Is the 20% Final Income Tax on Deposit Interest Still Relevant?

THE 20% final income tax rate on income in the form of deposit interest has remained in place for more than 2 decades. Amidst the government's ambition to increase the tax ratio whilst strengthening the financial market, is the 20% rate still relevant?

Richard Musgrave (1989) classified the functions of taxation into two dimensions: budgetair, as a source of state financing, and regulatory, as an instrument for directing economic behaviour.

In the budgetair dimension, the 20% rate can still be considered relevant. This is reflected in Indonesian banking third-party funds (TPF), which have consistently exceeded IDR8,000 trillion in recent years (Statistics Indonesia, 2025).

With the average deposit interest rate for tenors of 1–12 months in the range of 4%–6%, the tax base on deposit interest remains substantial. Taxation through the withholding tax mechanism on this instrument represents a stable and predictable source of revenues, thereby facilitating state treasury planning.

In the regulatory dimension, the 20% final income tax rate is intended to discourage the public from placing their funds solely in deposits. If public funds are overly concentrated in deposits, financial intermediation will be limited to the banking sector, making the development of the capital market, bond market and risk-based financial instruments less than optimal.

Ross Levine (1997) explained that countries with financial deepening consistently record higher long-term economic growth. By levying a higher tax on deposit interest than on bond interest, the government hopes that part of public fund flows will shift to the debt securities market.

However, there is a paradox in this policy. The assumption is that deposit savers are investors responsive to tax incentives. In reality, most people choose deposits not solely because of the rate of return, but because of factors such as security, convenience and certainty.

Further, the uneven level of financial literacy implies that taxation is not necessarily effective as an instrument for encouraging the migration of investment to other instruments. Products with more favourable tax treatment, such as bonds, require a greater level of understanding than deposits.

As a result, tax incentives designed to promote the deepening of the financial market are in practice enjoyed more by investors with adequate financial literacy, rather than by middle-class members of the public who still rely on deposits as their primary investment vehicle.

International comparisons also provide an interesting perspective. Data from the OECD (2023) indicate that a number of developing countries in the Asia-Pacific region apply withholding tax rates on deposit interest that are lower than Indonesia's.

Vietnam, for example, applies a rate of 5%, whilst India applies 10%. These relatively low rates are regarded as incentives to encourage the public to enter the formal banking system.

Indonesia, by contrast, maintains a final rate of 20%, which, under certain conditions, may be perceived as a disincentive for the public to deposit their funds in banks.

Structural Weaknesses

In this regard, there are a minimum of 3 structural weaknesses that warrant attention. First, the issue of regressivity. The 20% rate applies equally to deposit interest arising from savings of IDR10 million and IDR10 billion alike. There is no differentiation based on the amount of the deposit or the economic capacity of the fund holder.

Yet, according to Musgrave's (1989) theory of tax equity, an instrument that is regressive in nature, whereby the relative tax burden is heavier for lower-income groups than for higher-income groups, is at odds with the ability-to-pay principle.

Second, an overly optimistic assumption regarding financial literacy. The effectiveness of the regulatory function will only be achieved if the public genuinely takes tax considerations into account in their investment decisions and has access to alternative investment vehicles.

With Indonesia's financial literacy rate still below 50% (Financial Services Authority, 2022), this assumption remains overly optimistic. When deposit interest is subject to a relatively high tax, some members of the public feel that the benefit of saving with a bank is diminished.

Not understanding other investment vehicles, they do not switch to bonds or mutual funds, but instead choose to keep their money outside the banking system.

Third, a rate that has stagnated amidst shifting interest rate dynamics. Gov. Rreg. 131/2000 set the 20% rate at a time when Bank Indonesia's reference interest rate was considerably higher than it is today.

In the early 2000s, when deposit interest rates were in the range of 12%–15%, that rate still left an attractive real rate of return.

Now, with one-month deposit interest rates only in the range of 3%–5%, a tax of 20% reduces the proportion of the return significantly and, under certain conditions, can cause the real rate of return to fall below inflation.

Based on this analysis, the author puts forward 3 recommendations. First, the 20% rate need not be increased, but should be restructured on a gradual basis.

The 20% rate could be maintained for large deposits, for example, those above IDR1 billion, reduced to 10%–15% for medium-sized deposits and exempt for small deposits below IDR50 million. This scheme could reduce the regressive nature of the tax whilst promoting financial inclusion.

Second, when the Bank Indonesia rate is below 6%, the tax rate should not cause the real post-inflation return to fall by more than 25%. The aim is to ensure that formal savings remain attractive so that the public is not driven to move their funds into informal instruments.

Third, the rate differential between deposits and bonds should be narrowed gradually, for example, from 20% versus 10% to 15% versus 10%, accompanied by an expansion of public access to retail government securities (surat berharga negara/SBN in Indonesian) instruments, such as ORI and SBR. In this way, the regulatory function of tax policy can operate more effectively.

If accompanied by an expansion of access to e-SBN and a strengthening of financial literacy programmes, this rate reform has the potential to increase the depth of Indonesia's financial market without sacrificing the state revenue base. (rig)

* This opinion article represents the personal views of the author and does not reflect the position of the institution at which the author is employed.