax system. When taxpayers are

required to fill the tax form themselves and provide more information,

compliance costs respectively increases, while at the same time, it makes

administration cost reduced. In other cases, however, a more sophisticated

tax administration may result in the increase of both costs.

The other economic costs arise when taxes change economic agents’

behavior in a certain way. For instance, taxes on wages may reduce

incentives to work, and failure to tax capital gains until they are realized

encourages the holding of assets (a lock-in-effect). That is why efficiency

principle is also named neutrality principle which means that good taxes

should be as neutral as possible or able to minimize their impact on

changing behavior of economic agents. In economic term, this kind of

economic costs is also called deadweight loss or distortion costs. Such costs

are real, but they are not directly visible.

Since economic inefficiency is incurred with economic costs, good tax

policy must attempt to minimize unnecessary economic costs of taxation.

Experience suggests three general rules to overcome the problem. First, tax

bases should be as broad as possible, and treating all taxable objects as

uniformly as possible.2 Second, tax rates should be set as low as possible

and imposed to taxpayers in a single rate on a broad base. Thi d, careful

attention should be given to taxes on production, because, for instance, they

affect the location of businesses and change the forms in which business is

conducted.

r

Given the general rules of tax efficiency, governments cannot follow

them exactly simply because they usually contradict with equity or fairness

arguments as explained below. For the sake of equity, usually different tax

2 Commodity taxation is one exception. As observed by Ramsey (1927), uniform commodity taxation is similar with taxes on wages and it gives rise to economic inefficiency, i.e., it discourages works since leisure is untaxed commodity. Therefore, different tax treatment is required for different types of commodity.

5



treatment and different tax rate are preferable. Therefore, there needs to be

a balance between the two tax principles.

2.2 Equity or Fairness

There are two traditional approaches have been used to define

fairness. The first approach is called ability to pay principle. According to

this principle, there are two concepts of equity, namely horizontal and

vertical equity. Individuals who are the same in all relevant aspects (i.e.,

horizontal similarity) are treated the same and pay the same tax, while

individuals who have greater ability to pay (i.e, vertical difference) should

pay more tax. In the second approach, higher tax is imposed to individuals

that receive higher benefit from public services; hence this approach is

called benefit approach. In reality, the first approach has been widely accepted.

Unfortunately, two concepts in the ability to pay principle may have limited

usefulness in tax policy debates. Horizontal equity may lose its relevance

because 1) no one, in fact, is identical in all aspects; 2) the concept focuses

only on a short time period, and it ignores many benefits that may be

received by individuals; and 3) it is difficult to determine which differences

are important and why these differences justify different tax treatment.

Vertical equity may also in practice be implemented in different ways. Both

advocates of flat and progressive tax rates, for example, can fairly justify

that their tax design reflect vertical equity. Similarly, the proponents of

consumption tax may look their idea better reflect the vertical equity

principle than the proponents of income tax. In the end, only through its

political institutions can any country really define and implement its view

of what is an acceptably fair tax system.

Apart from the fairness consideration above, in the perspective of

social and economic inequality, the fairness can also be approached from the

overall impacts in any tax changes on the distribution of income as well as

the overall equity. For instance, in a country like the Russian Federation,

indirect taxes such as a VAT and excise taxes may be considered more

equitable than income tax. The reason is because untaxed sector in this

country is the relatively large shadow economy, and consequently income

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tax is unfairly and largely borne only by government employees and

employees of formal market firms. In other case, it is also desirable to

exempt certain basic needs items from the broad-based consumption tax

simply because it can heavily affect the poor.

In addition, economists also consider the economic incidence of

taxation in determining the fairness of a tax regime. Individuals who have

the liability to pay a particular tax do not necessarily bear the whole burden

of tax. In most cases, tax burden is economically shifted to other related

parties. For instance, tax imposed on producers is shifted by producers to

consumers in the form of price increase, or employees’ wages are reduced by

certain amount due to tax imposed on employers.

Determining tax incidence requires a good understanding of how

various markets operate in an economy, particularly the ability of different

types of taxpayers to shift the cost of the tax to other economic agents. Who

actually bears taxes depends on the relative supply and demand elasticity of

consumers and suppliers and other factors.

The incidence of a corporate income tax, for example, depends on

elasticity of supply curve that is affected by such factors as (1) the openness

of the overall economy in terms of the inflows and outflows of capital

investment; (2) the extent to which capital moves between the corporate and

unincorporated sectors; and (3) the relative capital-intensity of corporations.

The tax incidence also depends on the corporate elasticity of demand for

goods produced by corporations and other businesses.

Two other considerations add to the difficulty of trying to determine

the tax burden of both individuals and groups of individuals in different

income classes. The first factor is the necessity to consider the tax incidence

of a group of taxes. Second, a complete analysis of incidence requires

consideration of all parts of government activities, i.e., both taxes and

benefits from government expenditure programs. For example, a complete

analysis of the incidence of a social security tax requires estimates of the

incidence of the tax and the retirement benefits provided under the

retirement system.

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2.3 Tax Administration

Tax policy design must take into account the administrative

dimension of taxation. The resources used in administering and complying

with taxes are real economic costs, in terms of the ability of the economy to

provide goods and services. Good tax policy requires keeping such costs as

low as possible while also achieving revenue, growth, and distributional

goals as effectively as possible. Three ingredients seem essential to effective

tax administration: (1) the political will to administer the tax system

effectively, (2) a clear strategy for achieving this goal, and (3) adequate

resources for the task. It helps, of course, if the tax system is well designed,

appropriate for the country in question, and relatively simple, but even the

best designed tax system will not be properly implemented unless these

three conditions are fulfilled.

The first task of any tax administration is to facilitate compliance. It

can be done by completing the followings: (1) finding taxpayers through the

registration process that should be as easy as possible; (2) determining tax

liabilities through an administrative procedure or by some self-assessment

procedure; (3) collecting the taxes due, which is best done through the

banking system; and (4) providing adequate taxpayer service in the form of

information, pamphlets, forms, advice agencies, payment facilities,

telephone and electronic filing, and so on, to make taxpayer compliance with

the system as easy as possible.

The second important task is to reduce tax evasion. Tax authorities

require estimates of the extent and nature of the potential tax base, for

example, by estimating what is sometimes called the “tax gap.” In some

countries the major tax problem may be that many taxpayers who are in the

system are substantially under-reporting their tax base. Without some

knowledge of the unreported base, and its determinants, no administration

can properly allocate its resources to improve tax collection and to ensure

all parts of society bear their fair share of the tax burden.

In addition to exploring the nature of the tax gap and undertaking

the often difficult tasks involved in extending the reach of the tax system

into the informal economy to the extent feasible, close attention must also

be paid to the simple task of ensuring that those who are in the system file

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on time and pay the amounts due. Adequate interest charges must be

imposed on late payments to ensure that non-payment of taxes does not

become a cheap source of finance. Similarly, an adequate penalty structure

is needed.

