Indonesia has found itself at the center of economic debates following the government’s controversial decision to revise its value-added tax (VAT) policy. Initially set to increase from 11 to 12 percent across the board, the VAT hike was intended to boost state revenue and address the country’s low tax-to-gross domestic product (GDP) ratio, which stands at approximately 10.5 percent. However, the government revised this plan on December 31, 2024, announcing that the VAT increase would now only apply to luxury goods. This shift has left businesses and investors in a state of uncertainty, questioning Indonesia’s financial stability and strategic direction.
The initial proposal for a VAT increase aimed at generating funds for critical infrastructure and educational investments. Indonesia's tax-to-GDP ratio lags behind its peers, creating a pressing need for fiscal reform. The country hoped that by raising its VAT, it could better support essential public services and bolster economic growth. However, the economic landscape presents its own challenges. In the third quarter of 2024, Indonesia's economic growth slowed to 4.95 percent, with households facing stagnant wages and declining public services.
Regionally, Indonesia's VAT rate remains competitive despite these challenges. While Thailand maintains a lower VAT rate of 7 percent, both the Philippines and Vietnam have VAT rates of 12 and 10 percent, respectively. Nonetheless, President Prabowo Subianto's announcement to limit the VAT increase to luxury goods reflects a strategic pivot amidst concerns of its impact on the broader economy.
The decision to alter the VAT increase plan has not come without repercussions. Indonesia's middle class has been shrinking significantly, dropping from 23 percent of the population in 2018 to 17 percent in 2023. This demographic shift underscores the broader economic pressures faced by Indonesian households. Furthermore, the government's hesitance and indecision have raised concerns among investors and businesses about the country's reliability as a stable investment destination.
Indonesia's low tax-to-GDP ratio and indecisive policy-making have consequently eroded its reputation for stability and predictability in business circles. As businesses adapt to the revised VAT policy, they remain wary of further potential policy shifts that could impact their operations and profitability.
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