Tax hikes pose risks to Indonesia's GDP and inflation outlook: Citi

TAX hikes that Indonesia is contemplating could be "disproportionately" focused on households, posing downside risk to the country's GDP (gross domestic product) growth and upside risk to CPI (consumer price index) inflation in 2022, said a Citi Research report by economist Helmi Arman on Monday.

Last Thursday, Finance Minister Sri Mulyani Indrawati proposed tax reforms in Parliament, including new levies to help Indonesia boost next year's revenues while reducing the budget deficit, as reported by Reuters.

The policy reform is aimed at expanding the tax base and finding new sources of revenue by improving value-added tax (VAT) collection and reducing its regressiveness, said the minister. She also proposed changes to individual income tax policy, and a carbon tax.

The proposal was met with objections by several lawmakers, who warned against hiking taxes before a full economic recovery.

On Monday, the minister provided more details in a broadcast meeting with Parliament's finance commission, saying she planned to introduce a new band in individual income tax to charge 35 per cent for a portion of income on "high wealth individuals" making more than five billion rupiah (S$463,200) a year.

But there would be no change in rates for the majority of taxpayers, she said.

Indonesia's fiscal rules were temporarily relaxed for 2020-22, to fund the pandemic response. Normally, Indonesia's budget deficit is capped at 3 per cent of GDP, and maximum government outstanding debt is capped at 60 per cent of GDP.

Indonesian officials have signalled their intent to bring the deficit back under 3 per cent of GDP by 2023. The fiscal deficit for 2022 is targeted at between 4.5 and 4.9 per cent of GDP, compared to an estimated shortfall of 5.7 per cent in 2021. President Joko Widodo is scheduled to present a more detailed budget proposal for 2022 in August.

With high political hurdles against the cutting of expenditures, fiscal consolidation in 2022 is likely to be primarily pursued by boosting revenues instead, said Mr Helmi in the Citi report.

Furthermore, with corporate income tax rates having recently been lowered - from 25 per cent to 22 per cent last year, and with a second cut to 20 per cent due for next year - the brunt of the hikes is likely to fall on households and consumers instead.

This could pose downside risk to the 2022 GDP growth outlook, by restraining the recovery of household consumption at a time when consumer confidence has not fully recovered.

Mr Helmi pointed out that despite advances in export diversification, corporate capex cycles in Indonesia are "still very much" a function of how industries view the household consumption outlook.

The measures could also cast "non-negligible" upside risk to CPI inflation. Mr Helmi estimates that in a scenario where the blended VAT rate increases by five percentage points, and VAT exemptions are removed except for staple foods, CPI inflation could be about one percentage point higher than the baseline.

Additional upside could materialise if increases in non-tax revenues lead to a hike in the price of certain public services.

Hence, Citi now deems it more likely to see CPI inflation heading towards the upper bound of Bank Indonesia's (BI) 2-4 per cent inflation target in 2022.

"We sense that a rise of inflation towards BI's inflation target range will not be viewed negatively by policymakers," said Mr Helmi. "Instead it may be welcomed as a confirmation that domestic demand is recovering."

"In such a setting, policymakers will likely be gradual in their exit from loose monetary policy," he added, concluding that the hurdles for both hiking and cutting rates in 2021 still seem high.