A third major task is keeping the tax administration honest. Even a

sound tax structure and sound expenditure policy can be vitiated by a

capricious and corrupt tax administration. Tax officials must be adequately

compensated, so that they do not need to steal to live. They should be

professionally trained, promoted on the basis of merit, and judged by their

adherence to the strictest standards of legality and morality. Tax officials

should have relatively little direct contact with taxpayers and even less

discretion in deciding how to treat them.

2.4 Taxation and Growth

There is no instant tax strategy to encourage economic growth. The

relationship between taxes and growth is complex. Many countries have

sought to improve their economy by introducing a variety of tax incentives

for investment, for savings, for exports, for employment, for regional

development, and so forth. Often, such incentives are redundant and

ineffective, giving up revenue and complicating the fiscal system without

achieving their stated objectives.

Despite the undesirable facts above, a so-called “pro-growth” tax

system may have several characteristics. First, there would be little or no

taxation of profits, to avoid discouraging entrepreneurship and risk-taking.

Taxing profits reduces the return from entrepreneurship and risk-taking.

Most countries, however, do tax profits, and properly so – for example, to

prevent people from placing assets in a corporation to avoid personal income

taxes and to obtain a share for the host country of profits earned by foreign

investors. Nonetheless, high taxes on profits are unlikely to form part of a

growth-oriented tax strategy. Instead, at most a reasonably low and stable

broad-based profits tax seems called for.

A purely growth-oriented tax strategy would also likely tax

consumption more than income. The difference between consumption and

income is saving, and from a strict growth perspective, more saving is better

9



than less. So if domestic savings are essential to financing domestic

investment, there is a “growth” argument for taxing income from savings

more lightly.

Even in the most growth-oriented tax system, however, taxes should

kept be as low as possible on the poorest people simply because they must

consume to be productive. Equity (in the sense of not taxing the poor) and

growth (in the sense of enhancing the productivity of the labor force) are

thus quite compatible objectives. A “good” VAT in such a system, for

example, might exempt certain specific items that constituted a significant

fraction of the consumption of poor people.

Finally, a growth-oriented tax system in developing countries may

seek to increase the cost of operating in the non-monetized traditional sector

(through tax or other measures) to encourage movement into the monetary

(modern) sector. Imposing higher taxes on traditional agriculture may be

difficult politically and administratively, and it may not necessarily be

equitable, but it is likely conducive to growth by shifting resources away

from the traditional agriculture sector.

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3. ESTIMATION OF TAX POTENTIALS

As illustrated in Table 3.1, our best estimation for tax potential

revenue expansion for the next 2-3 year would be 2.1 % of GDP where PIT

and CIT contributed more than half of that expansion. This estimate is

quite conservative despite some tax incentives proposed by the Government

by increasing minimum tax allowances and a reduction in corporate income

tax rate.

Should this current tax reform initiative implemented, tax revenues

collective could be further expanded. We expect within the next five year,

total non oil central government tax minus property tax – which be

proposed shifted as local tax – would further expanded to 12.2% to GDP

compared to 8,6% in 2003.

Table 3.1 An Assessment of Tax Revenue Expansion (% of GDP)

3.1 Individual Income Tax in Indonesia: Potential Revenue and Its

Distribution 3

The administration system of the individual and corporate income tax

in Indonesia has great potential as an additional revenue source in the future

through the improvement of the design and administration as influenced by

economic growth. In 2003 the non oil and gas tax contribution reached

40.4 % for the total central government tax revenue, with approximately two

thirds amounting from individual income tax. Income tax also makes up the

only developing component of the national taxation system – including rapid

3 This section mainly derived from Mark (2003).

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growth and higher average tax rates for families with middle to high incomes

compared to families with middle to low income levels.

In this discussion, income tax is distinguished from other taxes based

on the most general commodities applied in Indonesia like added value tax,

excise duty and customs taxes.4 This assessment focuses on the income

potential and the allocation of tax in the individual income tax system in

Indonesia. This assessment refers to the calculation of tax payer incomes

from tens of thousands of families from the 2002 national economic and social

census (Susesnas).

The analysis framework developed in this assessment is an initial

step carried out though examination of the impact of income from

improvements of the administration and design changes to the individual

income tax management system. For instance, we can determine the impact

of income tax on farmers and the impact of changing the tax free income

structure or the growth of taxes. This assessment also provides further

information on how the income tax burden is spread across families through

income distribution.

Findings Table 3.2 shows a number of general characteristics of the tax payer

population in Indonesia based on an analysis of the census sample data. A

sample of 52.6 million families revealed 63.1 million tax payers. This analysis

tends to minimize the total amount of possible tax payers in a family, as

income from non-civil servant census data is reported as one unit for a family.

It is highly probable that a number of family members in a family have

individual non-civil servant incomes, meaning they themselves are tax

payers in accordance with tax regulations in Indonesia.

In addition, 69% of families have income from farming sources and

36.4% have income from non-farming sources. Approximately 33.7 % of

families receive tax free incomes.

4 Luxury goods tax has been supported; however it has not reached the growth levels achieved by income tax in the middle to high level. For example, luxury taxes on items like soft drinks, various types of shoes and electronic goods like mobile telephones have increased.

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Table 3.2 Characteristics of Households in Indonesia in the 2003 SUSENAS

Total amount of households (million)

Amount of tax payers (million)

Percentage of households with income from farming

Percentage of households with income from non-farming

Percentage of households that can submit a claim for

reduction

Percentage of tax free households (zero income tax)

52.6

63.1

69.0

36.4

6.3

33.7

Aggregate Income Potential Table 3.3 shows a number of important aggregate assumptions

resulting from the analysis.5 The total family income calculated reached Rp.

878.7 trillion.6 These findings should be compared to the official government

estimation in the form of GDP, national incomes, and family consumption in

2002 that also displayed the same table. The Susesnas sample clearly

reported the amount of family income below the actual amount; however it is

not yet known how great the difference is. 7 Perhaps the reason is the

principle that families report an amount of income to survey officials that is

below the actual amount. Because families also tend to report their income

below the actual value to tax officials, this bias is more accurate than the

official government calculated tax potential.

From the estimated Rp. 878.7 trillion total family incomes,

approximately Rp. 876.6 trillion are included in income tax article 21 and 25

and only Rp. 2.1 trillion is included in article 23 (mainly in interest, dividends

and royalties).

5 The source of the official introductory hypothesis is in the form of GDP and related findings based on Bank Indonesia, Indonesian Financial Economy, Jakarta, March 2003 Table IX.3. Source of official taxable income received from Ministry of Finance, Financial Statements and APBN 2003 program, Jakarta Appendix 1. 6 This funding is taxable income. Various families that have lost their businesses have negative income for the related year. However tax regulations resolve families in this case and take responsibility for loses to collect business profits in the next five years. If these losses are increased, then the taxable aggregate income findings will decrease to Rp. 862.7 trillion. 7 National income is different from family income in principle because the proportion of national income cannot flow to families.

