Corporate tax reform in Indonesia

This is the non-technical summary of the paper from NBER digest November 2019:

A study of Indonesian reforms finds that sharpening focus and boosting staff-to-taxpayer ratios produced major revenue gains at minor expense.

Most low-income countries collect between 10 and 20 percent of their GDP in tax revenue, in comparison to high-income countries’ average of nearly 40 percent. This may in part be due to fundamental characteristics of developing economies, such as their less sophisticated banking systems or prevalence of informal labor market relationships. These considerations suggest that there is little these nations can do to increase tax revenues.

The findings of a study by M. Chatib Basri, Mayara Felix, Rema Hanna, and Benjamin A. Olken, Tax Administration vs. Tax Rates: Evidence from Corporate Taxation in Indonesia (NBER Working Paper 26150), challenge this idea. The study focuses on how two corporate tax reforms in Indonesia affected tax revenues.

In the first decade of this century, Indonesia established a number of Medium Taxpayer Offices (MTOs) and transferred responsibility for overseeing tax administration with respect to large corporations in each region with an MTO to that office. The MTOs had the same structure as the country’s regular tax offices, which are called Primary Taxpayer Offices (PTOs), but boasted higher staff-to-taxpayer ratios, allowing for better customer service and tax administration. The country’s several hundred largest taxpayers were serviced out of a central Large Taxpayer Office in Jakarta.

The researchers found that assignment to an MTO, as opposed to a PTO, increased tax revenue significantly — by 128 percent for the firms affected — at a cost of less than 1 percent of the increase in revenues. The increases were broad, occurring across corporate income taxes, VAT payments, and other kinds of tax payments. The MTO policy raised at least $4 billion from the firms it affected — just 4 percent of Indonesian corporations. The researchers also found that the establishment of the MTOs resulted in an increase in the reported number of permanent employees, and in reported wages, at the affected companies, perhaps because increased administration increased formalization.

The positive effect of MTOs on tax revenue increased over time. The researchers hypothesize that, before the advent of MTOs, overburdened tax workers may have focused more on larger corporations than on their smaller counterparts, effectively levying an additional “enforcement tax” on growth. The MTOs may have eliminated this tax, equalizing effective tax rates across different-sized firms.

The researchers also study a second tax reform: a 2009 change from a progressive corporate income tax rate to a flat rate of 28 percent with revenue-based discounts, and a 2010 tax cut of the flat rate to 25 percent. Reported taxable income increased as the tax rate declined: a 10 percent increase in the share of after-tax profits retained by firms — equivalent to a tax rate cut from 30 to 23 percent — is associated with an increase of about 6 percent in reported taxable income. This response is similar to the value found in many developed countries; it implies that Indonesia’s revenue-maximizing corporate tax rate is 56 percent.

Benchmarking the MTO reform against a counterfactual tax rate increase, the researchers find that the increased corporate income tax revenue from improvements in tax administration would be equivalent to raising the marginal corporate tax rate on affected firms by about 23 percentage points.

The findings indicate that tax administration improvements can be effective in raising revenue in developing nations. “Meaningfully large increases in tax revenue from medium-sized firms can be obtained through feasible administrative improvements in a relatively short period of time,” the researchers conclude.

Tax cut, the stimulus effect and other links

The Financial Times had the following header, “Sugar rush from India’s tax cut starts to wear off” in an article yesterday. The contents were less negative. Stock market euphoria might or might not fade. But, the medium-term positive impact on corporate cashflows and hence on investments will be there. It might take some time.

Abhijit Banerjee, one of the winners of the Swedish Riksbank Prize for Economics, had wanted India to roll back the corporate tax cut. He has argued that the sure way to boost economic growth is to put money in the hands of the people and that the resulting higher demand would boost investments. Fair enough.

But, whether tax cuts for big businesses are an unfair advantage conferred on big businesses are entirely a matter of context. In the Indian context, the tax cut offered seems par for the course. The best response to the point put forward by Abhijit Banerjee came from R. Jagannathan, Editor of Swarajya, through his regular column (‘Arthanomics’) for Mint. He had explained beautifully as to why, in the Indian context, the corporate tax cut was not wrong and that higher taxes would not be welfare-enhancing. It is an important read.

Now, back to the context of this blog. I came across this review of the recent book by Piketty (ht: Ramagopal). The review was somewhat short and ended abruptly but it had an important statistic:

Per capita income growth was 2.2% a year in the U.S. between 1950 and 1990. But when the number of billionaires exploded in the 1990s and 2000s — growing from about 100 in 1990 to around 600 today — per capita income growth fell to 1.1%. [Link]

Piketty has a point about extreme inequality. But, I am not sure if forced redistribution would work simply because political economy forces would not allow the redistribution to happen. There is a moral hazard. Nations can cheat and allow tax arbitrage even if they agree on harmonisation of tax policies and rates.

OECD’s proposal for taxing the income of multinationals would be an important step forward, if it came about. In fact, this could be one of the most far-reaching tax reform to be proposed in recent years. Without that, redistribution of surplus between labour and capital would be a non-starter. However, it is chastening to note that OECD has been at it at least for six years if one went just by the first page hits when one searched for ‘OECD TAX PROPOSAL’

This F&D article (somewhat long) has a very useful overview and a wealth of links to pursue. It links tax-havens and tax-evasion to ‘Too much finance’. In other words, the jurisdictions that are willing to act as tax havens end up suffering from the ‘Finance’ curse.

One wonders if the post-Brexit Britain wants to or can double down on its role as a financial/tax haven?