Centralization vs. Decentralization: A Look at Indonesia's Tax System and Global Models

By Revanza Almaas, a Directorate General of Taxes officer

The way a country sets up its tax system depends on how tax collection and management responsibilities are divided between the national government and regional or local governments. On one side, there's centralization, where the national government calls all the shots on taxes. On the other side, there's decentralization, where the power is shared between the national government and regional or local governments.

Indonesia's current tax system incorporates elements of decentralization. However, the central government dominates. Provinces, districts, and municipalities have some autonomy in managing their Regional Budgets (APBD). This allows them to prioritize spending on local needs and infrastructure projects. Local governments have the power to levy taxes on things like land, buildings (PBB), and certain business activities. This provides them with a degree of financial independence and a stake in boosting the local economy.

In Indonesia, the central government holds the power to craft the overall tax policy framework for. This includes determining tax types, brackets, and rates for income tax, value-added tax, and other major sources of revenue.

Control and Consequences

Centralized tax administration offers lower costs through economies of scale, specialized staff, and IT systems, reducing compliance costs for both central and local taxes. However, decentralized tax administration at the local level can integrate tax collections with other charges, enhancing collection efficiency and cost-saving opportunities.

Compliance costs may be higher under decentralized tax administrations if each jurisdiction has different forms, regulations, and procedures, especially for businesses operating in multiple areas. A centralized tax administration can provide consistent treatment in assessments, audits, and appeals, promoting compliance. However, decentralized tax administrations can offer more personalized services to taxpayers and may lead to technological innovations faster.

The accountability of local government to residents is enhanced with separate local tax administration, as taxpayers can better evaluate the efficiency of local government services. Transparency and accountability may be compromised when central authorities administer local taxes, as the separation between local and central taxes may not always be clear to taxpayers. From a normative viewpoint, a decentralized tax administration of local taxes is preferred for better transparency and accountability, although there is a trade-off with cost efficiency.

The control of tax enforcement, revenue flows, tax information, payroll decisions, and corruption may influence the design of tax administration. Decentralized tax administrations allow governments to have more control over hiring decisions, revenue, and tax information. However, centralized tax administrations can provide quicker revenue control and potentially reduce corruption levels.

Balancing economic efficiency with public choice efficiency is essential in deciding the vertical structure of tax administration. Incentives, such as collection fees or revenue sharing, can align the objectives of different levels of government in tax administration. The presence of externalities and political economy issues may also influence the decision-making process, emphasizing the importance of weighing objectives in the organizational structure of tax administration.

Models across Countries

The international experience regarding the organization of tax administration reveals a diverse range of models. Sub-national governments in various countries such as Australia, Canada, China, United States, and others have their own tax administrations, often related to their taxing powers. Federal systems like Australia, United States, and Switzerland show multilevel tax administrations, while unitary countries like Spain and Hungary also have separate tax administrations for regional governments. Centralized tax administrations are more common in unitary systems like France and Scandinavian countries, where all taxes are administered by the central government.

Four main models for the vertical structure of tax administration are observed in practice. The first model is a single centralized tax authority where all tax administration staff are central government employees and all taxes are administered through unified arrangements. The second model is independent tax authorities at different levels of government, each handling taxes assigned to them, as seen in federations like Australia and Brazil. The third model is fully decentralized tax authorities, a rarity in practice, seen in countries like Germany and Laos. The fourth model is mixed models of tax administration, where features of centralized and decentralized administrations are observed. Indonesia falls into this model, along with Canada and Switzerland.

The categorization of countries into these models may be somewhat arbitrary, as some countries may exhibit characteristics of multiple models. For example, Italy has a centralized tax administration system, except for Sicily, where it is completely decentralized. Ultimately, the variety of organizational models in tax administration reflects different objectives, political economy issues, and historical contexts that shape the tax systems of each country.

In our country, we can see central government’s dominant role in tax collection and distribution. The central government handles the collection of most taxes. While local governments can collect specific taxes, a significant portion of total tax revenue ends up in the central government's coffers. This revenue is then distributed back to regional governments through a transfer system, but the central government has some discretion in how these funds are allocated. This can influence regional priorities and spending.

There is a recently noticeable trends towards increased centralization. Law 1 of 2022 regarding Finance Relation between Central Government and Local Government (UU HKPD), implemented in 2022, has shifted the balance towards central control. This legislation gives the central government more influence over regional finances, potentially lowering the flexibility of local governments in managing their budgets.
Overall, Indonesia's tax system reflects a balancing act between empowering regional authorities and maintaining national fiscal stability. While local governments have some room to raise their own revenue, the central government plays a dominant role in setting tax policy, collection, and distribution.

*) 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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