13



The payment of individual income tax of Rp. 114.3 trillion was

calculated from a sample under the assumption explained in the last

paragraph. From this amount, Rp 113.9 trillion is covered in income tax

article 21 and 25, while Rp. 0.4 trillion is discussed in article 23.

The income estimate above can be compared to the income from non

oil and gas tax shown in Table 2. Included in the official government data is

tax payment article 25 for final individual income tax, and individual

income tax for assets in article 23.

Total income from individual income tax is Rp. 49.1 trillion, meaning

only 43% of the potential income from individual income tax that

was estimated from the survey results.

If non-oil and gas income from companies is included, the total

income reaches 78.7 trillion, or approximately 69% of the potential

tax revenue from individual income tax estimated from the survey

results data.

Table 3.3 Total Estimated Aggregate Results from the 2002 Susesnas

Compared to the 2002 Data Publication (Trillion Rupiah)

Total household income Household income covered in article 21 and 25 Household income covered in article 23 Comparison of Realization Gross Domestic Product National Income Household consumption Total Individual income tax payments Covered in article 21 and 25 Covered in 23 Comparison compared to Realization Individual income tax covered in article 21 Income tax paid at the end of the year covered in article 25 Individual Organization/corporation Individual income tax from Final Nature Individual income tax covered in article 23 Total individual tax income Total income tax payments

878.7 876.6 2.1 1 610.0 1 380.5 1 270.0 114.3 113.9 0.4 19.5 0.9 29.7 13.7 15.0 49.1 78.7

14



A number or portions of income from family business that have been

reported in the Susesnas are not doubted to be based on legitimate family

businesses. Now, all corporate/business income tax payments originate from

medium and large companies, and only a small amount from legitimate

small family businesses. This consideration requires more research, but if

this is the case then it means that actual income from individual income tax

from families is close to the official estimation of individual income tax

without adding corporate/business income tax. This issue illustrates that

the income data reported in the Susesnas is much smaller than the real

figure, and this is a serious factor that must be considered further.

On the other hand, the variation of types of incomes reports in the

Susenas is in reality very difficult to apply to tax, because there are

informal regulations to determine the substance of transactions in the

Indonesian economy. This report will discuss this problem later, as an

important topic for the analysis of the results of the survey for the future.

Finally, we need to record that there is one area where a clear

deviation in the estimated potential income based on the survey results

occurs, namely in income tax on assets in accordance with article 23. The

amount of payments taken from the survey data only amount to Rp. 0.4

trillion, whereas the actual amount of income in 2003 reached Rp. 15.0

trillion. This provides the impression that reported income from assets is

smaller than that recorded in the survey results.

Alternative Scenario

Finally as a simplification from the sensitivity analysis, table 3

compares two alternative scenarios with the following characteristics:

Firstly, input from farming enterprise is removed from family

income, due to the difficulty of determining tax from this type of

income.

Secondly, only civil servant income (salary and pension) is included

in family income, because this type of income is the easiest to

determine.

The removal of income from farming reduces the aggregate income

estimation by 0.17% to Rp. 785.2 trillion. Considering farming, forestry,

15



fishery and animal husbandry contributes 17.5% of the 2003 GDP. Two

explanations regarding this issue can be presented. Firstly, that this type

of income is reported relatively smaller than the facts in the Susenas

sample, in line with the opinion that farming income is difficult to

determine as taxable. The other explanation maintains that the production

in the farming sector may involve businesses that are much larger than

small scale family business.

In another case, the removal of income from farming reduces income

tax payments by 1.7% to become Rp. 112.3 trillion. A simple explanation, in

line with the empirical evidence is that families involved in farming are

those families in the middle to low income category. Most of their income is

tax free and they tend to be considered low value tax payers.

Entering merely the income of civil servants reduces the incomes as

much as 35.5% compared to the standard, becoming Rp 568.1 trillion.

However, the revenue potential only reduces by approximately 11.4% to

become Rp. 101.3 trillion.

Table 3.4 Alternative Scenario for Income Tax

Absolute (Trillion Rp)

Relative (%)

Total Households Income Based on all types of income With removal of income from farming Only including civil servant salaries Total Individual Income Tax Payments Based on all types of incomes With removal; of farming income Only including income from civil servants Percentage of tax free Household Income Tax Payments Based on all types of incomes With removal; of farming income Only including income from civil servants

878.7 785.2 568.1

114.3 112.3 101.3

33.7 48.1 68.1

100.0 89.3 64.6

100.0 98.3 88.6

100.0 146.2 202.7

Conclusion

Various findings resulting from this assessment include:

1. Total family income calculated reached Rp. 878.7 trillion, where

approximately Rp 876.6 trillion included in income tax article 21 and 25

16



and Rp. 2.1 trillion included in income tax article 23 (mainly interest,

dividends, and royalties)

2. From the total income above, tax revenue should reach of Rp. 114.3

trillion, while in reality only Rp. 49.1 trillion was obtained. This means

that only 43% of the total estimated tax collection was achieved.

3. If non oil and gas income tax from business is included, the total income

reached 78.7 trillion, or about 69% of the potential tax revenue from

individual income tax estimated from the results of the survey.

4. Differences in estimation occurs in the estimated potential income based

on the survey results, namely on income tax on assets in accordance

with article 23. The amount of payments taken from the survey data

only reached Rp. 0.4 trillion whereas the actual amount of income in

2003 reached Rp. 15.0 trillion. This gives the impression that reported

income from assets is smaller than that amount in the survey results.

5. By establishing a scenario, namely the removal of income from farming,

this is estimated to reduce the aggregate income by 0.17% to Rp. 785.2

trillion. And reduce tax payments by 1.7% to Rp. 112.3 trillion. A simple

explanation, in line with empirical evidence shows that families

involved in farming are middle to low income earners.

6. The second scenario is a calculation only including the income of civil

servants. This scenario reduced revenue by 35.5% of the standard, to Rp

568.1 trillion. However, the income potential only reduces by 11.4% to

Rp. 101.3 trillion.

3.2 Assessing the Potential of Corporate Income Tax

In assessing the corporate income tax we have utilized data from the

Social Accounting Matrices (SAM) in 2000 and the corporate tax based GDP

estimation published by the Center Bureau of Statistic (BPS) in 2003.

Some steps to asses the potential of corporate income tax are:

1. To estimate the company’s profit share of GDP. Based on SAM’s data

either before the crisis or from 2000, the profit share is relatively stable

at about 28.2-30% of GDP. This profit share is presumed constant and

produces the company’s total profit of Rp. 603.14 trillion in 2003.

