Reforming Tax Policies and Tax Administration

International perspectives, lessons for Indonesia

Bert Hofman, World Bank With Michael Engleschalk and Anna Monica Hansson

Reforming Tax Policies and Tax Administration

Why tax and tax administration reforms?

What reforms (I)—taxes

What reforms (ii)—administration

Indonesia’s tax ratio is—and was—low

0.0 5.0 10.0 15.0 20.0 25.0 30.0

China

East Asia & Pacific

OECD

Indonesia

Korea, Rep.

Lower middle income

Malaysia

Philippines

Thailand

Vietnam

Central Government Tax Revenues to GDP Selected Countries, 1985-90 and 1995-200

1995-2000

1985-90

….but debt makes more taxes crucial…..

Government debt as a percent of GDP, selected countries

1996 Latest

ThailandKorea, Rep.BelarusLatviaChileAustraliaSwitzerlandOmanMexicoMauritiusGermanyNew ZealandIndiaIcelandPolandUnited KingdomPhilippines

SpainNetherlandsMaldivesLesothoFinland

SingaporeCanada

LebanonSierra LeoneGreece

BurundiCote d'Ivoire

0.00 50.00 100.00 150.00 200.00 250.00 300.00

PortugalLuxembourg

CzechColombiaLithuaniaBahrain

IndonesiaNorwayGeorgia

Bahamas, TheTurkeyMalta

AlbaniaPeru

BoliviaSt. Vincent

United StatesCyprus

MongoliaZimbabwe

AlgeriaNepal

HungaryPakistan

Sri LankaJordanIsrael

BelgiumCameroon

Congo, Dem.

Indonesia's government debt was small before the crisis

Luxembourg

Czech RepublicLithuania

Korea, Rep.BelarusBahrain

Bahamas, TheNew ZealandGeorgiaIcelandThailandPeruAlbania

MaltaNetherlandsZimbabweHungaryAlgeriaFinland

SingaporePakistan

Sri LankaJordan

GreeceIsrael

BelgiumCameroon

Switzerland

St. Vincent

0.00 20.00 40.00 60.00 80.00 100.00 120.00 140.00 160.00 180.00

PortugalLatviaChile

AustraliaColombiaNorwayMexicoOman

MauritiusGermany

PolandTurkey

United StatesIndia

BoliviaUnited Kingdom

PhilippinesCyprusSpain

MaldivesNepal

MongoliaLesothoCanada

IndonesiaLebanon

Sierra LeoneCote d'Ivoire

BurundiCongo, Dem.

Indonesia's government debt was large after the crisis

…since debt service takes more than half of revenues.

Debt Service as a Percent of Revenues 2001 and 2002

ABPN 2001

Revision Draft Budget

2002 Debt service before rescheduling 48.9 56.1

Domestic 24.9 30.2 Interest 21.4 20.6 Repayment 3.5 9.6

Foreign 24.0 25.9 Interest 9.9 9.5 Repayment 14.1 16.4

Debt Service after rescheduling 41.9 45.1

Domestic 24.9 30.2 Interest 21.4 20.6 Repayment 3.5 9.6

Foreign 17.0 14.9 Interest 9.9 9.5 Repayment 7.0 5.5

What taxes?it’s all in Smith

I.                    The subjects of every state ought to contribute towards the support of the government, as nearly as possible, in proportion to their respective abilities;

 II.                 The tax which each individual is bound to pay ought to be certain, and not arbitrary.

 III.               Every tax ought to be levied at the time, or in the manner, in which it is most likely to be convenient for the contributor to pay it.

 IV.              Every tax ought to be so contrived as both to take out and to keep out of the pockets of the people as little as possible over and above what it brings into the public treasury of the state.

Adam Smith (1776) The Wealth of Nations, Book V, Chapter II.

Indonesia’s tax structure is not highly biased biased

0.0 10.0 20.0 30.0 40.0 50.0 60.0 70.0 80.0

China

East Asia & Pacific

OECD

Indonesia

Korea, Rep.

