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Indonesia’s Value Added Tax (VAT) system, responsible for roughly 28% of its tax revenue, is falling short of its potential due to loopholes, weak enforcement, and a growing informal sector. In this policy-focused piece, Ilhamy argues for a reformed VAT framework that integrates all businesses, including SMEs, into the system without overburdening them, thereby boosting transparency, compliance, and long-term revenue growth.
Key Issues in Indonesia’s Current VAT System
Low VAT-to-GDP Ratio
- Indonesia’s VAT-to-GDP ratio has stagnated at 3–3.7% over the past 15 years.
- This lags behind regional peers:
- Philippines: 4.7%
- Thailand: 4.2%
- China: 4.7%
- South Korea: 4.9%
- UK: 7.3%
Problematic VAT Threshold
- IDR 4.8 billion (US$300,000) annual revenue threshold for VAT registration.
- Originally designed to protect SMEs from compliance burdens.
- This is exploited by businesses splitting operations across multiple entities to avoid VAT.
- This leads to unfair competition and significant tax leakage.
Policy Shifts and Proposed Solutions
2021 Tax Harmonisation Law
- Reclassified previously non-taxable goods/services as Taxable, though many remain VAT-exempt.
- Purpose: To bring these transactions into the VAT system for better monitoring and transparency, not necessarily to increase tax burdens.
A New Approach to SMEs and VAT
- Shift from a “register or don’t” model to one where:
- All businesses are registered in the VAT system.
- Only some are required to collect VAT, depending on size or risk.
- SMEs could:
- Be exempt from collecting VAT, but
- Be required to issue tax invoices, ensuring transaction data is recorded.
Equity and Efficiency Gains
- Stops larger businesses from manipulating thresholds.
- Encourages a fairer playing field where all economic activity is captured.
- Supports legitimate SMEs by simplifying compliance and avoiding overregulation.
Benefits of Reform
- Increased revenue without hiking VAT rates.
- Improved data collection and enforcement.
- A more competitive business environment, where rules apply equally.
- Supports sustainable growth and fiscal stability.
Author’s Perspective
Ilhamy emphasizes that VAT reform isn’t about raising taxes. It’s about creating a transparent, inclusive system. Capturing all economic activity without penalizing small businesses will enable the government to plug tax leaks, support honest entrepreneurs, and build a fairer economy.
“The ultimate goal of taxation is not just to generate revenue, but to create a balanced and sustainable economic ecosystem.” Agatha Bagus Ilhamy
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