Why Indonesia Keeps Raising Taxes | Value Added Tax (VAT)

Summary

Indonesia's recent decision to incrementally raise the Value-Added Tax (VAT) from 10% to 12% by 2025 has sparked significant public debate. While the VAT is a common form of consumption tax globally, the increase, although seemingly small, could burden low- and middle-income households. The government justifies the hike to address fiscal deficits, reduce national debt, and align with international standards. Additionally, VAT collection in Indonesia has been low due to its large informal economy. Despite opposition, measures such as an economic stimulus package aim to mitigate the impact on vulnerable populations.

Takeaways

• 😀 Indonesia is raising its Value-Added Tax (VAT) from 10% in 2022 to 12% by 2025 to strengthen its fiscal position.
• 😀 The VAT increase has sparked public opposition, as it directly impacts consumers by raising prices on goods and services.
• 😀 VAT is a consumption tax applied at each stage of the supply chain and ultimately passed on to the end consumer, impacting everyday purchases.
• 😀 Despite seeming like a small increase, the VAT hike can significantly affect household budgets, especially for low- and middle-income families.
• 😀 Indonesia’s VAT rate of 10% is relatively low compared to global averages, with OECD countries averaging around 20%.
• 😀 The government views VAT as a stable revenue source, especially during economic downturns, as consumption doesn't drop as much as income or corporate profits.
• 😀 Indonesia’s budget deficits have widened in recent years, particularly during the pandemic, prompting the need for increased tax revenue to reduce reliance on borrowing.
• 😀 The national debt-to-GDP ratio in Indonesia has increased but remains low compared to other Southeast Asian economies, highlighting a need for fiscal caution.
• 😀 The increase in VAT also aims to align Indonesia’s tax rates with international standards, making it more competitive globally.
• 😀 Indonesia's VAT collection relative to GDP is lower than regional peers, partly due to a large informal sector that doesn't contribute to tax revenues, limiting its potential tax intake.

Q & A

Why is Indonesia increasing its VAT rate from 10% to 12%?

Indonesia is increasing its VAT rate to strengthen its fiscal position, reduce the government's budget deficit, and ensure the sustainability of public services and infrastructure. This hike is also part of efforts to align Indonesia with global tax standards, as its VAT rate remains low compared to other countries.

What is a Value-Added Tax (VAT)?

A Value-Added Tax (VAT) is a consumption tax levied on goods and services at each stage of the supply chain, from production to sale. The tax is passed on to the end consumer, meaning it directly impacts everyday purchases.

How does a 1% increase in VAT affect Indonesian consumers?

While a 1% increase in VAT may seem small, it has a cumulative effect on household budgets, particularly for low- and middle-income families. Even a minor price increase on everyday goods can add up significantly over time.

How does Indonesia's VAT rate compare to other countries in Southeast Asia?

Indonesia's VAT rate of 10% is in the middle range compared to other Southeast Asian countries. For example, the Philippines has a VAT rate of over 12%, while Thailand has 7%. Malaysia employs a 6% Sales and Service Tax (SST).

What role does VAT play in Indonesia’s government revenue?

VAT is a crucial revenue source for the Indonesian government, contributing about 27.6% of the total domestic revenue in 2023. It is one of the most stable forms of taxation, especially during economic downturns, as it is less affected by fluctuations in income or corporate profits.

What is the fiscal deficit, and why is it relevant to the VAT increase?

A fiscal deficit occurs when a government spends more than it earns through taxes and other revenue sources. Indonesia’s widening fiscal deficit, particularly from 2020 to 2022, has put pressure on the government to raise taxes like VAT to reduce reliance on borrowing and ensure economic stability.

How does Indonesia’s national debt compare to other Southeast Asian countries?

Indonesia's debt-to-GDP ratio is relatively low compared to other large economies in Southeast Asia. For instance, Indonesia's debt-to-GDP ratio was 40.5% in 2024, making it one of the lowest in the region, especially compared to countries like Vietnam.

Why is Indonesia’s VAT-to-GDP ratio lower than other economies?

Indonesia’s VAT-to-GDP ratio is lower due to the large informal sector in the country, which operates outside the formal tax system. Small businesses and street vendors, who are not regularly taxed, contribute to the limited collection of VAT.

What measures is the Indonesian government taking to mitigate the impact of the VAT hike on consumers?

To alleviate the impact of the VAT increase on low- and middle-income households, the government has introduced a stimulus package worth approximately 827 trillion rupiah (US$51.5 billion). This includes measures like electricity tariff reductions, fiscal incentives, and VAT exemptions on certain goods and services.

How does the VAT increase help Indonesia stay competitive globally?

By increasing its VAT rate, Indonesia aims to align more closely with international tax standards, especially compared to OECD countries, where VAT rates often average around 20%. This helps ensure Indonesia’s fiscal sustainability as it continues to grow as one of the world’s largest economies.