(Bloomberg) -- Indonesia will proceed with its value-added tax hike in 2025, while offering a raft of incentives to mitigate the impact on consumption and economic growth.
The government will hike the value-added tax to 12% from 11% next year as set in the law, Coordinating Minister for Economic Affairs Airlangga Hartarto said in a briefing on Monday.
It will keep exemptions on basic goods and services related to food, health, education, public transport and religious services, and bear the one percentage point hike on some staples such as government-branded cooking oil, industrial sugar and wheat flour.
The decision to push through with the VAT hike comes despite a public and political backlash from Indonesians struggling with weakening purchasing power and a spate of layoffs in the manufacturing sector. Public outrage also escalated as the government floated the idea of a new tax amnesty, fueling perceptions that tax policy only burdens the lower and middle classes, while favoring the super-rich.
“We must keep the state budget healthy so that it remains a source of solutions, not a source of crisis,” Finance Minister Sri Mulyani Indrawati said in the same briefing.
The Indonesian rupiah was relatively unchanged after weakening to 16,000 per dollar on Monday, falling with most Asian currencies against the greenback. The benchmark stock exchange fell 0.9%.
According to a World Bank report launched on Monday, the various exemptions lead to loopholes that undercut Indonesia’s tax collections. Special regimes for VAT and income taxes also end up excluding as much as 99% of Indonesia’s firms.
That’s coupled with weak implementation, with Indonesia conducting fewer audits compared to countries with similar income levels. The World Bank estimates one in four firms commit tax evasion.
Read: One in Four Indonesia Firms Involved in Tax Evasion: World Bank
Consumption accounts for more than half of Indonesia’s domestic output and is a crucial growth engine for Southeast Asia’s biggest economy. Gross domestic product growth slipped to a one-year low of 4.95% in the third quarter, while inflation dipped to the lowest rate in more than three years in November.
Still, suspending the tax hike outright would risk eroding state revenues, with VAT making up more than 25% of total tax receipts last year. The latest round of exemptions and incentives is estimated to deck about 40 trillion rupiah ($2.5 billion) from state revenues, pushing up the total cost to to 445.5 trillion rupiah or 1.83% of GDP in 2025, according to finance ministry estimates.
Despite that, Indonesia can maintain its budget deficit target of 2.53% of GDP for next year, said fiscal policy chief Febrio Kacaribu. The government has repeatedly assured investors that the shortfall will be kept below the 3% legal cap despite President Prabowo Subianto’s spending plans. Next year, the country will begin rolling out its $30-billion free meal program, renovate schools and set up free medical check-ups across the country, among other projects.
“The government treads a fine line between the need to improve tax collections and the need to preserve the purchasing power of low-income households, given the regressive nature of indirect taxes,” said Radhika Rao, an economist with DBS Bank Ltd. in Singapore.
Private demand will likely face headwinds in the near-term, with consumer confidence, retail sales and loan growth looking tepid this year, she said. However, the exemption of staple items from the VAT hike will ensure that its inflationary impact will be less pronounced.
“The government is clearly keeping the sectors that involve public livelihoods away from tax hikes. It’s also ensuring stimulus to boost purchasing power and employment to assure both the domestic economy and the state revenue plan are not disrupted,” added Hosianna Evalita Situmorang, an economist at PT Bank Danamon in Jakarta
Read more about Indonesia’s package of tax measures:
- Food, health and education goods considered as luxury will be subject to the 12% VAT, including items such as salmon, tuna, wagyu beef, premium health services, and international school fees
- Partial or full VAT exemptions for certain home and electric vehicle purchases will be extended until next year. The government will also bear 3% of the luxury tax for hybrid cars
- A 0.5% final income tax for micro, small and medium-sized enterprises will be maintained through 2025
- The government will cover the income tax in labor-intensive sectors for employees with salaries below 10 million rupiah per month
- The government will offer a 50% discount on electricity tariffs for some beneficiaries and distribute rice aid of 10 kilograms a month to 16 million low-income households from January to February.
--With assistance from Soraya Permatasari, Prima Wirayani and Malavika Kaur Makol.
(Updates with market moves, cost estimate of tax perks, analyst comments)
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