Effectiveness and Economic Impact of Tax Incentives in the SADC ...

3-20 EFFECTIVENESS AND IMPACT OF TAX INCENTIVES IN THE SADC REGION
Exhibit 3-6
Elimination of Tax Incentives for Indonesia, 1984
In the early 1980s nearly two-thirds of government revenue in Indonesia came from petroleum. Non-oil
revenue amounted to just 7 percent of GDP. A major reason for the low tax yield was that political pressures
over many years had produced a proliferation of tax incentives that undermined the tax base and created
bountiful opportunities for manipulation of the system.
Wary of heavy dependence on mineral revenue, the government spent two years designing an
ambitious program of tax reforms that took effect in 1984. A central feature was a cut in the company tax rate
from 45 percent to 35 percent combined with the total elimination of selective tax incentives, including tax
holidays, preferential tax rates, special investment allowances, and selective accelerated depreciation. The
elimination of incentives provoked strong resistance and widespread fear that foreign investors would shun
Indonesia in favor of countries like Malaysia and Singapore, which continued to offer generous tax holidays.
The government’s decision was driven by technical analysis showing that a uniform 35 percent rate would
be simpler to administer, less distortionary, more equitable, and less prone to evasion and corruption. Above
all, the analysis showed that many actual investment projects would not be adversely affected by offering
lower tax rates in lieu of the former incentives.
What happened? The following figure, from Wells and Allen (2001), shows that the number of FDI
projects dipped in 1984 but then climbed rapidly for the rest of the decade. In value terms, FDI fell from a
plateau achieved the previous two years, but then soared to new heights after 1987. According to Wells and
Allen, Indonesia’s share of FDI coming into the ASEAN region was nearly twice as high in 1991-96 as it was
before 1984, while the share going to Malaysia and Singapore fell. Equally important, Indonesia continued to
enjoy rapid growth and declining poverty until the onset of the Asian crisis in 1997.
Indonesia’s tax reform program demonstrated that special tax incentives are not necessary for attracting
investment or stimulating economic development. Despite this success story, pressure to restore tax
incentives has been persistent. In 1994 the government negotiated several exceptions, and in 1996
discretionary tax holidays were reintroduced by Presidential Decree. The tax holidays were dropped in 2000,
in favor of a new investment allowance and accelerated depreciation. So the controversy continues.
SOURCE: Gillis (1989); Wells & Allen (2001).