17



2. The amount of corporate income tax depends on profit distribution. In

estimating such profit sharing we utilized the results of the BPS survey

which is grouped by the company’s scale.

3. From the amount of percentage of GDP share grouped by company scale,

the produced company profit is based on the their scale group (See

Table.1). This profit then is multiplied by the current tax rate and

produces the amount of tax that should be paid by the company.

4. The average CIT potential per each company is then multiplied by the

number of companies and results in a total CIT potential of about

Rp.130.26 trillion or 6.24% of GDP.

Table 3.5 Estimating Corporate Income Tax Revenue Potential, 2000-2003

Corporate Share in VA i Total Number Profit/ CIT Size GDP Profit Company Company Potential

(percent) (Rp Tr) (Rp Tr) (million) (Rp mill) (Rp Tr) (1) (2) (3) (4) (5) (6) (7)

2000 Small 0.40 558.17 161.31 38.67 4.17 16.13Medium 0.17 240.24 69.43 0.05 1,271.60 19.87Large 0.42 581.49 168.05 0.00 85,175.15 50.38Total 1,379.90 398.79 38.73 86,450.92 86.39In percentage to GDP 6.26

2003

Small 0.41 857.97 247.95 42.33 5.86 24.80Medium 0.16 325.78 94.15 0.06 1,518.90 27.16Large 0.43 903.25 261.04 0.00 116,379.98 78.27Total 2,087.00 603.14 42.39 117,904.74 130.23In percentage to GDP 6.24Memo items

Profit Ratio to GDP 0.289

3.3 Assessing the Potential of Value Added Tax (VAT)

Value Added Tax (VAT) in Indonesia is in accordance with the

general international regulations implement in various countries, including:

1. VAT on the expenditure of capital goods postponed on tax

obligations. Meaning that VAT is essentially a consumption tax.

18



Investment expenditure tax slows the growth of the economy and

development.

2. Export tax is zero, while imports attract compulsory tax; this is

based on the destination principle from VAT regulations. This

approach is consistent with the implementation in other countries.

3. To simplify and clarify administration, a VAT level system is

implemented. This factor is to avoid mistakes in the classification

of goods and services.

4. Retail transition is also subject to VAT.

However, while other countries exempt various goods and services,

Indonesia exempts more goods and major services.

In estimation the VAT potential revenues, we follow Mark (2005).

As in other countries, the Indonesian VAT system, export tax is exempted,

but imports are taxable. Certainly various imported products are tax-

exempt, and others are utilized as input products for companies where these

products are exempt from tax.

There are types of goods and services within the economy. For goods

to-i, the condition of a balanced market is:

(1) ∑=

++=+n

jiijijii XCQaMQ

1

If the company produces goods i that are subject VAT, then this is

calculated:

(2) ∑=

−−=n

jijijjiiiiii QaptXQptT

1

)( δ

With imports the VAT revenue is increased with import tax:

(3) ∑=

=n

iiiiM MptT

1

Total VAT revenue is the amount between the equation (2) and (3), which

can be written as:

(4) ( )∑ ∑∑= ==

+⎟⎟⎠

⎞⎜⎜⎝

⎛−−=

n

i

n

iiii

n

jijijjiiiii MptQaptXQptT

1 11

δ

19



With the definition provided in the equation (1) then the equation (4)

changes to become:

(5) ∑ ∑ ∑= = =

−+=n

i

n

i

h

jjijjiiiii QaptCptT

1 1 1

)1( δ

Equation (5) shows that if there are goods that are tax free (ti=di=0), then the VAT revenue is from tax paid on the purchasing input. While if the

goods mentioned are taxable, then the VAT revenue can be calculated from

household consumption tax for the goods mentioned.

2) Calculation Scenarios

When calculating the potential VAT revenue in 2002 we use six

scenarios: Scenario 1. Tax stipulation is in accordance with regulations

implemented where the sectors are, like sectors with

codes 01, 03, 24, 25, 26, 29, 51, 54, 55, 56, 57, 61, 63, and

64 are not subject to VAT.

Scenario 2. If scenario 1 is altered to establish VAT on electricity, gas

and drinking water sectors (code 51).

Scenario 3. If scenario 1 is changed to establish VAT on coal and

metal mining (code 24), along with Mining and other

excavations.

Scenario 4. Consolidation of scenario 2 and 3.

Scenario 5. Scenario 4 with the addition of the imposition of VAT on

oil, gas and geothermal (code 25).

Scenario 6. If all sectors are subject to VAT

3) Simulation Results

Table 3.6 and 3.7 below show explicitly that the potential tax

revenue for 2003 increased as much as 3.6% of the GDP compared to the

potential in 2000. With the actual tax revenue the same in both years

mentioned, this illustrates the decrease of efficiency of tax collection in 2003.

Table 3.6 Difference in Actual and Potential VAT Revenue, 2000

(percentage of GDP)

20



Actual Potential Ratio Scenario

(1) (2) (1)/(2)

1. 3.28 4.82 0.68

2. 3.28 4.88 0.67

3. 3.28 4.79 0.68

4. 3.28 4.82 0.68

5. 3.28 4.82 0.68

6. 3.28 5. 48 0.60

Table 3.7 Difference in Actual and Potential VAT Revenue, 2003

(percentage of GDP)

Actual Potential Ratio Scenario

(1) (2) (1)/(2)

1 3.28 4.99 0.66 2 3.28 5.05 0.65 3 3.28 4.96 0.66 4 3.28 4.99 0.66 5 3.28 4.99 0.66 6 3.28 5.69 0.58

Both tables show clearly the government stipulation of VAT laws

that exist at the present. VAT revenue can still be raised by 46.95% and

52.13% of the actual VAT revenue in 2000 and 2003 (Scenario 1). In order to

increase the revenue gained from VAT we can still endeavor to make tax

collection more effective, without having to increase VAT tariffs and impose

more taxable objects.

If the government decides to impose VAT in the electricity, gas, and

drinking water sector (scenario 2) the potential for the government to obtain

a rise in tax revenues is greater than if VAT imposed on oil, gas, and

geothermal sector. While if VAT is imposed on the coal and mineral mining

sector, along with other mining and excavation sectors (scenario 3), the

revenue potential for VAT will decrease as much as 3% from the normal

potential.

If all sectors attract VAT, the increase of tax revenue is estimated (Scenario

6) at about 67.07% and 73.47% of the actual VAT revenue from 2000 and

21



2003. In other words if all sectors attract VAT this will increase the

potential revenue by 13.6% in 2000 and 14.03% in 2003 from the normal

revenue potential. Although a significant increase, it will probably bring

about pros and cons in general society.

4. REVIEW ON TWO COMPETING TAX PROPOSALS ON

INCOME TAX BILL.

In this section we will review those two competing proposals from the GOI

and the Indonesian Business Communities (hereafter KPEN). We analyze

those proposal according to the subject of interest. We begin our analysis on

the discussion over rates and followed by the discussion on tax objects.

