Tax Reformasi

In an effort to increase revenue and broaden the tax base the Government of Indonesia is proposing a number of reforms. When the House of Representatives returns from its recess it will be asked to vote on a reform bill that includes:

• The top corporate rate being cut to 28% in 2009 and 25% in 2010.

• For public companies rates would be 23% in 2009 and 20% in 2010.

• Companies with below 50 Billion in revenue would see rates fall to 14% in 2009 and 12.5% in 2010.

• Maximum dividend tax rate cut to 10% from the current 20%.

The government hopes to increase its collection of tax by making the tax rates more competitive with its neighbors such as Singapore. Currently government tax revenue amounts to Rp 580 Trillion which is 11.4% of GDP. Though the reforms proposed could see a Rp 40 Trillion fall in tax revenue, the government expects to see revenue rise in 2009 to Rp 702 Trillion, through greater tax compliance from the lowering of the tax rates. The biggest barrier is corruption by the tax department which typically sees bribes of 40% of the tax owed being paid tax department officials.

Another measure in the reform package that may help broaden the tax base is the gradual phasing out of the hated Fiscal Tax. Currently all Indonesian nationals and all foreigners working in Indonesia are required to pay a 1 Million Rp Fiscal Tax every time they leave the country. In theory you are able to claim this back when you file your taxes but in practice most people do not seek the refund as it is a sure method to bring about a tax audit and the subsequent bribes that will need to be paid.

As proposed in the bill, the Fiscal Tax will be eliminated for all registered taxpayers in 2009 and for everyone else in 2011. This measure, along with fines of 20% of the tax owed for people who do not register as taxpayers by the end of this year, is expected to increase the appeal of registering and broaden the tax base. Indonesia, a country of 225 million people has its budget supported by only 6 million registered taxpayers of whom only 2 million actually pay their taxes. The reforms are expected to increase the tax base to 10 million people by 2010.

Also in Indonesia.

In an effort to deal with growing inflationary pressure, Bank Indonesia has raised its policy rate by 25 basis points to 9%. This increase is part of continued rate rise that have seen the benchmark rate rise a full percentage point since may this year.

These efforts are to combat inflation which was reported as a rise in consumer prices by 11.9% in July. Food costs alone are running at 19.9%, the most in a decade.

Producer costs as measured by wholesale price inflation was running at 34.7% in June which suggest that there is greater inflationary pressure that has yet to work its way through the system. This could push inflation by the end of the year above the government’s 12.7% forecast for this year.

This rate rise would have been greater if the central bank had not benefited from the rise in the value of the Rupiah. In the last 10 months the Rupiah has been the second best performing of the major Asian currencies. The central bank hopes to get inflation under control and forecasts inflation at 6.5% to 7.5% in 2009.

Stagflation Dilemma

By Callum Roxburgh

Central Bankers in the developed economies are faced with a dilemma, while economic growth is slowing and their economies are slipping into a recession, energy and food driven inflation is preventing them from cutting rates. The worry is that this inflation will lead to wage increases that will then drive a self sustaining inflationary cycle. While they may be handcuffed by inflation in terms of using Monetary Policy to stimulate growth, the prudent use of Fiscal Policy could increase consumer spending and at the same time reduce demands by workers for outsized wage increases.

The current inflation is being driven by demand in the developing world; the voracious Chinese economy in particular has increased competition for the world’s finite supply of basic materials. As the average Chinese worker has seen his spending power grow he has increased his consumption of meat. Since it takes 10 kilos of grains to produce 1 kilo of meat we have seen an increase in grain prices. As his wages have increased further he has traded in his bicycle for a Motor Scooter or Automobile, thereby increasing demand for hydrocarbons. This demand growth has been outstripping the rate at which supply has been able to catch up. Since this is a demand driven inflationary cycle, as opposed to the supply driven cycle we saw in the 70’s, it is unlikely that we will see a significant decrease in prices in the short term.

Increasing the spending power of consumers in developed economies will not have a significant impact on basic materials inflation. Faced with increased costs every time they fuel their vehicle, they are not going to stop driving and walk to work. They are going to compensate by reducing spending in other areas. They may chose to spend less money on holiday travel or eat less in restaurants or forgo their White Chocolate Mocha Frappuccino, evidenced by Starbucks reporting its first quarterly loss in Corporate History.(1) These activities are not resource intensive so reducing them will have little impact on resource demand.

The impact of the US stimulus checks allowed the US economy to achieve 1.9% annualized growth in the second quarter compared to 0.9% in the previous quarter. (2) I was quite critical of this approach when it was announced and I still am. While the supporters of this kind of stimulus will use the increased growth in the second quarter as evidence of its effectiveness, what happens next quarter? Will we see economic growth fall?

A much better approach would be to deliver a permanent tax cut that was targeted at all taxpayers. This could be done by lowering the percentage of the lowest tax band or increasing the basic exemption that allows income to go untaxed. This would be stimulating to the economy and at the same time would head off outsized wage demands by workers who would feel less pressured by rising food and energy prices.