VAT Rate Increase to 12 Percent in Indonesia: Challenges and Opportunities

By Muchamad Irham Fathoni, a Directorate General of Taxes officer

The Indonesian Government has decided to increase the Value Added Tax (VAT) rate from 10 percent to 11 percent starting April 1, 2022, and will increase on January 1, 2025, to 12 percent. The increase in the VAT rate to 12 percent is one of the tax adjustment plans stipulated in Law Number 7 of 2021 concerning Harmonisation of Tax Regulations (UU HPP).

This policy was part of the Government's strategy to increase state revenue and restore the economy. Strong state revenue is required to maintain the sustainability of a healthy State Budget in financing development. For this reason, the foundation of the tax system needs sustainable improvement. However, the increase in VAT rates also poses various challenges and opportunities for the business environment in Indonesia.

One of the main challenges of the VAT rate increase is its impact on people's purchasing power. With the rise in the prices of goods and services due to higher VAT, people with limited income will find it increasingly difficult to fulfill their daily needs. This may lead to a decline in consumption and reduced economic growth. In addition, price increases due to VAT may reduce consumer demand, as some may delay or reduce purchases of affected goods/services.

On the other hand, an increase in the VAT rate can also create an excellent opportunity for the Government to increase state revenue. With a higher VAT rate, tax revenue is expected to grow significantly. These additional funds can be utilized to finance various development programs and strengthen infrastructure, which in turn can boost long-term economic growth.

Indonesia's tax ratio is still relatively low among other developing countries, with an average of 27,8 percent. To improve the tax ratio and tax revenue, the Government has made various efforts through reforming and harmonizing tax regulations, one of which is by increasing the VAT rate to 11 percent and 12 percent in 2025. With the implementation of this tax reform, there has been an excellent increase in the tax ratio. Indonesia's tax ratio in 2023 was recorded at 10.21 percent of Gross Domestic Product (GDP). This tax ratio has increased compared to the 2022 tax ratio of 10.08 percent and the 2021 tax ratio of 9.21 percent.

Since the VAT system was introduced in Indonesia in 1984, the VAT rate has never been adjusted. OECD Revenue Statistics data shows that 37 countries have increased VAT rates in the last decade. Globally, the VAT rate in Indonesia is relatively lower than the world average of 15,4 percent and also lower than other countries, such as the Philippines (12 percent), China (13 percent), Saudi Arabia (15 percent), Pakistan (17 percent), and India (18 percent).

The structural reforms undertaken by the Government, such as the Job Creation Law, the Harmonization of Tax Regulations Law, and tax reform, will create more significant fiscal space through improved tax administration. This will lead to more inclusive and sustainable economic growth.

Regarding the increase in VAT rates, the Government will continue to formulate balanced policies to support economic recovery, help vulnerable and underprivileged groups, and support the business world, especially small and medium-sized enterprises, while still considering the country's financial health for a sustainable state life. The Government continues to analyze the impact of cost adjustments on low-income groups. Certain goods and services are still given VAT-free facilities and are not subject to VAT.

The VAT rate adjustment is accompanied by various supports for vulnerable economic communities and MSMEs. These include reducing the Individual Income Tax rate on taxable income of IDR50 million to IDR60 million from 15 percent to 5 percent. Then, there is a tax exemption for individual taxpayers who are MSME players with a turnover of up to IDR 500 million. Accelerated VAT restitution services up to IDR 5 billion are also still provided.

For businesses, the increase in VAT rates can be a challenge. Companies will have to adjust the price of their products or services to accommodate the higher VAT rate, which may impact competitiveness and profit margins. However, the increase in VAT rates can also encourage companies to be more efficient and innovative in running their businesses. Companies can leverage better technology and business strategies to optimize their operations and maintain profitability.

In dealing with this VAT rate increase, the Government, the community, and the business world must work together to minimize the negative impacts and maximize the opportunities. The Government will provide incentives and facilities for businesses and ensure that state revenue from VAT increases is used effectively for the welfare of society.

With good cooperation and adaptation from all parties, the VAT rate increase is expected to be an effective measure to strengthen Indonesia's economy in the future and ensure strong and resilient fiscal sustainability in the long run. Meanwhile, there are challenges to be faced, and opportunities for growth and progress are also wide open.*

*) This article is the author's personal opinion and does not reflect the attitude of the agency where the author works.

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