Tax reform: Time to shift from income to consumption-based tax

(The Jakarta Post Via Thomson Dialog NewsEdge) from THE JAKARTA POST — THURSDAY, DECEMBER 14, 2006 — PAGE 6 The Indonesian government is making a great effort to raise tax revenue. As is well known, the country’s tax system is dominated by income tax. The number of individual taxpayers, as represented by the NPWP (taxpayer registration number), is only 3.5 million, much less than the number of households in the country, around 40 million, on the assumption that each household has only one taxpayer
But not each household is able to pay taxes. Hence, if we say that the number of potential taxpaying households is one half of the total number of households, there should be at least 20 million taxpayers. If in one household the husband and the wife have separate incomes, the number of registered taxpayers should be more than the number of households

The campaign by the Directorate General of Taxation to increase the number of taxpayers seems doomed to fail in so far as personal income tax is concerned

It seems difficult and expensive to administer a large taxpayer base. Hence, there must be another and better way to raise tax revenues

In the past, there have been proposals to move from income-based taxes into consumption-based taxes. It is said that consumption or expenditure taxes are easier to administer and less costly compared to income-based taxes

One can infer from the Finance Ministry’s budget documents for 2006 that the income tax receipts are estimated to be only as high as 6.4 percent of gross domestic product, while the value added tax (VAT) is estimated at 4.2 percent. This means that income tax revenues would be 50 percent higher than the VAT

In 2002, the VAT in developed European countries was 7.6 percent of GDP, much higher than that of the United States, which stood at 2.2 percent of GDP. The U.S. is the only country in the Organization for Economic Cooperation and Development (OECD) with such a low ratio of VAT revenue to GDP. Indonesian VAT is surely lower than the average in developed countries in Europe but is still higher than the U.S

Academics such as Auerbach, Kotlikoff and Turnovsky, among others, have proposed that consumption taxes replace income-based taxes. They argue that consumption taxes will raise savings, and hence investment, resulting in higher economic growth. From an administrative point of view, the number of either producers or distributors-retailers is much smaller than the number of consumers, which are the base of income taxes. Hence consumption taxes are potentially less costly and much easier to administer

In 1977 there was a proposal in the U.S to shift to consumption-based taxes, or expenditure-based taxes, as it was expressed in the U.S Treasury’s Blueprint for Basic Tax Reform. A year later the Meade committee in the United Kingdom published a report, proposing a move to consumption tax as an alternative to the income tax. Unfortunately the two proposals were rejected by the parliaments. However, the two reports showed the reviving interest in tax systems based on consumption or expenditure

The report on the position of the VAT in developed countries shows that the U.S is still sticking to its old principles, the primacy of income taxes over consumption taxes. In the meantime, the United Kingdom has managed to integrate the VAT into their taxation system. In 1998 the proportion of its VAT revenue to the GDP was at 6.9 percent, much higher than the 2.2 percent in the U.S

How about Indonesia, and what is the importance of moving from income-based taxes to consumption taxes? The government has failed to increase the number of registered income tax payers. There are many people or households who do not posses taxpayer registration numbers, even though their incomes and wealth are well above the minimum taxable level

There were media reports recently about how even many public figures in Indonesia did not have taxpayer registration numbers. That is why it is important to find a better substitute for income tax

One thing is sure, everybody spends his or her income for consumption. It is here that the consumption tax will be an effective mechanism for tax collection. The consumption tax will capture those unregistered taxpayers, without bothering to know their incomes. It will broaden the taxpayer base and increase tax receipts

But the implementation must be accompanied by a transition period, during which income taxes will be slowly reduced and at the same time the VAT will be gradually increased. At present, a 5 percentage point raise in the VAT rate could collect more than Rp 100 trillion rupiah (US$10.8 billion), Even though the general VAT rate could be cut to as low as 5 percent, the VAT rates should be set progressively depending on the type of consumption. The goods and services consumed by the rich must be taxed higher than those consumed by poor people

People in France said that paying a big sum of money for income taxes at the end of the year is painful. Through consumption taxes, the payment of the tax is a gradual process, little by little each time someone spends money. There is a time lag between income receipt and paying the consumption tax, which intuitively is more conducive to savings. A simulation conducted by Auerbach and Kotlikoff confirmed the intuition that such a tax will yield higher savings

There is surely an inflation threat due to consumption tax. But as previously stated, consumption taxes must be accompanied by a reduction in income taxes. This is equivalent to incentives for corporations, because there is a shift of the tax burden to the final consumer

Presently, the government has announced several tax incentives for corporations. Such schemes should be in tandem with the imposition of consumption-based taxes

But an adequate information campaign should be made to explain the transition from income-based taxes to consumption-based taxes. The shift will broaden the tax base, which is expected to raise higher tax revenue, especially from the consumption taxes of people previously without an NPWP

The present situation where only around 1.5 percent of the population has taxpayer registration numbers should be the key reason to shift to consumption-based taxes, which are less costly to administer and less complicated, resulting in higher economic growth. An appropriate consumption-based tax will shift more of the burden to the goods consumed by the wealthy people, and less to the poor people, hence it has a dimension of justice

Djamester A. Simarmata, Jakarta The writer is a lecturer at the School of Economics, University of Indonesia

Copyright 2006 The Jakarta Post

Copyright 2006 The Jakarta Post. Source: Financial Times Information Limited – Asia Intelligence Wire.

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