4.1 Number of Tax Brackets and Top Marginal Tax Rates

Decisions regarding number of tax brackets, particularly in personal

income tax, aim at enhancing tax equity as well as raising more revenue. It

is expected that more tax brackets may result in more progressivity, and

accordingly more equity. In so doing, such number of tax brackets should be

administratively feasible, competitive (compared with other countries), and

more likely to broaden the tax bases. Moreover, careful attention should

also be paid to the choice and the level of tax deduction or exemption items

that probably undercuts the progressivity and more benefits high income

people.

In Indonesia, tax deduction or exemption items are very limited,

since social security system in Indonesia is not yet well developed. There

are only common personal and dependence allowance, complemented with

an optional zakat deduction for Moslem citizens. As a result, in deciding

number of tax brackets, more concern should be devoted on such factors as

tax progressivity and tax competitiveness, tax administration, and number

of tax bases.

Table 4.1 Proposed Changes of Non Taxable Income (Rupiah)

Present Proposed Changes

Individual Tax Payer 2,880,000 12,000,000 Married Tax Payer 1,440,000 1,200,000 For Wife with Combined Income 2,880,000 12,000,000

22



For Dependents 1,440,000 1,200,000 Maximum Dependents (per family) 3 people 2 people Maximum 8,640,000 15,600,000

The first p oposal gap between Ditjen Pajak and the KPEN team is

concerning the change in number of personal income tax brackets. Ditjen

Pajak proposed the idea of reducing tax brackets from five to four tax

brackets that eliminates the lowest 5 percent bracket. In addition, as

revealed in Table 4.1 above, Ditjen Pajak also proposed changes of non

taxable income (PTKP). The prior maximum PTKP is 8.6 million rupiahs,

while the proposed maximum PTKP is double to more than 15 million

rupiahs. On the other hand, the KPEN team insisted to have five brackets

with the underlying rationale that the poor will be heavily affected by the

higher 10 percent tariff.

r

In order to evaluate both progressivity and competitiveness of

current tax system, there needs the calculation of effective rates of personal

income tax. As calculated by Ikhsan et.al. (2004), effective personal income

tax rates in Indonesia as well as their comparisons with some other

countries are depicted in Figure 4.1 below.

Figure 4.1 Comparisons of the Effective Personal Income Tax Rates to

Levels of Income in Various Countries

23



Source: Ikhsan et.al.(2004)

From the figure above, we can observe the slope of each effective

tariff line. Effective tariff line of Indonesia is relatively steeper than that of

Malaysia, Cambodia, and, to some extent, Philippines. It indicates that

Indonesian personal tax is relatively more progressive than those respective

countries. On the other hand, the figure also shows that Indonesian

personal tax is more competitive than most countries in the figure, except

for Malaysia and Cambodia.

The removal of the lowest bracket (5 percent bracket) slightly reduce

both tax progressivity and tax competitiveness of income level in the new

lowest bracket (10 percent bracket), since the maximum PTKP is now also

double. Nevertheless, overall tax progressivity, indeed, is improved without

changing efficiency or competitiveness too much. Instead now, the tax

administration is more simplified and thus most likely to increase more tax

bases as well as tax revenue. Moreover, the fear of the KPEN team that the

poor is heavily affected by the tariff increase will not materialize. The tariff

increase is sufficiently compensated with the higher maximum PTKP for

the poor. Therefore, this policy needs support to be implemented in

Indonesian tax system.

Table 4.2 Number of Tax Brackets and Top Marginal Tax Rates for both

Personal and Corporate Taxpayers

24



Source: LPEM UI and various sources, mainly from the Tax Authority website

of those respective countries

25



Apart from the discussions regarding tax brackets, Table 4.2 also

shows top marginal tax rates of both personal and corporate income taxes in

various selected countries. The proposals of Ditjen Pajak and the KPEN

team regarding these rates are slightly different (i.e., the second and the third proposal gaps). Ditjen Pajak proposed the maximum rate of 30 percent

for personal income tax, and the maximum 5 percent increase depending on

local governments’ decisions. Corporate tax rate was proposed to be a single

flat rate of 28 percent that will gradually decline to 25 percent within three

years.8 On the other hand, the KPEN team suggested the maximum rate of

30 percent for personal income tax and the single rate of 25 percent for

corporate income tax.

Decisions regarding top marginal tax rates in both kinds of taxes

should be made mainly on the basis of raising revenue, tax competitiveness

and tax harmonization concerns. Tax competitiveness is required in any

country especially to attract foreign investment and to avoid tax revenue

flight. As a consequence, the maximum tariff, either in multiple rates or

single rate system, should be set as comparable as in other countries, i.e.,

not too high and not too low. Moreover, the maximum tariff in both kinds of

income taxes should also be harmonized. In practice, too big gap between

the two top rates may provide a strong incentive for some taxpayers to shift

their tax burden to one tax that has a lower tax rate.

Therefore, in support to this analysis, again we need to know

effective rates of both top marginal tariffs in personal and corporate income

taxes that complement the information provided in Table 4.2.

From Table 4.2, we can roughly observe that the gaps between top

marginal tax rates in personal and corporate income tax vary among

countries. Five countries, namely the U.K., South Korea, Thailand,

Cambodia, and China, have relatively big gaps, while the other countries

have either no gap or narrow gaps. Furthermore, top official rates of both

personal and corporate income taxes are relatively competitive. Indonesian

official rate of personal income tax in the highest bracket is 35 percent,

which is higher than that in Malaysia, Philippines, Singapore, and

8 Except for SMEs, corporate tax tariff is set 10 percent, and the KPEN team already agreed with this proposal

26



Cambodia. On the other hand, for corporate income tax, Indonesian official

rate is only higher than that in Singapore and South Korea.

Figure 4.2 Comparison of Effective Corporate Income Tax Rates in

Indonesia and in Several Neighboring Countries

Source: Directorate General of Tax, Academic Assessment Report, 2003

Nevertheless, the above information may not show a true picture.

Different tax exemptions, tax deductions, and tax credits can diminish the

effective tax rate in each country, while compliance costs (either legal or

illegal through bribery activities) that may arise can boost up the effective

tax rate. Based on the simulation of effective income tax tariff calculations,

Indonesia is still relatively more competitive than Vietnam, China,

Thailand, and all selected developed countries for all levels of profit (see

Figure 4.2 and 4.3). However, for levels of profit above $25,000, the most

competitive is Cambodia. Indonesia is still also more competitive when

compared to the effective tariff levels in Malaysia for levels of profit up to

$115,000.

Figure 4.2 Comparison of Effective Corporation Tax Rate, FY 2004

27



Source: the Ministry of Finance, Japan

From Figures 4.1 and 4.2, effective personal income tax rate in the

top bracket is approaching 30 percent, while in corporate income tax, the

maximum rate is approaching 28 percent. This is indeed relatively ideal

composition, both in competitiveness and harmonization point of view.

