Bridging The Predictability Gap: Rationalizing Indonesia’s Tax Incentive Policy In Special Economic Zones – OpEd
A central concern in today’s global political economy, particularly amidst the rise of geoeconomics and renewed industrial policy, is the convergence of tax, trade, and investment agendas. Over the last decade, tax agenda has brought the extensive reform for global economic governance, which is by OECD-led international tax regime. Ranging from Global Forum on Transparency and Exchange of Information for Tax Purposes to Base Erosion and Profit Shifting 1.0 and now 2.0, all these initiatives have drastically transformed the progress of trade and FDI activities. Emerging economies, including Indonesia, become active stakeholders in grasping this momentum.
One promising discourse emerging at the intersection of “back to industrialization-driven development” and the increasing integration of tax, trade, and FDI is about location-place based policy. The term of location-based policy is a target specific geographic area for special treatment, in order to accelerate national growth with industrialization and development.
The Special Economic Zones (SEZs) are a widely adopted, high-intensity form of location-based policy among emerging markets and developing nations. The early political economy of SEZs suggests a dichotomy, in the right institutional context, SEZs tend to promote economic growth. Conversely, in the wrong institutional context, they tend to foster misallocated investments and skewed incentives. Understanding the role of tax incentives or tax breaks is therefore essential to analysing SEZ outcomes.
Since the enactment of its first income tax law in 1983, Indonesia has used several tax incentives to attract FDI, including tax allowance, reduced tax rate, and location-based investment tax incentive. Prior to this, tax holiday for FDI treatment has instead introduced in 1967 under the FDI law. Indonesia has been through a few location-based economic policy, from Free Trade Zone (FTZ), Bonded Zone (BZ), and Integrated Economic Development Area (KAPET). The new one is Special Economic Zones (SEZs), which launched in 2009.
Under the New Order regime, Batam Island became a notable success story in Indonesia’s location-based investment, transitioning from a dedicated industrial project in the 1970s to a Free Trade Zone by the 2000s. Subsequently, during the transition toward democracy (the reformasi era), Indonesia introduced the Integrated Economic Development Area (KAPET). This policy coincided with the country’s “big bang” decentralization, which involved the significant transfer of administrative and fiscal authority from the central government to regional governments. Unfortunately, while offering tax breaks, the KAPET policy suffered from several problems, primarily due to the lack of quality infrastructure in regions outside Java.
In 2009, one decade after the democratic transition, Indonesia relaunched its commitment to location-based economic policy with the establishment of Special Economic Zones (SEZs). It can be said that Special Economic Zones (SEZs) constitute the government’s most significant strategic deployment of tax incentives. From an economic well-being discourse, the social outcomes linked to place-based policy strategies of SEZs remain debatable, presenting varied outcomes. From political economy perspectives, their performance and impact on the economy and structural transformation are also quite mixed.
The World Bank’s 2019 report on Indonesia’s place-based policies states that, based on the country’s history, place-based investment tax incentives have neither driven growth nor generated sustainable productivity effects needed to improve national welfare. Instead, it is only become a wasteful tax giveaway.
One discovery also highlights the need to rethink tax incentive policies due to the minimal actualization of labour absorption and investment goals within the SEZs. Framing this performance, it is clear that the management of tax incentives under the Special Economic Zones (KEK) seems not optimal.
We must ensure that this picture does not continue to demonstrate that the tax incentives were only effective at securing large, theoretical investment commitments, but fail to realistically guarantee operational success that benefits Indonesia’s working population and drives the substantive economy. In other words, it is crucial to conduct regular assessments of tax incentives to verify that they encourage investment and contribute to the development of both the SEZ and the national growth.
Furthermore, the rise of OECD-led multilateral tax regime, specifically Pillar 2 in BEPS 2.0 with its implementation, shows a real challenge to country take a preferential tax regime in SEZs. So, both limited achievement in SEZs and global minimum tax create the momentum for the Government of Indonesia to re-strategize its package of tax incentives in SEZs.
Amid global minimum tax implementation, the government must take a step back to re-evaluate its preferential tax regime in SEZs, using it more wisely and sparingly, as generous and short-sighted exemptions narrow the tax base, reduce overall revenue potential, and distort the substance economy. Following numerous expert and scholar recommendations, it is time for Indonesia to intensify its efforts in providing well-established non-fiscal incentives in SEZs, including a secure investment climate and improved infrastructure.
About the authors:
- Andi Mohammad Ilham is a graduate of the School of Government and International Relations, Griffith University. He is currently a Tax Researcher at MMStax Consulting, Indonesia. His research area focuses on the International Political Economy of Global Tax Governance.
- Andi Mohammad Johan holds a Master of Tax Policy at the University of Indonesia. He is a Partner at MMStax Consulting, Indonesia, and a member of the Indonesian Tax Consultants Association (ITCA).
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