Fiscal and Growth

History is perhaps a gloomy account about dissension, rivalry and conquest, including disputes between emerging forces and established forces.

Ancient Greek historian Thucydides once wrote how the Peloponnesian War broke out because the Athenians had become stronger, causing concern for the Spartans. The tension between China and the United States is a repeat of this history. A Harvard academic, Graham Allison, called it the Thucydides trap.

The tension between China and the US is not just a trade war. It deals with the US’ fear over China’s increasing dominance. Therefore, it seems that we must be prepared for a long tension. And the world economy has also felt its effects. In Asia, Singapore only grew 0.5 percent, Thailand 2.35 percent and Malaysia 4.37 percent. From this point of view, Indonesia is still doing quite good. We can still grow 5.02 percent in the third quarter of 2019. But of course we cannot close our eyes: Vietnam and the Philippines grew 7.31 percent and 6.18 percent respectively, better than us.

The decline in commodity and mining prices due to the economic slowdown in China has had an impact on us. We’ve still been fortunate, despite the slight slowdown, household spending can still grow 5 percent. And spending is the main pillar of our current gross domestic product (GDP). The phenomenon of relatively steady household spending was explained by economist James Duesenberry in his book, Income, Saving and the Theory of Consumer Behavior, published in 1949. He wrote: Our spending is not only determined by current income but also by our past spending patterns.

The simplest example: someone who is a fan of good coffee will find it difficult to suddenly reduce his coffee consumption to a lower quality when his income falls. It is easy for spending to increase but it is not easy for it to decrease.

On the other hand we note: falling tax revenue. The Finance Ministry data shows, in the January-October 2019 period total tax revenue only grew 0.23 percent from the same period in 2018. Non-oil and gas income tax itself only grew 3.3 percent, while the value added tax (VAT) in the country, which reflects purchasing power, experienced negative growth (-2.42 percent). This data confirms that an economic slowdown is taking place.

KOMPAS/ALIF ICHWAN

Finance Minister Sri Mulyani Indrawati (center) accompanied by Chairman of the Financial Services Authority Commission Board Wimboh Santoso, Bank Indonesia Governor Perry Warjiyo, Head of Bappenas Bambang Brodjonegoro, and Head of the Central Statistics Agency Suhariyanto (from left to right) gave an explanation during a work meeting with the Council House of Representatives Commission XI in the House Commission XI Room, MPR Parliamentary Complex of the DPR DPD RI, Jakarta, Thursday (29/08/2019).

Counter-cycle fiscal policy

Then, what can be done to anticipate it? Bank Indonesia has lowered the interest rate by 100 basis points. Unfortunately, a decrease in the interest rate has not encouraged investment as quickly as expected. Even undisbursed loans as of September 2019 increased by 5.07 percent compared to the same period in 2018. This phenomenon reminds me of what economist John Maynard Keynes wrote 90 years ago: demand is what drives production.

The problem is, with the condition of decreasing tax revenue, fiscal space is limited. Then what can be done? There are several things that can be carried out.

If demand for goods and services is weak, why should the business world ask for credit and expand production? Even if licensing is simplified, if there is no demand, why expand? The implication: simplifying licensing, revising the manpower law, reducing interest rates will not necessarily boost the economy. In the short term, spending increase is what will drive production. That is why we need fiscal policies that are counter-cyclical. The problem is, with the condition of decreasing tax revenue, fiscal space is limited. Then what can be done? There are several things that can be carried out.

First, a study by me and Sjamsu Rahardja from the World Bank (2011) shows that our fiscal policies tend to be pro-cyclical. It means that when tax revenues fall due to an economic slowdown, the government tends to make savings. In fact, we need more spending to drive the economy. Therefore, it is very natural for the government to increase the budget deficit, and even encourage spending. The budget deficit is expected to reach 2.2 percent this year. In my opinion, even increasing the budget deficit to 2.5 percent is no problem to drive the economy.

Of course, we still have to be careful if the budget deficit is too high. Why? There is a risk of crowding out. What does it mean? Greater budget deficits must be funded by issuing bonds. Because yields on government bonds are more attractive than deposit rates, there is a transfer of savings from banks to government bonds. As a result, resources for credit expansion in the banking sector are limited. The implication: private investment stagnates or slows down.