However, as argued by the KPEN team, effective corporate tax rate could

even be higher with so many illegal official activities such as bribery that

should be borne by companies. This kind of problem is rarely found in

personal income tax compliance.

Even though this condition should be accommodated by the

Indonesian government, indeed, corporate tax rate cannot be set too low.

First, in the competitiveness point of view, it is clear that such problem is

not only faced by Indonesian firms, but also firms in our neighboring

countries that have similar administrative problem. Perhaps hence,

28



Indonesian tax competitiveness is not harshly violated by this problem.

Second, too low corporate tax rate certainly reduce government’s revenue.

Therefore, Ditjen Pajak’s proposal seems to be more reasonable, i.e.,

corporate tax rate is reduced slightly to 28 percent, and gradually adjusted

within three years. This study suggests that during the three years period

the government can evaluate tax competitiveness, corporate tax revenue, as

well as tax harmonization, so that the tariff adjustment can be set lower or

even higher than 28 percent. We also suggest that personal income tax rate

should also lower gradually to 30 % within 5 years.

4.2 Taxable Objects and Gross Income Deduction

Taxable objects in income tax should follow the so-called Haig-Simons concept. In this concept, a number of adjustments have to be made

to convert “cash” income into the “comprehensive” income that is believed

most accurately reflecting “ability to pay”. In the comprehensive income

definition, what is categorized as income should include not only cash

income (net of expenses required to earn the income) but also capital gains

(whether the gain is realized or simply accrued). However, no country can

adopt such concept completely. Certain adjustments should be made

especially to improve equity and provide incentives for certain activities.

Moreover, accrued capital gains are usually hardly taxed.

Examples of certain adjustment of taxable income are medical

expenses and casualty losses. Since such expenses can be very large amount,

they certainly reduce ability to pay of taxpayers. Therefore, as shown in

Appendix 1, in most countries tax system, these items are deductibility from

gross income. Nevertheless, there should be some limit for the amount of

deduction. In the U.S. for instance, medical expense is deductible in excess

of 7.5 percent of taxpayers’ gross income. If such expense is lower than the

percentage amount, then no deduction is applied. Similar treatment is also

applied for casualty losses of corporate tax payers.

Governments usually also have to provide incentive for persons or

firms to give charitable or social contributions. In this respects,

governments again need to adjust their comprehensive income-based

principle.

29



1) Addition of grants, dividends, and bond interests received by mutual fund

as taxable objects

The first objection from the KPEN team is regarding the addition of

grants, dividends, and bond interests received by mutual fund as taxable

objects. As mentioned previously, in principle, all kind of income should be

taxed, including grants, dividends, and interests, but with some necessary

adjustments. For grants and dividends, proposed treatments from the

KPEN team need to be supported. Grants or aids should be exempted from

taxpayers’ taxable income. Moreover, on the side of the aids providers, such

contributions should also be excluded from their taxable income. This

treatment is required to provide incentives for individuals and firms to

make social and charitable contributions, as well as to remove tax burden

from the aids recipients.

The KPEN team proposal regarding the treatment of dividend is to

exempt dividend from personal taxable income if it is already taxed in

corporate levels. This proposal obviously reflects the fairness principle,

because in essence, corporations are a group of people, thus taxing dividend

from both corporations and individuals create a double taxation problem.

Therefore, the solution is either to put the dividend tax burden to

corporations or individuals or to give relatively low rate for dividend tax.

As for exemption of interests received by mutual funds, it cannot be

satisfied for some reasons. First, such kind of privilege cannot guarantee

the persistence of more competitive mutual funds in Indonesia, and even

provides disincentive for similar institutions like insurance funds or

provident funds, which is certainly unfair. Second, economic inefficiency will

arise following the misallocation of resources to the inefficient mutual funds.

Finally, in some extent, capital (or interest) taxation along with casualty

loss deduction, indeed, can encourage risk taking investment even by small

investors that is better for the economy.

2) Profit from changes in foreign exchange rates

Government, according to the KPEN team, should give taxpayers

the authority to decide whether to follow a bookkeeping system or a

realization payment system for calculating profit from changes in foreign

30



exchange rates. Decisions regarding what kind of procedure must be taken

in the above problem should be based on the simplicity (or administration

feasibility) principle. Certainly, the easier procedure should also result in

the more effective result.

In this point of view, therefore, the government proposal does more

make sense. Potential fraud in calculating profit using a bookkeeping

system can be minimized by a realization payment system. With only one

approach used in calculating such profits, the tax authority task to check

the validity of firm’s calculation is relatively easier.

3) Reduction of gross income

The other disagreement between the government team and the

KPEN team is about tax treatment on taxpayer that buys luxury goods. The

rejection of the KPEN team for similar treatment given to such taxpayers

simply has no strong ground. In most tax system, there is a separation

between income and consumption taxes, even though both taxes are

theoretically similar. Consumption taxes hence are used to fill the potential

revenue gap left by income tax, and in particular, the specific tax on luxury

goods is intended to tax the rich (that is obviously rich) more heavily. In the

situation where this separation still exists, we cannot let anybody that pays

a certain consumption tax to be compensated with the low obligation in

other tax. Therefore, there should be no special treatment for taxpayers that

buy luxury goods.

The idea of including promotional and entertainment cost as the

deduction items for firm’s gross income is actually similar with the

stipulation in the Japanese tax system. In the Japanese tax system, 90

percent of entertainment expense has been exempted since January 1998.

Similar with other firm’s expenses, both promotional and entertainment

expenses can reduce the ability to pay of the firm. Therefore, such expenses

should probably be excluded from firm’s gross income.

Nevertheless, these kinds of business expenses are relatively hard to

define. People or firms can cheat by treating their own expenses to be such

business expenses. In Japan, probably the rule that defines these expenses

is already clear, and their people are also more honest as they live in a

31



better system. In Indonesia, the potential for cheating can be much bigger,

and there is no study yet concerning how big the expenses are. Therefore,

for these kinds of expenses, at most the government can give the deduction

allowances but in certain extent like medical expense in the U.S.

Lastly, the proposal of the KPEN team to include loss from changes

in foreign exchange rates in deduction items of gross income should be

accepted. In fairness principle, there is a so-called symmetry principle. If

individuals or firms are taxed on what they earned, thus what they lose

should be deducted from their taxable income. Similarly, when individuals

or firms earn capital gain from the fluctuation of exchange rates, they are

taxed. Otherwise if they earn capital loss, the loss should be deducted from

their taxable income.

4.3 Tax Administration

Some major disagreements in our gap matrix regarding tax

administration are related to at least three things, namely tax

discrimination between tax payers who have tax filing number (TFN or

NPWP) and who have not, different time limit for delivery of the tax

notification form (SPT) between individual and company taxpayers, and

administrative sanction on overdue SPT. Considerations used in

determining the appropriate acts for these disagreements mainly are

fairness and administration feasibility principle along with effectiveness

concern.

