Indonesia, a ‘real tax haven’ nation
This article’s title may be shocking and antagonize Indonesia’s staunch position of opposing tax evasion by way of tax havens. But, let’s look deeper.
While there is no standard definition of a tax haven, it is generally defined as a state, country or territory where tax rates are very low or even zero. Tax havens are usually associated with the tax-evading activities of corporations.
However, tax expert Dhammika Dharmapala emphasizes the important role of tax havens in facilitating tax evasion by individuals, in line with the Organization for Economic Cooperation and Development’s (OECD) initiative that focuses on the use of tax havens by individuals seeking to evade taxes.
Indonesia’s corporate income tax rate has changed a couple times in the last decade from 30 percent in 2007, to 28 percent in 2009 and where in 2010 it was 25 percent.
Whereas the highest personal income tax rate lowered from 35 percent to 30 percent in 2009. The decreasing tax rate has followed global trends of a downward income tax rate, also known as the “race to the bottom” phenomenon.
With the existing income tax rates, Indonesia does not appear on the standard list of tax havens because its rates are not considered particularly low.
The 25 percent corporate income tax rate and the 30 percent personal income tax rate are the tax rates set by the government, known as the statutory tax rates (STRs).
But, are STRs or the actual tax rates burdened by taxpayers? They are not. The actual tax rates burdened by taxpayers are the effective tax rates (ETRs). For a corporation, ETRs are the ratio of total tax expenses to the firm’s profits before taxes. For an individual taxpayer, it is the ratio of total tax expenses to their taxable income.
The nonconformity of STRs-ETRs is not uncommon. In academic literature, the deviation is referred to as a “book-tax income gap”. Economist Alfred Tran explains that the gap is mainly caused by deliberate government policies and different objectives of tax and financial reporting systems.
Therefore, as economist Sinclair Davidson argues, the mere existence of a book-tax income gap does not necessarily mean widespread tax avoidance.
However, he also emphasizes that just because we can explain the gap does not mean that some taxpayers are not avoiding tax either.
In Indonesia, it is inevitable that a significant number of taxpayers do not pay the amount of tax they ought to pay.
Recently, in its special report, the Economist quoted Finance Minister Bambang Brodjonegoro’s estimation that only 27 million of Indonesia’s 255 million people are registered taxpayers and in 2014 just 900,000 of them paid what they owed.
Bambang also claims there are thousands of companies that have never paid income tax, since commencing their businesses in the country. This suggests that those burdened tax payers pay an actual tax rate that is much lower than the rates set by the government.
Some may not even bear income tax altogether. This leads to a massive gap between the STRs and ETRs, and Bambang’s claim above illustrates that the gap is likely caused by tax avoidance rather than by a book-tax income gap. Accordingly, Indonesia might not be included in the list of tax havens by STRs but the country would certainly appear on the top of the list if it were determined by ETRs. And, it’s worth noting that despite that ETRs are often difficult to determine, according to tax experts Brian J. Arnold and Michael McIntyre, average ETRs of a country is a somewhat better indicator of its status as a tax haven.
The fundamental question is: why are the taxpayers so bold to avoid or even evade income tax in Indonesia? The answer is likely because the taxpayers understand that the Directorate General of Taxes (DGT) is not a powerful nor efficient tax authority.
Avoiding taxes is a human nature that occurs even in developed countries with the most efficient tax administration. But in Indonesia, tax avoidance/evasion seems to be legitimated by its weak tax administration.
A shortage of employees, (currently around 36,000 tax officials compared to the population of 255 million) exacerbated by difficulties in executing its powers, granted by the tax law, contributes to the weakening of the DGT.
Let’s compare Indonesia to a strong and efficient tax authority. The Australian Tax Office (ATO), for example, possesses around 23,000 tax officers to monitor the tax-related activities of its approximate 23 million population.
In addition, the ATO is granted executable wide-ranging powers, including the power to restrict taxpayers from leaving the country and to enter tax payers’ premises even without a warrant.
The government’s plan to establish a new Indonesian tax authority that directly is responsible to the President is an imperative necessity for the country to having a strong and efficient tax authority.
The new institution is expected to have broader powers and administrative flexibility to support its aim of achieving the government’s targeted level of tax revenue.
President Joko “Jokowi” Widodo’s administration currently struggles to collect more tax revenue. At the same time, Indonesia has become a tax haven by inadvertently facilitating tax evasion for millions of individuals and companies for many years now.
The Economist writes that Jokowi has much to do, and little time to get it done. I agree, and revamping the DGT to becoming a strong and efficient tax authority should be one of his top priorities.
