High entry costs for business are strongly correlated with the size of the unofficial economy. Shutterstock.com/Vector1st

E-government can reduce Indonesia’s shadow economy and increase tax revenue

Indonesia claims its tax amnesty as one of the most successful in the world. But its shadow economy – a range of activities not included in the national accounts – is keeping the country back from reaching its tax revenue potential.

Last year, Indonesia introduced a tax amnesty to increase the country’s meagre revenue. By March 2017 – when the program ended – Indonesia had collected Rp 147 trillion, or about 1.1% of GDP. This is considered the highest rate of return of any tax amnesty program in the world.

But Indonesia could have gained up to US$18 billion, or Rp 237 trillion, in extra revenue had the government managed to tackle shadow activities.

Shadow economy

Some researchers define the shadow economy as all unregistered economic activities. This would include anything from street vendors and home industries to unregistered full-scale factories.

Economist Friedrich Schneider defines the shadow economy as activities intentionally hidden from authorities to avoid payment of taxes and other obligations.

Indonesia’s shadow economy averaged around 19% of GDP between 2003 and 2013, according to Schneider’s report for the World Bank. With a GDP of US$861.9 billion in 2015, according to the World Bank, this means Indonesia’s shadow economy is worth about US$164 billion.

The additional US$18 billion tax revenue is estimated by taking into account Indonesia’s 11% tax-to-GDP ratio.

Estimating the size of shadow economy

We can estimate the shadow economy through indicators such as:

  • tax burdens: the greater the difference between total cost of labour and after-tax earnings, the bigger the incentive to work in the shadows

  • ease of doing business index: the longer it takes to open a business and the higher the cost to start a business or get a licence, the lower a country’s ease of doing business – a situation in which businesses would most likely work in the shadows

  • the amount of cash in circulation: the more cash in circulation the bigger the shadow economy, assuming that shadow transactions mostly occur in the form of cash payments, so as to leave no observable traces for authorities

  • unemployment rate: a high rate might force people to work in shadow activities.

Indonesia’s shadow economy is smaller than other developing nations in the region such as Malaysia (35% of GDP), the Philippines (37%) and Thailand (57%). Singapore at 13% and Vietnam at 18% are the only ASEAN countries with lower ratios than Indonesia.

Nonetheless, with Indonesia having the biggest GDP in the region, the value of the nation’s shadow economy is very large compared with these neighbours.

What it takes to set up a business in Indonesia

High entry costs for business are strongly correlated with the size of the unofficial economy.

In Indonesia, the cost for business start-up procedures) in 2016 was 20.3% of gross national income (GNI) per capita. That’s among the highest in the region, compared with Malaysia (6.2%), Thailand (6.6%) and Vietnam (4.6%).

This means an aspiring entrepreneur in Indonesia would need to retain at least 20.3% of their annual income just to obtain licences or register their fledgling business, in addition to the capital they need to operate the business.

Beyond the tax amnesty program, there is a need for greater reforms aimed at reducing the costs of doing business.

The government could expect to increase the tax base and reduce the size of the shadow economy by reducing the number of days, procedures and office visits needed to register a business.

The role of e-government

Many studies have found that implementing e-government will ease the handling of administrative tasks, reduce administrative costs and streamline administrative procedures by following the once-only principle.

The once-only principle means citizens and businesses are required to provide information to the government only once. Government offices would share this information internally through their e-government system.

By integrating data systems, the government reduces the need for citizens to provide the same data multiple times. In a country like Sweden, for instance, citizens just need to register their whereabouts once at the tax office (Skatteverket). The data will then be shared among government institutions.

Wherever required for accessing public services such as education, health and taxation, a citizen need only mention their person number (personnummer). The same happens for business purposes.

Jakarta’s Pelayanan Terpadu Satu Pintu (PTSP) (one-stop service office) is a good initiative that provides one access point for all public services (registration of business, document submission, etc).

But Indonesia is still among the region’s poorest performers in implementing e-government. It’s above Myanmar, Lao and Cambodia, but below China, India and ASEAN neighbours Singapore, Malaysia, Thailand and the Philippines.

Data from the United Nations Department of Economic and Social Affairs (UNDESA) show that Indonesia’s e-government index of 0.45 ranked the country 116th of 193 countries.

Towards better e-government

In 2014, the government released the Indonesian Broadband Plan that envisions better e-government. The aim is to improve citizens’ access to education and health and to make it easier for businesses to arrange logistics and procurement.

The plan involves several stakeholders (e.g. Ministry of Finance, Ministry of Internal Affairs, Ministry of ICT, the Central Bank). But it lacks a directive on which agency is in charge of co-ordination between institutions.

Considering the value of a sound e-government strategy, it’s important for the government to set up a specialised unit to direct the strategy and ensure the compliance of all institutions involved. Whether the unit is a new ministerial-level one or is placed under an existing ministry, it’s important that it has a well-defined, strong and recognised mandate.