Different tax treatment between taxpayers with TFN and without

TFN is certainly imprecise, as complained by the KPEN team, if the

socialization of TFN – including its function, its benefit, and its obligation –

is not sufficiently conducted. In various countries being observed in this

study, there is also no such tax discrimination between TFN and non-TFN

taxpayers. First, it is because tax payment is only conducted by a registered

(or TFN) taxpayer. Second, a person who does not have a tax filing number

usually gets a difficulty in accessing and receiving public services. Therefore,

such discrimination treatment should be abandoned until the socialization

is sufficiently conducted.

32



There is a difference in time limit for delivery of tax file (or SPT)

between individual and company taxpayers in all our selected countries.

Company taxpayers usually are provided a longer limit for delivering. In the

case of Japan, company taxpayers have one month longer for delivering SPT

than individual taxpayers. It probably more makes sense as we knew the

complexity in corporate tax file returns. Moreover, the time limit must be

set in order to have a tidy tax administration.

Regarding the administrative sanction on overdue SPT, we could

also find a similar rule in other countries. However, it was considered less

relevant to compare the amount of the penalties or the different penalties

for different fouls amongst countries. Therefore, the appropriate amount of

penalties should be set with full concerns on fairness and effectiveness of

the penalties.

33



5. THE PROPOSALS ON VALUE-ADDED TAXES BILL

5.1 Taxation on Services Export

The KPEN team has proposed that services export should be taxed on zero

rate VAT. The rationale of this idea is to meet the neutrality principle, as well as to

support services export and avoid economic distortion. VAT should be based on

consumption in one country, so that service export should be charged at zero percent.

There are some notes from the KPEN team about her proposal:

- The implementation of taxation on export and import of taxable services should

be consistent.

- The use of taxable service inside the customs area should be prioritized

- Neutrality concept can be employed to avoid distortion and unfair competition

by using taxable services from outside the customs area.

The first point of the KPEN team idea is related to the place of taxation, in

which tax on consumption of goods and services should be charged within the

jurisdiction where the consumption takes place. This idea can be clear for goods but,

for services, it is often less clear. In international trade there is a widely accepted

principle that goods should be effectively zero-rated at export and taxed in the

country of import (destination principle). This ensures that, at least in principle, the

goods are taxed where consumed. However, the principles are less clear cut for many

services and intangible goods, certainly because of their intangible nature. Some

countries apply the jurisdiction of delivery place for services so the export of service is

taxed and the import is not.

The taxing rights that each country asserts depend on whether the country

uses a system for place of taxation that is origin-based, destination-based or the

mixture of the two. Under an “origin” model services and intangibles are taxed in the

country where the supplier is based unless they are specifically defined as being

taxed somewhere else. Other countries use a “destination” model under which

services and intangibles are taxed where the customer is based. The global situation

is therefore that some countries are taxing on an origin basis (albeit with many

exceptions), while other tax on a destination basis (also with exceptions). Both

approaches, with their exceptions, appear to have the objective of taxing services and

intangibles at place of consumption.

34



Based on this reasoning, applying the taxation on taxable service from import

and export (as proposed by the KPEN team) is not fully correct. The decision whether

or not to charge a tax for export or import on services has to consider the method

applied by the partner countries. This consideration plays the main role to avoid the

double taxation and unintentional non-taxation. For example, if one country has a

policy on taxable services which is based on “origin model” and Indonesia charges a

tax both for import and export services, then it causes a double taxation problem. On

contrary, if one country has a policy on taxable services which is based on

“destination model” and Indonesia does not charge a tax both for import and export

services, unintentional non-taxation problem persists.

As a conclusion, it can be argued that the proposal of the KPEN team on the

export services is not appropriate. There is a way to hinder the neutrality problem by

coordination with other countries for example by treaty agreement between countries.

Therefore, it keeps the decision to tax or not is correct to avoid the two above

problems. A policy that either charge or does not charge a tax both for export and

import services is not appropriate and, furthermore, creates a potential distortion.

5.2 VAT on General Mining Goods

In Indonesia, the paid VAT on gaining goods and services can be credited to

sales VAT, as long as the related goods are taxable goods. The problem arises for

mining goods which is, by law about VAT, classified as non taxable goods. Based on

Article 4A Law No 18/2000, goods classified as non taxable goods include mining

goods get directly from their sources, for example: crude oil, natural gas, sands, iron,

tin and gold and so forth (the Government Regulation No 144/2000). It implies that

VAT on buying of goods and services can not be credited, so it can be an additional

cost for mining industry. On the other hand, mining industry supposes that to

produce mining goods it requires some process so has to be classified as taxable goods.

It compares to log wood industry, which is only through cutting process, classified as

taxable goods.

The KPEN team argues that mining goods should be VAT taxable goods

because this additional cost makes the mining industry in Indonesia is not attractive

35



for investors. The reason from the government that most of all mining output in

Indonesia is exported is difficult to understand from the mining business view.

Investment activities in mining sector in previous years had indicated the

negative trend due to the bad business climate. Therefore, this idea related to VAT

probably can be an incentive for mining investment. However, this policy also can be

viewed as a promotion to increase domestic value added from mining industry. As we

know, from Input Output Table, it shows that mining industry in Indonesia has a low

forward linkage. It is expected that mining industry starts thinking to increase its

value added and not only exports their raw output abroad. By increasing value added

domestically, automatically it should be classified as taxable goods.

Furthermore, the changing classification (similar to the KPEN team’s idea)

may probably reduce the government revenue. This factor has to be addressed

because Indonesian State Budget has a strong dependence on taxes revenues.

According to the taxation principle, the effort of government to increase taxes

revenues should not distort the economy as a whole.

As a conclusion, we can say that the idea of the KPEN team is reasonable

especially for coal mining. For other mining goods, however, government needs to

decide the percentage of cut off from mining industry or how much share of exported

production to be classified as taxable goods. At the same time, the percentage of local

content used in mining industry to promote other domestic economic activities has to

be decided as well. It is conducted to cancel off the potential reduction on taxes

revenues from mining sector.

5.3 VAT Rate on Specific Goods

The KPEN team has proposed the idea to charge a special VAT rate on

specific goods. Those specific goods, for example, are food, livestock, fishery,

agricultural goods and other goods supposed to be national priority. Team agrees

with this idea. The decreasing rate may probably not significantly reduce government

revenues because there is also bigger potential revenue caused by the expansion of

other economic activities.

There are some notes from team about this proposal as follows:

36



- This specific rate has to guarantee the fairness principle. It means that it

should be employed for poor people or small medium enterprises. It is also in

line with the pro poor taxation policy

- Related to the former note, it should be determined about who is appropriate to

get this facility.

