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Don't stop with VAT

Jakarta Post Editorial - March 18, 2024

Jakarta – Indonesians will have to pay more for most goods they buy in 2025 once the government increases value-added tax (VAT) to 12 percent in 2025, from the current 11 percent.

The planned new rate will apply to the clothes you buy, the restaurants you choose to eat at, the video games you will play or the Netflix subscription you decide to pay out for, all in 2025.

There is not much we can do at this point, as it is part of the gradual increase that the government planned in the 2021 Tax Harmonization Law, which allows the government to hike VAT up to 15 percent. At the time of its deliberation, the country's rate stood at 10 percent, and that had applied for many years.

The hike comes at the right time given that the upcoming administration will require a larger revenue pool to fund a myriad of its campaign promises, and a rise in VAT would be among the easiest ways to increase the fiscal space, reducing the need to take up more debt.

Rising VAT also seems to be a logical choice, as Indonesia has a moderate rate compared with the average Organization for Economic Co-operation and Development (OECD) member at 19 percent or BRICS member at 17 percent, regardless of the purchasing power gap between Indonesia and countries in the two groups.

VAT is also deemed relatively hard to evade, as it applies to most goods and services that people consume, including those by high-income earners.

However, relying solely on VAT would be a lazy way to increase tax revenue.

VAT is classified as a regressive tax, meaning that it does not proportionally differentiate between the rich and poor as both pay the same rate regardless of their purchasing power and income.

A hike would eventually cost the poor a larger share of their income. Those with a relatively higher income, on the other hand, could easily absorb the additional tax burden.

If anything, the government should balance this regressive tax regime with other progressive means, such as the introduction of a wealth tax, which applies to each individual's net worth and assets each year. Other options may include opting for an increased luxury goods tax.

The government should also consider utilizing its core tax system, expected to take effect in July 2024, which would allow the government to better navigate critical data in managing and supervising tax collection.

Ideally, this would enable Indonesia to make the shift from a system requiring people to submit their tax return voluntarily, to one that requires the government to do the tax management for its citizens.

In theory, this would better reduce common cases of underreported or unreported tax obligations, which have plagued the country for so many years.

Other initiatives could include the speedy implementation of the OECD's two-pillar tax solution, which would allow any participating countries to charge tax on multinational enterprises (MNEs), especially tech giants, as well as the application of a global minimum tax of 15 percent on corporate income, which many believe would lessen incentives for MNEs to shift their profits out of developing countries.

We should also caution the government that, with the hike in VAT, it should expect a one-time inflationary shock for the year it is enacted.

Though the impact would likely be small and would not derail the inflation target, it is worth noting that such a hike could still discourage consumers from spending, which is why some economists suggest it could backfire and hurt revenue projections.

The impact on inflation would be far greater if the government included staple foods and other essential goods and services, which is why the exemption should remain in place despite the government having prepared the scheme since 2021.

That's food for thought indeed.

Source: https://www.thejakartapost.com/opinion/2024/03/18/dont-stop-with-vat.htm