Tax Reform Direction: Boosting Revenues, Reducing Disputes

This article and the one discussing withholding tax have served as references by the OECD in formulating recommendations for improving Indonesia’s tax system.

The Changing Tax Landscape

Today we are witnessing drastic changes in the tax domain, both globally and domestically. Tax matters have become a top priority in the global agenda, focusing on the exchange of information, revenue mobilisation and tackling tax avoidance. Domestically, the urgency to fund development—without sound revenue performance—has become a growing concern.

To date, the tax to Gross Domestic Product (GDP or Produk Domestik Bruto/PDB in Indonesian) ratio in Indonesia has levelled at 11% for the past five years, noticeably below the world average of 16%. This is attributed to low tax compliance, tax leakage, the size of the shadow economy, the lack of elasticity of tax revenue to economic growth, imbalanced revenue structure and so forth. These challenges have prompted comprehensive tax reform initiatives, starting with the tax amnesty programme.

The revision of the tax law package, institutional transformation within the Directorate General of Taxes (DGT) and adoption of policies subject to global consensus are among the components in Indonesia's ongoing tax reform agenda. These initiatives engender optimism for a more robust tax system, which is expected to impact revenues. However, such changes often come with frequently overlooked side effects. Post-tax amnesty law enforcement, the strengthening of the capacity of tax authority institutions, availability of information in the transparency era and changes in tax law that demand adjustments, contribute to a higher risk of tax disputes. This is particularly relevant in the context of Indonesia, where there are issues of asymmetric information and the lack of a tax-literate society as noted by the author (Darussalam, 2015).

Tax disputes, though inevitable in the tax system, negatively impact compliance in two major ways. First, the rise of disputes leads to uncertainty and undermines trust in the tax system (Gangl, et.al., 2012). Second, disputes result in substantial compliance costs due to the time, effort and financial resources required (Vaillancourt, et.al., 2016). As such, shifts in the tax landscape may be counterproductive to long-term compliance.

The momentum of tax reform should be leveraged to redesign our tax system in a way that on the one hand, ensures sustainable revenues and on the other hand, minimises disputes. Simply put, plucking the goose without making it squeal.

Tax System Design

Enhancing revenues with minimum disputes is achievable. A minimum of ten key aspects should be taken into account, as follows.

First, one contributing factor to disputes is the lack of participation of stakeholders in the process of drafting policies and designing tax laws (Wales and Wales, 2012). A transparent and inclusive policy-making process supported by robust institutions and the availability of tax experts will ensure ideal outcomes and broader public acceptance.

Second, targeting tax revenues. Which parties constitute the targets and how such targets are set play a major role. The government, as the body responsible for setting the targets, must be capable of projecting ideal tax revenues, whereas the legislature must be able to assess the feasibility of such targets through meticulous and informed debates. To set realistic tax target figures, institutions tasked with formulating tax policies and administration must be actively involved.

Third, the obsession with achieving targets or compensating for shortfalls tends to promote a short-term mindset that may result in frequent changes in tax regulations. Instability and lack of unpredictability in the tax system may lead to the risk of unforeseen disputes (unintended tax consequences). As such, tax collection administrative cost and cost of compliance rise, leading to an inefficient economic system (Bird and Zolt, 2003). A stable tax system is a must for fostering credibility, reputation and investor trust. This does not imply that the tax system is not responsive to the rapid changes in the landscape but changes should be introduced gradually by considering long-term interests and projections (Bird and Martinez-Vazquez, 2014).

Fourth, from an administrative standpoint, it is essential to revise the performance measurement indicators for tax authorities, so they are not solely oriented towards revenue. As elaborated by Crandall (2010), the strategic objectives of the tax authority should include efforts to promote compliance, improve productivity and efficiency of tax collection, service orientation and ensure that tax revenues are sufficient to cover government spending. Therefore, other indicators, such as tax collection administrative costs, taxpayer satisfaction, scope of tax socialisation, effectiveness of audits and time required for dispute resolution are also equally important.

Fifth, the government must shift away from a compulsive approach and avoid the paradigm that the tax court is the ‘last resort’ that decides disputes (Butani, 2016). The principle of think before act (of filing appeal) promoted by the National Litigation Policy formulated by the Ministry of Law and Justice, Government of India in 2010, can serve as a valuable reference. When deciding to continue a tax dispute to the courts, the government should conduct a thorough review and cost-benefit analysis. This also includes refraining from appealing the same and repeated as well as factual (non-interpretive) disputes.

Sixth, designing clear, detailed, simple and legally certain tax laws to eliminate any ambiguity, multiple interpretations and inconsistency in their application. In addition, in practice, the laws must be expressly clarified in administrative guidelines to avoid interpretations based on personal discretion (de Cogan, 2011).

Seventh, a new framework for taxpayer compliance grounded in enhanced relationships or frequently coined as cooperative compliance (Veldhuizen, 2015). This new paradigm requires a relationship founded on transparency, openness, mutual trust and mutual understanding between taxpayers, tax authorities and tax consultants. Ultimately, potential tax disputes may be identified and discussed before escalating into a matter in dispute. In other words, tax disputes can be resolved at an early stage.

Eighth, filing objections and appeals is one of taxpayers’ fundamentals. However, the imposition of a 50% surcharge on the disputed tax amount that is not paid if the objection is rejected and a 100% surcharge in the amount of the appeal is denied, has hindered taxpayers’ efforts to seek justice and undermined the proportionality aspect in the tax system. This obligation can be perceived as a scare tactic that pressures taxpayers to pay the disputed amount in advance to avoid the surcharge penalty. As a result, a moral hazard tends to develop among the taxpayers in the appeal process to go to great lengths to win the disputes and the tax authorities become more inclined to ‘conveniently’ escalate disputes to the appeal stage.

Ninth, in terms of tax disputes, it is worth exploring legal procedures for resolving disputes outside the courts, commonly referred to as alternative dispute resolution (ADR) (Thuronyi, 2013). Methods such as mediation, consultation and so forth, are expected to generate a more efficient and effective dispute resolution process as well as lower the number of appeals and lawsuits in the tax court. Statistics released by the Tax Court Secretariat (2016) may offer some perspective. In 2015 alone, over 25,000 appeals and lawsuits were filed to the Tax Court. Moreover, the annual ratio of decisions to case files continues to decline, standing as low as 36% in 2015.

Tenth, strengthening the capacity of both the Tax Court and the Tax Supervisory Committee (tax ombudsman) as key institutions that protect taxpayer rights. The institutional strengthening should be supported by efforts to improve accountability and transparency.

To sum up, the above-mentioned ten points are rooted in the principle of fiscal justice, which encompasses legal certainty, fairness, adherence to the law, non-retroactivity, efficiency and collection by institutions trusted by the public (Vanistendael, 1996). Further, upholding this principle will foster a tax system characterised by tax compliance, stability, certainty, inclusivity and adaptability to changing times. Thus, it is possible to increase tax revenues while minimising disputes.

This article was published in the book titled Menuju Ketangguhan Ekonomi: Sumbang Saran 100 Ekonom Indonesia, (Jakarta: Kompas, 2017), 30-34.