DOK HUMAS BCA

Discussions related to fiscal easing took place in BCA Cafe: Economy Outlook 2020, on Friday (18/10/2019), in Jakarta. The discussion presented, Chief Economist of PT Bank Central Asia Tbk David Sumual, Research Director of the Center for Reform on Economics (CORE) Piter Abdullah, and Economist at the University of Indonesia Febrio Kacaribu.

What is interesting is that the relationship between budget deficits and banking liquidity is not linear. To a certain extent, deficit financing through domestic bonds has a positive effect on the growth of third party funds in banks because people have investment options. However, after passing a certain level,

it will absorb third-party funds in banking. In conclusion: budget deficits are indeed needed to drive domestic demand, but must be maintained at an optimal level.

Second, if the source of domestic funds is limited, why don\'t we just take foreign sources? I must remind here: if the government bond market is dominated by foreign investors, the Indonesian economy will be vulnerable to fluctuations in capital flows. An increase in the budget deficit will increase the current account deficit because the savings and investment gap increases. If the increase in the current account deficit is largely funded by the portfolio, every time there is a shock overseas the financial market will fluctuate and the rupiah will be hit.

Improvement of the spending quality

Third, with such fiscal constraints, the government must focus on improving the quality of spending. It must be ensured that spending being disbursed has a positive impact on economic growth and welfare. A study conducted by Joppe de Ree, Karthik Muralidharan, Menno Pradhan, and Halsey Rogers (2017) shows: teacher professional allowance has no impact on improving the quality of education, even though the amount is very large.

Another example, transfers to local governments. We know that the funds that are deposited in the regional cash accounts are so large that they have no impact on economic growth. Allocation of spending for various ministries certainly needs to be seen which ones have to be prioritized and have an impact on economic growth and welfare. This is important because Basri and Rahardja (2011) show that government expenditure outside of salaries and subsidies is actually counter-cyclical. What does it mean? If the quality of spending is improved by allocating more budget to expenditures beyond salaries and subsidies (for example capital expenditure), then fiscal policy becomes counter-cyclical.

Fourth, when demand has occurred, the business world will respond by increasing production. To increase production, the business world needs low interest, easy licensing, and various economic deregulation. Therefore, we must thoroughly look at this policy.

Because this will make the economy increasingly experience contraction.

Fifth, we know that our fiscal space is limited. Although in the short term fiscal policy must be counter-cyclical, in the medium to long term, the fiscal space must be maintained to be sustainable. Under these conditions, tax revenue must be increased. However, this is not possible by increasing tax rates or chasing compliant taxpayers. Why? Because this will make the economy increasingly experience contraction.

Then, how? My study with Ben Olken, Mayara Felix of the Massachusetts Institute of Technology (MIT) and Rema Hanna from Harvard, at the National Bureau of Economic Research (NBER) (2019), shows: for every increase of one rupiah in tax rates, taxpayers will get an additional burden of 0.51 rupiah. Therefore, another way must be considered that does not burden taxpayers, but still raises the total government tax revenue. The way to do it is by improving tax administration by moving business services from the regular tax office to the Intermediate Tax Office (MTO). Why?

We suspect that the limited resources in the regular tax office make them tend to focus on several taxpayers with high income potential. As a result, large business entities will be targeted. There is a possiblity that they will increasingly avoid paying taxes in line with the company\'s growth scale. When transferred to MTO, with a greater number of staff, the treatment of business entities becomes more uniformed. The tax burden is not only "borne" by several large companies. As a result they can still grow and pay taxes.

KOMPAS/HERU SRI KUMORO

Muhamad Chatib Basri

Ironically, the world economy must pay for the tension between China and the US. History always repeats itself. And, we write it down pessimistically. I remember the writer, Albert Camus, who wrote bitterly: if there is the most important part of human history to be written, it is a record of remorse and incompetence. Camus might be too moody.

Muhamad Chatib Basri, Lecturer, School of Economy and Business, University of Indonesia