Tax reforms are expected to improve the government’s overall fiscal position, but does not address some longer term issues such as a high VAT coverage threshold.
On October 7, 2021, the Indonesian parliament passed the Harmonization of Tax Regulation law earlier than expected. In 2022, the law implements a value-added tax (VAT) hike to 11% from 10%, a carbon tax hike, a modified tax amnesty program, an increase in personal income taxes for high-income individuals, and cancellation of the next round of corporate tax cuts from last year. The law also seeks to raise VAT to 12% before 2025.
The revised version of the tax amnesty program from 2016, to be in place from January 1 to June 30, 2022, is aimed at further encouraging Indonesian taxpayers to declare and repatriate assets back home. Assets acquired between January 1, 1985 and December 31, 2015 will be subject to tariffs ranging from 6% to 11%, while those acquired between January 1, 2016 and December 31, 2020 will face higher tariffs of 12% to 18%.
The Ministry of Finance (MoF) estimates the tax reform program will increase tax revenues to 9.2% of GDP in 2022 versus 8.4% set in the budget. This forecast 0.8 percentage points increase is optimistic as we think tax revenues as a proportion of GDP will increase only by a modest 0.5 percentage points, mainly supported by the VAT hike and new tax amnesty.
There is no doubt the tax reforms will help the government’s fiscal position, but based on the MoF's own estimates, tax revenues will reach only around 10% of GDP by 2025. This is still among the lowest for emerging markets and will likely remain a constraint to more productive fiscal spending, such as on infrastructure.
As the economic recovery in Indonesia is still not clearly well-entrenched and a great deal of uncertainty remains, the government cannot tighten spending allocations too early. For 2022, we have reduced fiscal deficit forecast only marginally to 4.6% of GDP from 4.7%, even after taking into account the impact of the tax reforms.
While implementing tax reforms is commendable during challenging circumstances, longer-term fiscal issues are yet to be addressed. For instance, the threshold for VAT coverage was left unchanged, and distortions from this threshold – which is among the highest in the world and leaves many firms out of the tax net – can be amplified as VAT rate hikes are phased in. It could continue to create inefficiencies in the system and discourage firms from expanding.
The tax reforms are not expected to provide a material negative impact on growth next year when they kick in as they have been watered down significantly from what was originally envisaged.
We maintain our GDP forecast at 3.2% in 2021 and 5.5% in 2022. For the remainder of 2021, downside risks remain in part due to the slow pace of vaccination and the slower-than-expected actual disbursements of government spending through September. At the current rate of inoculations, 80% of Indonesia’s population will be fully vaccinated only by June 2022, leaving it susceptible to recurring Covid-19 waves and lockdown measures. These risks are mitigated by the sharp price increases for key commodities such as coal, LNG and crude palm oil, boosting the economy’s terms of trade far more than its regional peers.
For a complete overview on Indonesia’s newly implemented tax law, read our full report.
Southeast Asia Economist
Southeast Asia Economist
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