Micro and macroeconomics of tax reform: Indonesia

Indonesia enacted reforms in taxation in 1983. The new laws replace outdated, complicated and unproductive taxes adopted several decades earlier. A complete overhaul of the tax system was required. Use of higher tax rates or other forms of tinkering with the old system were not options under the circumstances. Reform studies began in early 1981. They were strongly focused on base broadening and drastic simplification. While the original impetus for the reform was not fiscal crisis, the new system will be in place in time to supplant much of a projected decline in oil revenues. Other objectives of the reform were more effective income redistribution, simplification of taxation, a new tax information system and streamlining of tax administration. The Indonesian reform made eclectic use of the lessons from similar fiscal exercises in Asia, Africa and Latin America and of recent innovations in tax analysis elsewhere, but was tailored to national objectives and constraints. Prospects for fruitful implementation of the reform are as yet unknowable: one factor augering for some success is that the tax reform was introduced as one of a series of six major belt-tightening policy measures which gained a measure of public acceptance. None were imposed or required for external assistance. It is unclear which, if any, of the lessons derived from this tax reform are transferable elsewhere. However, among the lessons of possible relevance elsewhere is the importance of identifying at the outset those fiscal problems lying at the intersection of the sets of ‘complex’, ‘difficult’ and ‘politically sensitive’ issues. Of the dozens of issues faced in the process of reform in Indonesia, three such issues in this intersection accounted for more than half the intellectual and other resources expended on the reform.