Indonesia has decided to curtail its previously planned increase in value-added tax (VAT), in response to increasing dissatisfaction from the public. The decision was made mere hours before the tax hike was due to take effect.
Originally, the tax legislation passed in 2021 had outlined an increase in VAT by one percentage point to 12% starting from January 1, following a similar increase the previous year. However, President Prabowo Subianto, at the eleventh hour, declared that the increase would only be applied to goods already subjected to luxury tax. This announcement came unexpectedly during the year-end meeting of the Finance Ministry, as reported by Bloomberg.
President Subianto confirmed that the tax hike is primarily targeted towards luxury items consumed by the wealthier demographics such as private jets, luxury yachts, and luxury residences above the median income level. This information was reported by the Jakarta Globe.
The President reassured that all other goods and services will continue being taxed at the existing 11% VAT rate and basic necessities will continue to enjoy VAT exemption.
Despite the legal mandate for the VAT increase, both business associations and union bodies in Indonesia have expressed their desire for the hike to be postponed. Their argument is based on the belief that the increase could further dampen the already slow consumption and manufacturing levels.
Finance Minister Sri Mulyani Indrawati defended the increase, arguing its necessity in maintaining fiscal health. This will undeniably be challenging under President Prabowo, who entered office with grand plans involving increased defense spending, hikes in civil servants’ salaries, and a $28 billion program for free meals for children and expectant women.
In response to public outcry, it was announced that the VAT increase would be limited to luxury goods. However, the finance ministry showed intent to broaden the tax hike, while also introducing measures to alleviate the impact on lower-income earners.
The decision to limit the planned VAT increase, which constitutes about a quarter of the country’s tax income, will undoubtedly have a fiscal effect. The country had set a tax revenue goal of 2,490.9 trillion rupiah ($157.25 billion) for the fiscal year 2025, which is 12.3% higher than the expected tax income for the current fiscal year.
Bloomberg reported that Mukhamad Misbakhun, the chair of the parliamentary commission overseeing financial matters, stated that the partial implementation of the VAT increase would likely only improve tax income by about 3.2 trillion rupiah ($191 million) compared to the 75 trillion rupiah ($4.5 billion) that was expected to be raised from a comprehensive rate hike.
Finally, President Prabowo has evidently determined that the economic disadvantages of a widespread VAT increase surpass the potential benefits for public accounts. The political implications of such a move are equally, if not more, significant. The VAT increase was a rare policy opposed by both labor and capital, and approving another increase in living costs could tarnish Prabowo’s reputation as a defender of the common people.
