Improving the Tax System in Indonesia

Indonesia has come a long way in improving its tax system over the last decade, both in terms of revenues raised and administrative efficiency. Nonetheless, the tax take is still low, given the need for more spending on infrastructure and social protection. With the exception of the natural resources sector, increasing tax revenues would be best achieved through broadening tax bases and improving tax administration, rather than changes in the tax schedule that seems broadly in line with international practice. Possible measures to broaden the tax base include bringing more of the self-employed into the tax system, subjecting employer-provided fringe benefits and allowances to personal income taxation and reducing the exemptions from value-added taxes. Similarly, broad-based investment credits would be a less distortive way to enhance investment incentives than selective tax holidays. Introducing a targeted, simplified tax regime for small and medium-sized enterprises, as currently planned by the government, could foster their integration into the tax system in the longer run, even if its short-run revenue potential is limited. Upgrading tax administration has made substantial progress in Indonesia since 2002, although there is still scope to improve the training of tax officers and the administration’s audit and litigation capacities, while strengthening internal control systems and enhancing the transparency of administrative decisions. The audit system could be further improved by allocating more tax audits on the basis of compliance risks. In the natural resources sector, particularly in mining, there is a case for increasing the government’s share of resource rents through higher tax rates imposed on these rents, as opposed to taxing revenues. This would imply a willingness of the government to bear a larger share of the exploration and development risk than heretofore, which Indonesia, with its improved access to international financial markets and a diversified resource portfolio, is now well placed to do. In the mining sector, a powerful rent tax regime with a large government take would serve the country better than export taxes and ownership restrictions that have been decided recently. This Working Paper relates to the 2012 OECD Economic Review of Indonesia (www.oecd.org/eco/surveys/Indonesia).