Indonesia has diluted a planned hike in the country’s value added tax (VAT) due to growing public discontent, just hours before the increase came into effect.
Under tax legislation passed in 2021, the country’s VAT rate was scheduled to increase by one percentage point to 12 percent on January 1, after rising the same amount last year. But President Prabowo Subianto announced on Tuesday that the legislated increase would only apply to goods that were already subject to a luxury tax. Bloomberg reported that this came after he “unexpectedly” attended the Finance Ministry’s year-end meeting.
“This increase is aimed at items consumed by the wealthier segments of society,” Prabowo said, according to the Jakarta Globe. “Examples include private jets, yachts, and luxury homes above the median income level.”
The Indonesian leader said that all other goods and services will still be subject to the current VAT rate of 11 percent, while Indonesia’s VAT exemption for basic necessities will remain in effect.
While the VAT increase is prescribed by law, Indonesian business associations and unions alike have called for the legislated increase to be postponed, arguing that it would depress already stagnant consumption and manufacturing levels. “The declining purchasing power will worsen market conditions, threaten business continuity, and increase the possibility of layoffs in various sectors,” Said Iqbal, president of the Indonesian Trade Union Confederation, said in a statement at the time, according to a Reuters report from November.
Finance Minister Sri Mulyani Indrawati has defended the hike on the basis that it is necessary to “maintain the health of the state budget.” Indeed, this is likely to be a challenge under Prabowo, who came to office in October with a number of ambitious spending plans, including an increase in defense spending, hikes in civil servants’ salaries, and a $28 billion program to give 83 million children and pregnant women free meals. All of these plans are designed to serve his ambitious goal of increasing annual economic growth to 8 percent by the end of his five-year term. In order to offset this spending increase, Prabowo has promised to increase revenue – but mostly by improving tax collection, rather than hiking tax rates.
On December 6, in response to public pressure, a senior politician announced that Prabowo had agreed to restrict the increase in VAT to luxury goods. However, the Finance Ministry later indicated its determination to raise the VAT across the board, albeit with additional measures to soften the blow for lower-income earners. Prabowo said on Tuesday that these measures, which include electricity discounts and other tax breaks amounting to 38.6 trillion rupiah ($2.4 billion) will still go ahead.
The decision to scale back the planned VAT tax, which makes up around a quarter of the country’s tax receipts, will clearly have a fiscal impact. In September, Indonesia set a tax revenue target of 2,490.9 trillion rupiah ($157.25 billion) for fiscal year 2025, or around 12.3 percent higher than the expected tax revenues in the current fiscal year.
According to a report by Bloomberg, Mukhamad Misbakhun, who chairs the parliamentary commission overseeing financial affairs, said that the partial implementation of the VAT hike is likely to only boost tax receipts by about 3.2 trillion rupiah ($191 million) compared with the 75 trillion rupiah ($4.5) that was set to be raised from a rate hike across the board. He described the decision to forego most of this revenue as a “difficult choice” for Prabowo’s administration.
Prabowo has now clearly decided that the economic downsides of a broad VAT hike outweigh the possible benefits in terms of the public accounts. Just as important, if not more so, are the politics of the move: the VAT hike was one of those rare policies that was opposed by both labor and capital, and approving another increase in the cost of living could undermine Prabowo’s image as a champion of the common man.
The president’s apparent intercession to restrict the tax hike could be a harbinger of more frictions between Prabowo and Sri Mulyani, who as finance minister under Prabowo’s predecessor Joko “Jokowi” Widodo, played an important role in the crafting of the 2021 tax legislation that included the VAT hikes. The purpose of this legislation was to optimize revenue collection and improve tax compliance, to offset the excessive spending that took place during the COVID-19 pandemic.
In October, Prabowo asked Sri Mulyani to stay on as finance minister, despite the open disagreements that took place between the pair during Jokowi’s second administration, when Prabowo served as defense minister. At the time, many suggested that her appointment was designed to calm international markets, which had become unsettled by Prabowo’s expansive spending plans.
The scaling back of the VAT hike is an early sign that Sri Mulyani’s conservative stewardship may come into conflict with Prabowo’s less predictable, more politically-minded approach to economic affairs.