- This specific rate should promote the other economic activities

- It is needed the strong administration capability to handle this multiple rate

on VAT.

In addition to confirm the above ideas, every country selected in this study

seems also to give special treatments not only for its small and medium enterprises

(SME’s), but also for certain type of industry and sector. In the U.K., Thailand, and

Malaysia, certain activities were exempted from consumption tax (either VAT or

sales tax) while some other activities were liable to consumption tax at the rate of

zero percent. Moreover, those three countries generally provide tax exemption or zero

percent tariff to the followings: foods, education related sector, export goods, and

drugs or health services. The U.S. also has similar treatment for foods and drugs. As

for Japan, we could not find such types of treatments. Japan only gave a different

consumption tax tariff for different type of business, such as wholesaler and retailer.

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6.SUMMARY OF RECOMMENDATIONS

Two proposals from the government and business communities have been elaborated in the previous sections. We find that in

many cases both have the same objectives but at the same time they tend to bias toward their own interests. The government

proposal eventhough is aiming at to improve country’s competitiveness but tends tu put more weight on the revenues objective.

While on the other hand the business communities proposal goes with a more weight to tax competitiveness than revenues

consideration.

Our recommendations are derived from tax priciples – which are elaborated in the section two – try to fill the gap between

those two extreems. The summary of recommendations both from the GOI and the KPEN and our recommendation is

presented in Table 6.1

Table 6.1 Income Tax: Gaps and Recommendations

Issues Government KPEN Team recommendation

1. Personal income tax bracket

Four (4) brackets, the lowest taxable income is Rp 50 million with 10% tax rate

Five (5) brackets (keep old regulation). Lower income tax payers should not be effected by higher tax tariff

Our (4) brackets

2. Top marginal tax rate of PPh

Old stipulation Reduced from 35% to 30%

Reduced gradually to 30%.

3. Tax tariff for national corporate

Single tariff, 28%, and gradually reduced to

Single tariff, 25% Single tariff, 28%, and gradually adjusted within

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taxable income and perma- nent establishment

25% within 3 years 3 years either becomes higher or lower

Addition: Grants and dividends as taxable objects

Motion nullified - Grants are exempted - Dividends are taxed

once either in individual or corporate level

Addition: Bonds interest received or obtained by mutual fund for the first 5 years

Motion nullified Interest bonds are taxed

4. Taxable objects

Profits from changes in foreign exchange rates calculated based on realization

It’s best that taxpayers are given options to choose to follow a bookkeeping system or a realization payment system

Agree with government

5. Reduction of gross income to determine the amount of taxable income

Old regulation - Adding entertainment costs, promotional costs, and firms’ social contribution as objects that reduce gross income

- Loss from changes in foreign exchange rates reduces taxable income

- Entertainment and promotional costs are deductible from taxable income at a certain limit

- Loss from changes in foreign exchange rate: agree with the KPEN team.

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Tax payers that buy luxury goods have to pay tax set by PP

Deleted. Not fair and not appropriate with income tax principles


6. Tax Cut Non TFN Taxpayer pays twice more than TFN Taxpayer

The different tariff cut application for Article 22 (3) is imprecise

Agree with the KPEN team, until government sufficiently socialized the Tax Filing Number to its citizen.

7. Yearly tax notification form (SPT)

The limit for delivery of SPT is different for individual tax payers and company tax payers

Disagree, must not reduce people’s right


8. Administrative sanctions on overdue SPT

• Rp 500,000 for SPT of VAT

• Rp 50,000 for other SPT

• Rp 1,000,000 for yearly SPT

• Rp 250,000,000 for yearly individual income tax

Disagree, inappropriate. Persist with old stipulation

Indifference

Table 6.2 Value-Added Tax: Proposal Gaps

1. VAT Tariff Old stipulation (10%)

General tariff of 10% Special tariff of 3% (or 2.5% - 5%)

Agree with the KPEN team

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2. VAT Tariff on taxable

export goods 0% 0% tariff maintained

for: a) Taxable export

goods b) Grouped areas or

other specific areas c) Delivery of non-

tangible taxable goods from inside to outside the customs area

d) Delivery of services from inside the customs office area to outside the customs office area


General mining sector is non taxable object

It should become taxable object

Agree with the KPEN team

3. Non taxable objects:

general mining output and insurance services

Insurance services are taxable object

Motion nullified Agree with government

Currently, there is another independent team led by former minister finance Bambang Soebijanto consists of both parties tries

to mediate and fill these two proposals. This team is given mandate from Ministry of Finance to finish the final draft of new

41



tax package at the mid of August before being submitted to the Parliament. Up to now, we are optimistic that new draft will

be submitted to the Parliament on the target and by 2006 will be implemented.9

9 In fact some elements of new proposals have been implemented in 2005. For example, the non taxable income scheme has been

changed to a new proposal. The objective to implement that in advance in responding to give an incentive the Indonesia families as

part fuel price adjustment compensation scheme as well as a smoothing revenue shortfall possibility caused by a lower tax rate.

42



REFERENCES (To be completed)

Bird, Richard M. and Eric M. Zolt (2003), “Introduction to Tax Policy Design and Development”, draft prepared for a course on Practical Issues of Tax Policy in Developing Countries, World Bank.

IMF Institute (1991), Macroeconomic Adjustment: Policy Instruments and Issues, IMF.

Indonesia-Japan Economic Cooperation Working Team (2004), “Strengthen-ing Tax Policy through Tax Reform”, prepared for the program for economic policy support for the Republic of Indonesia (Unpublished).

Mark, Stephen (2004), Mark, Stephen (2005) Leuthold, Jane H. (2001), “Taxation in Developing Economies”, Draft

(Unpublished). Slemrod, Joel (1990), “Optimal Taxation and Optimal Tax Systems”, the

Journal of Economic Perspectives, Vol. 4, No.1, p.157-178 Slemrod, Joel and Shlomo Yitzhaki (2000), “Tax Avoidance, Evasion, and

Administration”, NBER Working Paper No. 7473. Stiglitz, Joseph (2002), Economics of the Public Sector, 3rd ed. New York:

W.W. Norton & Company. Tanzi, Vito and Howell Zee (2001), “Tax Policy for Developing Countries”.

IMF Working Paper 00/35. Tax Bureau (Ministry of Finance), Japan (1998), “Taxation in Japan The Ministry of Finance, Japan (2004), “Let’s Talk About Taxes”. Japan www.inlandrevenue.gov.uk www.irs.ustreas.gov www.nta.go.jp www.mof.go.jp

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Appendix 1Taxable Income for both Personal and Corporate Taxes

and Some Required Adjustments

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Appendix 2 Tax Deductions, Tax Exemptions, and Tax Credits

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46



47



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Appendix 3 Special Consumption Taxes Tariff

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Appendix 4 Tax Administration

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