Lower middle income

Malaysia

Philippines

Thailand

Vietnam

Tax structure in selected countries 1995-00, percent of total

Taxes on Goods and Service

Taxes on income and profit

Taxes on international trade

And rates seem within reason

Tax rates in selected countries Personal income

(highest) Corporate Income

(highest) VAT

(standard rate) South Africa 45 30 14 Argentina 35 35 21 Brazil 28 15 .. Chile 45 15 18 Mexico 35 35 15 Indonesia 35 30 10 Malaysia 28 28 .. China 45 30 14 Philippines 33 33 10 Thailand 37 30 10 Singapore 26 26 3 Source: WDR 200/2001, Tanzi and Zee2000, PriceWaterhouseCoopers

The question

If Indonesia has a reasonable tax structure, and reasonable rate, Where’s the revenue?

What you see is not what you get

50 exemptions in VAT

19 exemptions in sales tax on luxury goods

21 exemptions in Income Tax

15 exemptions in land and building tax

………..

Source: Barents Group

Reform Lesson

Lesson No. 1: Look at exemptions first

What taxes—international trends?

Rely less on trade taxesTax consumption rather than personal income—but do not forget equity Avoid overtaxing capital—especially if you need it—but luring capital with exemptions is counterproductive

Build broad agreement on what to tax and how much

Reform Lesson

Lesson No. 1: Look at exemptions firstLesson No. 2: The process of tax reforms is as important as the outcome

Reforms—tax administration

“Tax Administration IS Tax Policy”

Milka Casanegra de Jantscher, 1990

Principles of Good Tax Administration

A good tax administration:• Applies the law in a fair, reliable and transparent manner;• Outlines and communicates to taxpayers their rights and

obligations as well as the available complaint procedures and redress mechanisms;

• Consistently delivers quality information treats inquiries, requests and appeals from taxpayers in accurate and timely fashion;

• Provides an accessible and dependable information service on taxpayers rights and obligations with respect to the law;

• Ensures that compliance costs are kept at the minimum level necessary to achieve compliance with the tax laws;

Principles of Good Tax Administration

• Where appropriate gives taxpayers opportunities to comment on changes to administrative policies and procedures;

• Uses taxpayer information only to the extent permitted by law;• Develops and maintains good working relationships with client

groups and the wider community.

OECD 1999

How to make these principles work?

Benchmark

Commit to improvement

Report regularly on improvement to public and Parliament

Reform Obstacles

Political interferenceLack of tax cultureCorruptionLack of resourcesShort-term revenue focusLack of support for reforms

Requirements for an effective reform process (1)

Sustained political commitment and supportCompetent, committed and dynamic leadership. A clear vision of the organization’s future stateWell-articulated strategies and comprehensive plans to realize the vision.Change initiatives are introduced in manageable “chunks”, rather than a “big bang” approach.Efforts are made to develop executive, middle management and institutional capacities.

Requirements for an effective reform process (2)

Adequate resources, funding and cash flow arrangements are in place.A high level of accountability, founded on corporate governance and management structures and process, is enforced.Good project management and budgeting processes are employed, with external oversight and supervision.Staff and external stakeholders are fully involved and receive comprehensive and timely information.There is a good level of cohesion within the administration, between those developing and implementing reform and those performing current operations.

Singapore: A Success Story

By 1990 the Inland Revenue Department had the lowest public satisfaction rating in the entire public sectorIn 1992 the Inland Revenue Authority of Singapore (IRAS) was establishedAn integrated, computerized approach to tax administration along functional lines was adoptedA completely new administrative system was introduced step-by-step over the next eight yearsToday 95% of taxpayers are satisfied with IRAS

How did Singapore do it?

Commitment from the highest levels of governmentThe tax administration was reorganized and given adequate resourcesThe system was well-planned and carefully implemented in a phased and monitored manner…..and of course, it is Singapore!

Reform Lesson

Lesson No. 1: Look at exemptions first

Lesson No. 2: The process of tax reforms is as important as the outcome

Lesson No. 3: Tax Administration IS tax policy.

Want to know more?

World Bank Tax Policy and Administration Web site: http://www1.worldbank.org/publicsector/tax/