We must rethink how we implement our fiscal policy to address this problem.
The World Economic Forum (WEF), held last month in Davos, Switzerland, is an example. This annual meeting was back to present famous figures from both government and private circles. WEF chose “History at a Turning Point” as a theme, with the hope that policymakers could join forces to overcome economic turbulence and political tension due to Russia’s invasion of Ukraine.
But this prestigious forum, launched in 1974, is not without critics. WEF has often been considered too exclusive and more of a friendly platform for millionaires and world politicians that makes their views comparable to those of the world economists’. This year is no different.
Policymakers become nervous when millionaires and entrepreneurs speak about the dangers of a global recession, unemployment and political instability. As a response, various incentives flowed heavily from the government’s pockets to the business world to survive during the pandemic.
Ironically, the support for businesses happens against the backdrop of increasing income inequality.
In Indonesia, millionaires’ total wealth rose by 57.9% during the pandemic, from US$57 billion to US$90 billion (Rp 847 trillion to Rp 1,337 trillion).
At the same time, 2.1 million people fell into extreme poverty. Indonesia’s Central Statistics Agency reported that the total number of poor people in Indonesia reached 9.71% or equal to 26.50 million people.
Challenges of strengthening fiscal policies
Concerns regarding increasing economic inequality have been the main focus of economic research over the past few years. These includes works by world-renowned economists Thomas Piketty, Joseph Stiglitz and Facundo Alvaredo.
One of the key messages from their research is the downward trend in tax rates for the rich, which results in greater inequality. Besides, the wealthy population and their companies benefit significantly from the low tax rates and tax amnesty, including the chance to avoid tax with legal or illegal means.
In Indonesia’s context, evidence shows that tax burdens are not distributed equally. The income tax rates of individuals in Indonesia are still considered low. The highest rate of 35% is mandatory for individual taxpayers, which is still below China, India and most of Europe.
Another challenge is that indirect taxes, such as Value Added Tax (VAT), still dominate Indonesia’s tax revenues. VAT rates applied in Indonesia are not set according to each individual’s different needs and financial capabilities. As a result, low-income families have to bear a more significant tax burden than the rich.
Meanwhile, taxation amounts primarily come from personal income, irrespective of the profit they earn from other economic activities or asset values. The government should implement a more innovative approach and use net wealth taxes – such as property transfer – and financial transaction taxes for trades of currency, stocks, and other financial instruments.
Tax justice to reduce inequality
In 2020, the United Nations officially added an indicator to its Sustainable Development Goals to encourage policymakers to maximise fiscal policies to reduce inequality. Tulane University had even developed Commitment to Equity (CEQ) tools to monitor the impact of fiscal policies on inequality and poverty.
In other words, the choice of approaches is in our own hands.
We can choose to push more incentives toward the business sectors that have the potential to multiply the wealth of entrepreneurs, or we can strengthen our tax policy. We can opt to tolerate tax evasion, or we can decide to improve tax records and impose more significant penalties for those who neglect their tax obligations. Otherwise, we can also choose to increase the budget for social protection or distribute it to non-essential sectors.
In Indonesia, we need to improve at least three aspects.
First, the government must refocus tax policies, especially by optimising measures for income tax.
Currently, Indonesia’s highest proportion of tax revenue comes from corporate income tax, followed by VAT or goods tax and service tax. The government’s decision in October 2021 to increase taxable income by 35% for individual taxpayers who earn above Rp 5 billion per year should be appreciated.
However, this effort should accompany increasing taxes on economic activities with high valuations, such as transactions of property asset sales or asset ownership in the financial market.
Although the current indirect tax scheme does not attempt to distinguish between primary and supporting materials, basic needs are still burdened by VAT rates and disadvantageous for the less privileged. For instance, cooking oil, considered a basic need, is included in the list of commodities with a VAT rate of up to 11%.
Second, we need to increase the quantity and quality of government spending.
Indonesian government spending on social protection in 2022 is only around 1.59%, or the second-lowest in ASEAN, below Cambodia at 3.8%, Malaysia at 2.50%, Vietnam at 2.15%, Myanmar at 3.18% and Timor-Leste, which reached 4.62%. This condition certainly hits the quality of public services in Indonesia.
For example, the minimal support for infrastructure and quality government schools forces the community to spend more money on private schools. In the long term, this impacts the decline in people’s purchasing power while also affecting economic growth.
Thus, the government must increase financial allocations for vulnerable people while opening access to job opportunities. It can also reduce spending on the military sector to make more room for fiscal space. Despite the COVID-19 pandemic-related declines in economic output, the Ministry of Defense’s annual budget increased by 13.28% to Rp 134 trillion in 2021.
Third, the country should encourage efforts to reduce tax evasion and space for corruptors in the tax sector. To make this happen, the government may promote continuous public discussion while involving the community and civic organisations to have a constructive conversation.
Finally, the government is responsible for ensuring a fair tax system. However, we should not forget that entrepreneurs, including millionaires, play a significant role in creating an equitable economic system.
As British multimillionaire and financial activist Phil White has put it, “tax the richest and tax us now”. This statement is still rarely heard from the rich in Indonesia.
Media Wahyudi Askar does not work for, consult, own shares in or receive funding from any company or organization that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.
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This content was originally published by The Conversation. Original publishers retain all rights. It appears here for a limited time before automated archiving. By The Conversation