As the sun sets on 2024, the Indonesian government charts a new fiscal course by raising the Value Added Tax (VAT) rate to 12 percent that effective on January 1, 2025. Framed as the torchbearer of the Tax Harmonization Law’s (UU HPP) mandate, this increase is seen as a lifeline for a tax ratio struggling to stay afloat. This decision signals a bold yet controversial attempt to navigate through the nation’s growing budget needs.
With this rate, Indonesia becomes one of the ASEAN countries with the highest VAT rate, alongside the Philippines, which also implements a 12 percent rate. Vietnam, as a rising economic power in ASEAN, has even reduced its VAT rate to 8 percent for certain goods. Indonesia’s VAT rate not only stands as one of the highest in ASEAN but also surpasses that of several developed countries, such as Japan and South Korea, which impose a VAT rate of only 10 percent.
When compared to other countries, the question becomes even clearer in the public’s minds. Is raising the VAT rate truly the right approach—and the only path—to ensuring adequacy for Indonesia’s budget needs?
To put it into perspective, VAT is inherently a regressive tax. Regressive taxes impose a uniform rate regardless of income level. By its very nature, VAT exacerbates inequality, placing a disproportionately heavier burden on low-income consumers. This structural imbalance underscores the harsh reality that VAT, while efficient in revenue collection, often does so at the expense of those least able to bear it.
Instead of focusing solely on revenue, why doesn’t the government turn its attention to spending? Budget deficits in the national budget arise not only from insufficient revenue but also from reckless spending that often fails to deliver any real economic value to the country. This is akin to pouring water into a leaky bucket, where inefficiency, ineffectiveness, and weak oversight in the use of funds render any increase in revenue meaningless. Perhaps, the key to fiscal stability lies not in how much water is poured but in fixing the holes in the bucket—ensuring that every penny spent truly adds value to the economy.
An initial step that can be taken is to minimize expenditures that fail to provide added value, such as official travel expenses. These costs are often allocated to fabricated activities and have repeatedly been flagged by the Audit Board of Indonesia (BPK) in its audit findings. At the regional government level, decentralization has yet to yield significant benefits. The General Allocation Fund (DAU), a block grant providing regional governments with flexibility in its use, often becomes a platform for wastefulness. The MoF frequently highlights that a large portion of DAU is spent on local government personnel expenditure rather than programs benefiting the public.
This situation is further exacerbated by the bloated number of ministries and agencies under President Prabowo’s administration. As noted in my op-ed for The Jakarta Post (25/10) titled “Prabowo’s Bloated Cabinet: Beware of Political Cholesterol,” the expansion of the cabinet has significantly increased budgetary demands, amplifying inefficiency and ineffectiveness.
The weakness of monitoring and evaluation by external institutions completes this vicious cycle. The Corruption Eradication Commission (KPK), with its diminished functions, has shown a declining ability to address corruption cases in recent years, allowing significant misuse of the state budget. Similarly, BPK is limited to conducting audits and calculating state losses, unable to prevent these financial disasters from occurring.
The vicious cycle can be broken through comprehensive reform of government institutions. Douglass North, the 1993 Nobel Prize laureate, emphasized that institutions play a critical role in economic performance because they influence transaction costs. These costs include the resources required to design, negotiate, and enforce rules—both formal and informal—that govern the functioning of a nation. Daron Acemoglu, in “Why Nations Fail,” also asserts that institutions are the cornerstone of a nation’s survival, determining its rise or fall.
When institutions are absent or weak—such as when laws are poorly defined, ineffectively enforced, or budgeting processes are mismanaged—the costs of governance rise, and the potential for economic growth diminishes. Strengthening institutions is essential, not only to streamline legal frameworks and enhance enforcement mechanisms but also to establish robust budgeting practices that prioritize efficiency and transparency. By aligning institutional reform with sound fiscal management, governments can reduce inefficiencies, lower transaction costs, and ensure that public resources are allocated effectively.
The economy cannot self-correct as neo-classical theories suggest, given the unrealistic ceteris paribus assumptions. Effective budgeting policies require the support of strong government institutions that can guide resources efficiently and equitably. These institutions play a decisive role in shaping policies toward a market equilibrium that benefits both the state and society, aligning economic growth with real-world complexities and public welfare.
Furthermore, stable and well-managed institutions not only ensure fiscal discipline but also enhance a nation’s resilience to global economic shocks, as evidenced by the stability of most developed countries. By integrating sound budgeting with robust institutional frameworks, nations can establish a sustainable foundation for growth and adaptability in an ever-changing global economy.
Institutional reform in budgeting requires time, making credible oversight institutions essential for checks and balances. Restoring the independence of KPK could strengthen its impartiality, while BPK could enhance accountability by expanding its scope to include performance audits. These audits provide clear insights into the efficiency of public spending, fostering transparency and supporting long-term reform.
Indonesia’s fiscal future hinges not on short-term fixes like VAT hikes but on bold, comprehensive institutional reform. Without strong, independent institutions to enforce accountability, eliminate waste, and optimize budgeting, the nation risks perpetual inefficiency and stagnation. Breaking this vicious cycle requires political courage to restore institutional integrity and prioritize the public good over reckless spending. The path to sustainable economic growth begins with fixing the system, not merely raising revenues.