Govt plans tax hike for rich amid large deficit

More room for tax evasion among high-income individuals

While struggling to finance a deficit budget to pull the country through a health crisis and economic recession due to the pandemic, Indonesia is seeking to increase taxes on high-income individuals and families.

Through an amendment of Law No. 6/1983 on general provisions and tax procedures (KUP), the government is proposing a higher personal income tax rate for people who earn at least Rp 5 billion (US$351,500) a year. These people are also known as high-networth individuals (HNWI).

The proposal goes along with other increases in value-added tax, a new carbon tax and another proposal for tax amnesty.

Finance Minister Sri Mulyani Indrawati said the proposed tax increase for HNWIs was between 30 and 35 percent.

“It is not that big,” she told lawmakers during a hearing with lawmakers at the House of Representatives.

Indonesia currently groups its taxpayers into four different income brackets ranging from less than Rp 50 million to over Rp 500 million per year. Each bracket is subject to one of four tax rates, namely 5 percent, 15 percent, 25 percent and 30 percent.

The new rate for HNWIs will add a new income bracket, meaning that the 30 percent tax rate will apply to those earning Rp 500 million to Rp 5 billion. Individuals who earn more than Rp 5 billion per year will be charged the proposed 35 percent rate.

The top tax rate is still lower than those in other countries, such as China (45 percent), India (42.7 percent) or the average for the eurozone (41.7 percent), according to data aggregator website Trading Economics.

The government has proposed the tax reforms as it tries to control the state budget deficit caused by the pandemic, which is 5.7 percent of the country’s gross domestic product (GDP) this year.

With low spending and domestic consumption, the government has yet to bring the country out of economic recession. At the same time, it is still lacking sources to finance the deficit.

According to a regulation in lieu of law (Perppu) on state spending and financial relief efforts for COVID-19 emergency response, the government is obliged to bring the deficit back to under 3 percent of GDP by 2023.

The government’s plan on taxing the rich more has been lauded by experts, saying that applying a higher rate to the rich could play a significant role in tackling the inequality in Indonesia. Moreover, many international organizations have projected the number of wealthy individuals in Indonesia to grow significantly over the next few years.

“That is why taxation policy should target the richest more,” Danny Darussalam Tax Center (DDTC) managing partner Darussalam told on Thursday.

World Development Indicators (WDI) data from the World Bank show Indonesia’s richest 20 percent held over 45 percent of the income share as of 2019. The figure has worsened within two decades from 38 percent.

Concurring with the World Bank, Credit Suisse’s Global Wealth Report says around 82 percent of the population had less than $10,000 but about 1 percent of the population had $100,000 to $1 million as of 2019.

On the other hand, the number of HNWIs in Indonesia is forecast to grow around 41 percent over the next five years, while the number of ultra-high net worth individuals (UHNWI), or those with a net worth of at least $30 million, is expected to grow 27 percent, according to a report by consultancy Knight Frank.

Despite sounding good on paper, implementing the policy would be challenging. Darussalam said most of Indonesia’s HNWIs relied on their passive income that is subject to final income tax.

“So, it would not follow a progressive rate as in personal income tax,” said Darussalam, adding the government could consider changing the final income rate instead.

Taxation directorate general spokesperson Neilmaldrin Noor said the agency was aware of such obstacles but remained optimistic the government could convince HNWI taxpayers that their money was used for the greater good and managed well.

Families earning over Rp 5 billion (US$357,000) in net annual income may soon be subject to a 35 percent personal income tax (PIT), if an article in a taxation bill under deliberation in the House of Representatives comes into law. The revised PIT rate is one of six major tax reforms in the bill designed to increase state revenue, as the government is legally obliged to cut the budget deficit from an estimated 6 percent of gross domestic product (GDP) last year to at most 3 percent by 2023. This, according to Bahana Securities analysts, will require the government to cut the fiscal deficit from last year’s Rp 956 trillion to Rp 543 trillion in 2023 and to increase tax receipts by Rp 353 trillion annually within the three-year timeframe.

Even at 35 percent, Indonesia’s highest PIT rate would still be among the lowest in the world, compared to 45 to 55 percent in Europe, 56 percent in Japan and 42.75 percent in India. No wonder 90 percent of PIT receipts in Indonesia are derived from wages or workers and only 10 percent are provided by non-employees, comprising high net-worth individuals such as businesspeople and highskilled professionals.

At present, the highest of our four-tier PIT rates is 30 percent, imposed on net annual income of over Rp 500 million. Seen from our per capita income of only $4,000, the 35 percent tax rate will apply only to the wealthiest 1 percent of the country’s families, which according to Credit Suisse’s Global Wealth Report 2019, account for 45 percent of the nation’s household wealth. The country does not have wealth or inheritance taxes.

Most studies have concluded – and the government has acknowledged – that tax receipts in Indonesia, which are only around 11 percent of GDP, are the lowest of the Group of 20 countries and trail behind emerging market and ASEAN peers. The tax ratio even fell to less than 9 percent last year due to the 2.2 percent economic contraction.

The biggest challenge is how to design a wealth tax with a simple, easy-to-administer mechanism, because wealth and assets have to be measured and their value has to be updated regularly. Unfortunately, our tax administration system is notorious for its inefficiency and complexity, with many exemptions and loopholes for discretionary measures by tax officials.

However, with a better design and an overall IT-based reform of the tax administration, as planned in the bill, a wealth tax could still be introduced. It is time for the government to close many of the tax minimization loopholes that allow the richest families to pass down property and financial assets to their heirs without either party paying any taxes on the appreciation in their value.

We think the risk of capital outflow in response to the higher income tax could be mitigated, as Indonesia is a signatory to the global Automatic Exchange of Information on tax matters, which makes it more difficult to hide assets within the country and overseas.