Informality, Middle Class and Tax Ratio

ARI KUNCORO

· 5 minutes read

Every year, taxpayers in Indonesia are required to submit their tax return forms (SPPT) to the tax office before March 31. Inevitably, the tax ratio or the ratio between tax revenue and gross domestic product (GDP) becomes a topic of discussion.

The tax ratio measures the ability of the state to finance state administration activities with taxes. However, increasing the tax ratio is not easy. In the context of social utility maximization (Ramsey, 1927), state administrators determine tax rates by maximizing the condition of taxpayers.

The equation of the first order condition implies that the marginal tax rate that does not cause distortion is zero. This means that taxes are paid at one time or in a lump sum for each person or household.

The result is quite surprising and counter-intuitive. The lump sum tax, which means everyone has to pay the same amount, is seen as very unjust so that it is politically impossible, except only in the form of user free charges, such as on toll roads, exhibitions and cinemas.

This view is reinterpreted naively, that is, the taxation system must balance efficiency and justice (Mirrlees, 1971). The zero marginal tax rate means that citizens and business units basically want an uncomplicated tax system. In this model, the government will collect taxes from high-income people and transfer the money to disadvantaged communities, without making those who have the ability pretend to be incapable.

Observations show that taxation systems in some countries are moving toward a reduction in tax rates and uniformity of tariffs on final goods taxes (Mankiw et al., 2009) as a modern reinterpretation of Ramsey (1927) to optimize tax revenue.

The tax reform in 2005 and the tax amnesty program in 2017 were attempts at moving toward this ideal model.

Development of tax ratios

Data shows that by including natural resource revenues in 2012, the end of the commodity boom period, Indonesia\'s tax ratio reached 14 percent of GDP. This ratio fell to 13.6 percent and 13.1 percent in 2013 and 2014, the end of the commodity price boom. It fell further to 11.6 percent in 2015, 10.8 percent in 2016 and 10.8 percent in 2017. In 2018, it rose to 11.5 percent and in the 2019 state budget it is projected to increase to 12.2 percent.

Commodities contribute to improving the tax ratio in times of increase in commodity prices, but it is temporary. It is very risky to rely on commodities as a source of taxes. Commodity prices are very

dependent on the global economic cycle. Before 1998, when Indonesia was still a net exporter of petroleum, the tax ratio with natural resources never exceeded 10 percent. In 1990, the tax ratio was 6.72 percent, and rose to 8.03 percent in 1997. Now, without natural resources, Indonesia\'s tax ratio is around 10 percent of GDP.

Informality

There are several things that determine the tax ratio, including the large portion of the informal sector in the economy, tax avoidance and collection and incentive systems. The tax behavior in the informal sector is a reflection of behavior that seeks to avoid acute risk (Feder, 1980; Spiegel et al, 2018).

To many farmer households and micro-business units in the manufacturing and service sectors, which carry out their activities only in order to survive, the formal sector is something strange and scary.

There are fears of the business cycle, regulatory burden and things that are perceived as bureaucratic harassment. As a result, they remain outside the mainstream of the national income.

The government’s policy to provide subsidized micro loans (KUR), land certification and the like give them the opportunity to leave the informal sector. However, this often requires role models from among themselves. For example, in Sembalun village at the foot of Mount Rinjani, Lombok, West Nusa Tenggara, is a center for garlic production. Interestingly, those who are agents of change are women who work as both collectors and farmers. The women provide market information and information on how to grow crops to other farmers who are all men. As a result, the garlic production center is gradually recovering, which could in turn make the farmers become taxpayers.

The principle of voluntary self-identification is very important in tax incentives. State administrators must be able to design an incentive system so that taxpayers continue to pay taxes according to their capabilities. These incentives need not always be in the form of funds, but can also take the form of health services, management of pensions/old age insurance, and the like. The appreciation given to the largest taxpayers in Indonesia is an example of the application of this principle.

We also often hear of incentives in the form of tax holidays for entrepreneurs. However, what about ordinary middle class citizens, do they need incentives?

The United States is an example of a country that uses a tax refund as an incentive. This year, there was a growing complaint against President Trump as the average tax refund declined from US$2,135 to $1,949. It shows such an incentive is quite effective for the middle class.

Moreover, according to the Statistics Indonesia (BPS), Indonesia has reached an average per capita income of $3,927 a year, entering the list of upper middle-income countries. Examples mentioned above indicate that such kinds of incentives can be used for the country’s growing middle class, although its financial costs and the improvement of the tax administration should be further reviewed.

Ari Kuncoro,

Professor and Dean, Economics and Business School, University of Indonesia

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