The Threat of Reflation and Tax Challenges in 2023

Indonesia has just completed its role as the host of the G20 Summit in Bali. This big celebration resulted in a 52-point declaration of principles towards various global economic and security issues—the recurring, mutating, and constantly relocating issues. 

A series of classic issues being the subject of discussion by the leaders of the countries controlling the global economy included geopolitical tensions, supply chain disruptions, food and energy crises, soaring inflation, rising financial risks, to systemic dangers that are often overlooked: climate change and corruption. 

The huge impact of the Covid-19 pandemic has not yet subsided, yet the prolonged Russian-Ukrainian war has actually triggered a new crisis in parts of Europe, and the effects quickly spread to various parts of the world. Gas and grain supplies are disrupted, world food and energy prices are soaring, an economic recession and waves of layoffs are becoming more and more inevitable as well.  

The majority of European Union (EU) countries are currently faced with relatively similar problems to its ally, the United States (US): economic contraction and high inflation. 

The United Kingdom (UK) economy, for example, was minus 0.2% in the third quarter of 2022, and the inflation reached the highest record in the last forty years (10.1%). 

According to the Office for Budget Responsibility (OBR), the UK economy will contract by 1.4% and enter a recession in 2023. The Bank of England was forced to tighten the monetary policy by raising interest rates by up to 200% since the beginning of this year. 

Previously, the US inflation reached 8.6% in June 2022, which was the highest level in 41 years. The Federal Reserve (Fed) even had to raise the Fed Funds Rate (FFR) by 200% throughout 2022 to 3.25%. Despite triggering capital withdrawals from developing countries, the Fed's policies have so far been effective in turning the US economy from negative 0.9% in the second quarter to growing by 2.6% in the third quarter of 2022. 

This fact led a number of international financial institutions to lower their predictions for global economic growth in 2023. 

The Organisation for Economic Co-operation and Development (OECD) cut the global economic growth outlook for 2023 to 2.2% from the previous prediction of 2.8%. 

Meanwhile, the International Monetary Fund (IMF) revised down its projection for next year’s world economy to 2.7% from 2.9%. In fact, the IMF predicted that 31 countries that contribute 43% of the global economy will be threatened with recession in 2023. This means that almost half of the world's economic powers will experience negative growth next year. 

Fiscal Risk 

The World Bank has warned of potential further dangers from the economic slowdown and high inflation, especially to the fiscal health of each country. 

First, the increasing economic burden on the people due to rising prices of goods and services often demands an economic stimulus to maintaining the purchasing power. As a result, high inflation usually does not only trigger drastic policy changes from the monetary but also the fiscal side. 

The problem is, due to the Covid-19 pandemic, practically almost all countries have recently granted significant tax incentives. Extending the provision of stimuli certainly contradicts the fiscal normalization phase, which requires more tax revenue to patch up an overly large deficit. 

Additionally, inflation frequently disturbs the cycle of tax revenue. This is because the increasing economic burden due to the rising prices of goods and services often forces business actors to postpone paying their taxes. 

For multinational companies, the effect of inflation usually triggers cost allocation problems and uncertainty of transfer pricing. Citing the International Tax Review, the complications of supply chain disruptions and rising prices have made the data collected less reliable than before. 

Policy Response  

With a growth rate of 5.72% in the third quarter of 2022, the Indonesian economy at least still remains quite robust. However, Indonesia still has to keep an eye on the recent spike in inflation since it reached 5.72 % in October 2022, far from the target of 3% in the 2022 State Budget. 

At least Indonesia can learn from the policy responses of several countries in dealing with the crises. 

The UK, for example, when led by Prime Minister Liz Truss, announced massive tax cuts.  Instead of avoiding the threat of a recession, this policy actually triggered a spike in inflation and caused turmoil in financial markets. This is because tax cuts tend to be contradictory to the central bank’s tight monetary policy. 

After Rishi Sunak came to power, the UK targeted budget savings of up to £55 billion, such as by cutting spending, reducing tax incentives, and expanding the tax base. 

A number of EU countries have also started to restrict the tax stimulus, among other things, by limiting Value Added Tax (VAT) relief to only food products and renewable energy which are widely consumed by the public. The goal is to maintain people's purchasing power and economic growth. 

Belgium, for instance, lowered the VAT rate from 21% to 6% only for the use of solar panels, heat pumps, and solar water heaters.  Meanwhile, Poland exempted VAT only on the consumption of staple food.  

Then, Luxembourg limited the VAT rate cut from 17% to 16% for only one year or until 2023. Meanwhile, Bulgaria exempted VAT only on bakery products until 1 July 2023. 

In general, the EU has avoided the policy of cutting VAT on petrol and diesel even though both are triggers for inflation.  The reason is political, that the policy is considered only benefitting Russia as the culprit of the energy crisis. 

Indonesia's Challenges 

Back to Indonesia, 2023 is the deadline for the fiscal deficit normalization to return to 3% of the Gross Domestic Product (GDP). In addition, starting next year, Bank Indonesia (BI) will no longer provide assistance of State Budget financing through the burden sharing scheme (buying the government bonds). 

For this reason, the government must be able to optimize the role of the State Budget as a shock absorber for the global recession, namely by optimizing tax revenue, reducing dependence on debt, and prioritizing the budget only for urgent needs. 

To increase revenue, the expansion of the tax base needs to be encouraged, especially by optimizing the imposition of taxes on economic sectors that have not been impacted by the system (underground economy). 

The collection of taxes from digital economic activities needs to be intensified, such as the collection of VAT on trade transactions through electronic systems (PMSE), cryptocurrency transactions, to the technology-based financial industry (Fintech). 

Speaking of economic stimuli, tax incentives are actually still needed.  However, the distribution must be selective and more measurable. We don’t want Badan Pemeriksa Keuangan (BPK) to find yet another misdirected provision of incentives just like those found during the pandemic. A thorough evaluation needs to be conducted, and the economic sectors that are starting to recover should be excluded from the list of those eligible for tax incentives.  

The government is also demanded to improve tax compliance through proportionate means, without causing commotion and concern for taxpayers. Inconsistencies of law enforcement frequently highlighted by the taxpayers need to be considered and corrected. 

On the other hand, taxpayers need to reduce their dependence on incentives and be prepared if the stimulus is reduced or withdrawn. Compliance also needs to be improved by ensuring that no tax provisions are violated. This is important in order to minimize risks and reduce tax costs in the future. 

Keep in mind that 2023 will not be an easy year. The government and taxpayers should not rub salt into the wound?—affected by the crisis, entangled in debt, and then burdened with problematic taxes. (AGS)

 

*Author: Asep M. Zatnika, Researcher at MUC Tax Research Institute

**Article published in Kumparan, December 8, 2022

Disclaimer! This article is a personal opinion and does not reflect the policies of the institution where the author works.