Indonesia’s Tax Reforms Risk Being Undermined By Reckless Spending – Analysis

By Yosephine Uliarta

Indonesia’s tax-to-GDP ratio has beendeclining for over a decade, standing at 12.1 per cent in 2022 — just above Laos in ASEAN and well below the Asia-Pacific average of 19.3 per cent and the OECD average of 34 per cent. In response,tax reformshave been ongoing, with two major policies set to take effect soon —Core Tax Administration System (CTAS)by the end of 2024 and a potential value-added tax (VAT) rate increase in 2025.

The long-awaited CTAS will modernise Indonesia’s tax system by integrating all tax processes into a unified platform, using accurate data to enhance oversight and improve collection. CTAS is expected to expand the tax base and increase efficiency by identifying new taxable objects and untapped revenue potential, improving compliance and making it easier to track income sources. Along with the introduction of aSingle ID for taxationin 2022, it will boost Indonesia’s low personal income tax (PIT) collection.

Indonesia’stax revenue structurerelies heavily on corporate taxes (28.8 per cent) and VAT (28 per cent), while the contribution of PIT remains minimal (13 per cent).International trendsshow that countries with higher tax-to-GDP ratios typically generate a large share of revenue from PIT.

Most PIT revenue in Indonesia comes from employees, whose taxes are automatically withheld by employers, while self-reported taxes from business owners, doctors and lawyers remain nonoptimal.The tax gap— the difference between potential and actual collections — was 42 per cent for overall PIT and a striking 80 per cent for non-employee income taxes in 2019.

The small contribution of PIT is not unique to Indonesia. Due to limited capacity in collecting VAT,less developed countriesshould maximise revenue through easier-to-collect taxes, such as VAT, while continuing to reform PIT. VAT is harder to evade, making it a more reliable tool for revenue generation.

Indonesia has already begun reforming its VAT system through the 2021 Tax Harmonization Law, which mandates a VAT rate increase from 11 to 12 per cent as early as 2025. This will bring Indonesia’s VAT rate closer to the OECD average (19 per cent) and global average (15.4 per cent).

VAT is often criticised for being regressive —affecting lower-income households disproportionately. But this concern can be mitigated by strengthening targeted social assistance programs, offsetting the rate increase impact on lower-income groups. What matters ultimately is the overall distributional effect of the fiscal system, not just the impact of an isolated policy. Additionally, VAT is not imposed to basic necessities such as food, healthcare and education.

While the VAT hike is necessary, the current economic downturn — marked bycontraction in the manufacturing sectoranddeclining consumer purchasing power— means raising VAT in 2025 could worsen financial pressures. Fortunately, the law includes flexibility, allowing the government to adjust the timing of the VAT increase according to economic conditions and providing the option to delay the hike if necessary.

Indonesia is moving in the right direction with its tax reforms, but it’s important to recognise that much of the increased revenue from optimising personal income tax and VAT will come from the middle class. This group already bears asignificant tax burden, providing 42 per cent of indirect taxes (VAT and excises) and representing the majority of Indonesia’s income taxpayers. Naturally, they will expect public benefits and better governance in return for their contributions and their political importance cannot be underestimated.

Tax reform success depends not just on raising revenue but on how well those funds are spent. Effective delivery of public goods builds support for higher taxes, while reckless spending erodes trust. Ideally, tax and expenditure reforms should go hand in hand, but this alignment is lacking in Indonesia.

While revenue efforts are underway, several questionable spending plans risk undermining public support. The government’s plan to cut the Public Service Obligation (PSO) subsidy andadjust commuter train faresin greater Jakarta based on income levels could raise fares for the already financially strained middle class, despite the principle that public transport should serve all citizens equally. The president-elect’s proposal for a nationwide free school meal program has also raised concerns about itseffectivenessandfunding, which may divert essential resources from education and lower the education budget below legally required levels.

More broadly,delays in budget disbursementand the failure to meet spending targets have historically undermined the effectiveness of public programs. These spending choices, along with the slow pace of disbursement, highlight a disconnect between tax reform efforts and the responsible, timely use of public funds.

As Indonesia advances with its tax reforms, it is crucial to ensure these efforts aren’t undermined by reckless spending. A budget reveals a government’s true priorities, where policy goals meet the reality of implementation, determining how resources are raised and allocated. Responsible budgeting builds and sustains public trust.

• About the author: Yosephine Uliarta is a Master’s student at the Crawford School of Public Policy, The Australian National University.
• Source: This article was published by East Asia Forum