Raising VAT Rate Solves Problems (Not) Without Problems

Good news for the Indonesian upper middle class, especially for big users of four-wheelers. In the midst of the Covid-19 pandemic, which has demanded restrictions on social activities, even banned Eid homecoming travels, the government is providing massive tax discounts on new car purchases, by bearing part of the Sales Tax on Luxury Goods (STLG). This policy will last until the end of December 2021. So, for the wealthy, what are you waiting for? 

As contradiction, another news came out for Indonesian people in general, especially those who have not been able to buy a car. The Ministry of Finance plans to increase the Value Added Tax (VAT) rate starting next year. Bisnis Indonesia daily newspaper (4/5) revealed this policy plan from the Ministry of Finance Work Plan for fiscal year 2022 . 

It is unclear how much the increase of VAT rate is. Whether the VAT rate increase targets all types of goods and services is not even clearer. However, the VAT Law does indeed provide discretion for the government to adjust the tax rate to a 5% minimum and a 15% maximum. Because the initial agenda is to increase the rates, bear with the potential rise of VAT rate from 10% to up to 15%.? 

If the first policy pleases the upper-middle class, the second policy is quite a relief for the state treasurer who is trying hard to patch up the fiscal deficit. For any groups who will be disadvantaged, isn’t it the consequence of policy making? That, surely cannot please everyone. 

A fiscal deficit that hits 6% of GDP—beyond the safe limit of 3% of GDP—is indeed a big deal for state actors. The economic crisis triggered by the Covid-19 pandemic forced the government to carry out extraordinary policies at a very, very high cost. 

Social assistance, for instance, on one hand is needed by small communities but on the other hand is quite burdensome to the state budget. Similarly, tax incentives, despite eroding state revenues but in the current crisis conditions, are indispensable to reduce the economic burden of taxpayers, especially the business world. As a result, debt becomes an inevitable option amid decades of efforts by the government to repay thousands times trillions of debts inheritance.  

Income Inequality  

Managing state finances is certainly not easy. However, the issue of partiality should be the main consideration for policy makers. There are about 270 million people in Indonesia, and most of them, either directly or indirectly, are taxpayers. Of the population, around 10.19% or 27.55 million people fall into the category of poor people. Meanwhile, those who are categorized as rich people are 129,000 people or around 0.05% of Indonesia's total population, according to the Capgemini report titled World Wealth Report (2019). I and, perhaps, you—who read this paper—may be in between: neither poor nor rich.? 

Economic inequality is a global problem.?Credit Suisse (2016) accounts for 0.7% of the world's wealth. Similar conditions also occur in Indonesia, where 1% of the richest households control 50.3% of the total national wealth, and 158 thousand of them are included in the group of 1% of the richest people in the world. The National Team for the Acceleration of Poverty Reduction (TNP2K) in 2019 also made a similar report, revealing the control of 50% of national assets by the richest 1% of Indonesia. 

Indonesia's income inequality is confirmed through the Gini ratio data based on the last report of Statistics Indonesia (September 2020), which has increased to 0.385. Gini ratio is the level of inequality in the expenses of the rich and poor using a ratio of 0 to 1. The closer the number to 1, the wider the income inequality of the population is, and vice versa. 

Wealth Tax Can Be an Alternative Solution 

We know it well, that to maintain fiscal credibility, a breakthrough is needed to restore the state budget deficit to a safe level. Fiscal instruments that can be used are quite diverse, although their implementation must really pay attention to many variables. 

Adjusting VAT rates may be one of them and is acceptable according to the mandate of the law. However, is it the right policy to increase the VAT rate amid a condition when people's purchasing power is weakened after being hit so badly by the pandemic and economic crisis? Again, the government's side is questioned because if this discourse comes into reality, a lot of people will get impacted.

However, the government can actually take another approach to increase tax revenue while reducing income inequality. For example, taxing wealth or inheritance of the rich (wealth tax) may work. As stated by the International Monetary Fund (IMF) in a report titled Fiscal Monitor 2021, the application of a tax on wealth (wealth tax) can be a solution to boost tax revenue in a short term. This refers to the practice of wealth tax imposition in various countries, which has been quite successful in reducing fiscal inequality due to the Covid-19 pandemic. 

Norway, for example, applies a wealth tax to 1% of the wealthy population. This policy has proven effective in reducing wealth inequality by approximately 0.4% to 0.6% of GDP. Other success stories of wealth tax applications are also recorded by the OECD, including in France, Spain, and Switzerland. 

If the national assets mentioned by Credit Suisse and TNP2K are Gross National Product (GNP), starting from 2020, the amount is estimated at IDR15,018.5 trillion (Indonesian Economic and Financial Statistics, Bank Indonesia). Using this assumption, imagine how much the potential tax will be if half of GNP becomes the target of the wealth tax? 

The OECD classifies wealth tax into six types of taxes on property ownership: 1) Recurrent taxes on immovable property; 2) Recurrent taxes on net wealth; 3) Estate, inheritance, and gift taxes; 4) Taxes on financial and capital transactions; 5) Other non-recurrent taxes on property and (6) Other recurrent taxes on property. 

In addition to increasing tax revenue and reducing income inequality, the implementation of wealth tax can actually encourage more efficient utilization of assets. Because, wealth tax is imposed on assets regardless of the amount of income generated from the management of these assets. This means, rather than letting the assets settle or be left idle, the tax will encourage the owners to optimize the utilization of their assets.  

Instead of raising the VAT rate that will certainly burden the common people, it would be better if the government applies the wealth tax concept in Indonesia—among other things, by taxing certain types of property or inheritance with a certain minimum value. Inheritance tax seems quite prospective to increase tax payment if it is true that the asset value of the crazy rich Indonesian, which amounts to 1% of the total population, controls 50% of the national assets. 

**) This article was published in CNBCIndonesia.com on 5 May 2021?and undergone minor revisions. 

 

 

CNBCIndonesia.com

Disclaimer! This article is a personal opinion and does not reflect the policies of the institution where the author works.