Page 8 - Working Paper (Tax Incentives: An Alternative to Revenue Enhancement)
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DDTC Working Paper 1115

                   many other less obvious costs. They influence the   climate . Tax policies, according to recent studies,
                   investment decisions  of  private investors,  which   become more important  as a  determinant to
                   can  distort the allocation  of resources. Those   foreign investments. Increasing regional economic
                   investors might just want to get short-term profits.   integration has driven tax policies as an important
                   Another cost relates to tax  authorities’ limited   determinant to attract foreign investment.
                   capacity  and capability  leading to unachievable
                   incentives targets.                                 Foreign investments are also influenced by an
                                                                    accelerated revision of the Revised Negative Lists
                                                                    (Daftar Negatif List – DNI) on foreign investment
                            Figure 1 - The Theory Investment        across  business  sectors.  The  principle of
                                                                    government strategies to keep revising the DNI is
                         Rate of Return
                                                                    to incorporate on foreign equity investment which
                                                                    apply in some sectors (e.g. horticulture sector), but
                                                                    provides clarity and relaxation for foreign equity in
                                                                    other sectors such as tourism and transport.
                                                                    5. Indonesia’s Experience with Tax
                                                  product of                  The governmenT is offering
                                                  capital                  various Type of Tax incenTives
                                                                                 such as Tax holidays; Tax
                                                                          allowances for invesTmenT in
                                   I   I*            Investment              cerTain business secTors or
                                                                       regions; simplificaTion of income
                                                                           Tax calculaTion wiTh cerTain
                      Tax incentives can be justified if they address   amounT of gross income; income
                   some  form of market failure, most notably those   Tax reducTions for publicly lisTed
                   involving externalities (economic  consequences
                   beyond  the  specific  beneficiary  of  the  tax   companies; and Tax reducTions for
                   incentive). For  example,  incentives targeted to      residenT corporaTe Taxpayers.
                   promote high-technology industries that promise
                   to  confer  significant  positive  externalities  on  the   In 2015, the Government has conducted various
                   rest of the economy are usually legitimate. By far   fiscal  and  monetary  mix  policies  to  anticipate
                   the most  compelling  case for granting  targeted   challenging global economic trends that affecting
                   incentives is for meeting regional  development   Indonesia’s economy. Following the Budget
                   needs  of  these  countries.  Nevertheless,  not  all   Revision in January 2015, the Government needs
                   incentives are equally suited for achieving such   to execute its reform agenda that are particularly
                   objectives and some are less cost-effective than   infrastructure, maritime, agriculture, and social
                   others. Unfortunately, the most prevalent forms of   programs. Effective execution of the budget  will
                   incentives found in developing countries tend to be   require increasing in budgeted revenues. However,
                   the least meritorious.                           the Governments will  likely face the challenge
                                                                    of adjusting  spending to account  for lower than
                      Previous research identified that the statistical
                                                                    expected realized revenues. Tax revenue accounted
                   determinants of the location  of investment are
                                                                    only 94 percent of the 2014 revised budget target
                   market  size,  labor  cost,  infrastructure  quality,
                                                                    of  IDR  1,635.4  trillion.  Lower  value-added  tax
                   share of industry to Gross Domestic Product, level
                                                                    (VAT) growth was a major contribution to the weak
                   of  FDI,  growing  domestic  markets,  and  stable
                                                                    performance  of  revenue  in  2014.  VAT  collection
                   international relations . Over the past few decades
                                                                    growth in 2014 was only 5.8 percent, relative to an
                   time-series  econometric  analysis  and numerous
                                                                    18.8 percent average for 2009 – 2013 and only 85.1
                   surveys of international investors have shown that
                                                                    percent relative to the revised 2014 Budget target.
                   tax incentives are not the most influential factor for
                   multinationals  in selecting investment locations.
                   Both analysis and surveys have confirmed that tax
                   incentives are poor instrument for compensating     The  introduction  of  a  final  tax  of  1  percent
                   for  negative factors  in a country’s investment   on  annual  gross  turnover  for  small  medium
                                                                    enterprises  with  gross  turnover  below  IDR  4.8
                   18. United Nations,” Report of the International Conference on Financing
                   for Development,” Monterrey, Mexico, Mar. 18-22, 2002.  19. Morisset, Jacquest, Op.Cit., page 2
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