Indonesia' president Joko Widodo has criticized his ministers due to the country's widening current account deficit - Photo: Privacy.

JAKARTA (TheInsiderStories) – Indonesia’s President Joko Widodo came to office with an ambitious economic and social agenda five years ago. He famously wanted to push Indonesia’s economy forward, aiming for a 7 percent growth target and introduced 12 policy packages to stimulate economic growth and create more jobs.

Very, unfortunately, their results have not been fully visible on the grounds. That growth target was not realized during his first term, with the economy growing at around 5 percent. This was in some part due to global economic circumstances such as global economic uncertainty, a slowdown in Europe and China, and a trade war between the United States and much of Asia, plus a commodities slump.

While Indonesia is on track to become a US$2 trillion economy in the next five years and a top 10 economy by 2030 or earlier, Widodo still has his work cut out to move Indonesia from an emerging market to developed country status. Millions of Indonesians still live on the poverty line.

Growth has not rapid enough in a country of 260 million people, with many young people finding it hard to get work, in part because they lack the basic vocational and practical skills to secure employment. Widodo has pledged during the presidential campaign to create 100 million jobs in the next five years, boost spending on education, and refocus from infrastructure to human capital development.

For this reason, Widodo began in 2019 by issuing a number of fiscal policies by providing incentives to investors who want to invest in Indonesia. He offered the super deductible tax policy as one of the government’ efforts to foster a conducive business climate for the growth of the country’ industrial sector.

The government has given a large tax holiday for 5-20 years. No other country has given a maximum tax holiday until then. Also provided incentives to five industrial sectors, namely food and beverages, textiles and clothing, automotive, chemicals and electronics. The five sectors are being prepared by the government towards Industry 4.0. The benefits of this policy for industry players include fiscal incentives tax allowances as well as tax holidays.

The massive provision of fiscal incentives is expected to have an impact on Indonesia’s investment realization. But the Investment Coordinating Board reported that the country recorded realization investment Rp195 trillion (US$13.73 billion) in the first quarter of 2019, far from the investment needs in 2019, around Rp5,276 trillion and 2020 are around Rp5,803-5,823 trillion.

So it’s difficult to say this tax incentive policy has been effective. Multinational companies do take into account fiscal policies related to tax incentives when they consider locating their investment, but there are also other factors such as political stability, exchange rates, labor markets, institutional conditions, and regulatory frameworks.

Some notable experts mention other problems that need to be addressed before implementing tax incentives, including poverty and inequality, rampant corruption, inadequate infrastructure, worsening economic conditions and limitations of number and capacity of tax officials.

Tax incentives could be the best tools to address these problems since foreign companies will not enter and engage in destination countries without them. These countries compete against each other to provide a better business climate for foreign investors.

Therefore, it is the duty of the government to create a safe environment to protect existing investment, although in reality that is hard to execute. Without proper planning and identification, the design and implementation of tax incentives will not be well structured.

Of all the forms of tax incentives, tax holidays (exemptions from paying tax for a certain period of time) are the most popular among developing countries. According to the UN Conference on Trade and Development, as many as 67 countries have offered tax holidays.

For each tax incentive that the government undertakes, it should be able to measure the loss of revenue from tax incentives against the benefit originating from future investment. There is no doubt that tax incentives are costly. The first and most direct associated costs are those associated with the potential loss of revenue for the authorities.

Additionally, tax breaks risk causing adverse selection problems because most of the incentives are for specific sectors and regions and not related to the performance of each entity. It is imperative that both central and local government regulations and business environments are favorable. Tax incentives may have many other, less obvious costs.

They influence the investment decisions of private investors, which can distort the allocation of resources. Those investors might just be looking for short-term profits.

Tax incentives can be justified if they address some form of market failure, most notably involving externalities (economic consequences beyond the specific beneficiary of the tax incentive), for example, incentives aimed at promoting high-technology industries that promise to confer significant positive externalities on the rest of the economy.

Nevertheless, not all incentives are equally suited for achieving such objectives and some are less cost-effective than others.

However, tax incentives are more a function of the sufficient than of the necessary. Political and macroeconomic stability, pro-business institutions and the capacity and readiness of the administration appear to be the most important determinants in foreign direct investment.

Also important is good coordination between ministries in terms of regulation synchronization and implementation. Indonesia still suffers from stiflingly complicated regulations and red tape over areas such as land permits and suffers from endemic corruption.

Moreover, local and national regulations often overlap, making it difficult for companies to maneuver through a quagmire of bureaucracy. The erratic regulatory environment and a failure to tackle bureaucratic and legal reform during this his first term, plus poor legal certainty and ideological economic nationalism, has also meant a continuation of Indonesia’s weak competitiveness in its investment climate and limited growth.

Tax incentives and other tax measures to attract foreign investments are costly and ineffective for Indonesia if not done properly. In addition, current regulations that focus on applying tax incentives based only on location, size and business sectors might create adverse selection problems.

Written by Lexy Nantu, Email: lexy@theinsiderstories.com