Unholy Trinity: Tax, Investment, and Corruption

By: Erikson Wijaya, the Directorate General of Taxes officer

During his visit to Sri Lanka in December 2023, Jacque van den Bos, an investment advisor, said that without collecting income taxes, the government could not rely on indirect taxes to reduce the budget deficit. It means that the government must continue with borrowing --in other word: debt. Jacque implied that the government should put tax first instead of expecting third parties, like investments and loans, to contribute. Nevertheless, it is widely understood that prudent investors will look into how governance operates before issuing their money under any investment scheme. They also consider the massive corruption because they trust the commitment to eradicate it will win their confidence. Then we know how corruption is an intervening variable in the decision to invest and how significant investment is for the government since, with investments, the country can generate income and jobs, so there will be hope for high growth.

The same case applies in Indonesia, where direct taxes, like income taxes, do not contribute as much as indirect taxes. According to the Corruption Perceptions Index (CPI), a measure of how corrupt each country’s public sector is perceived to be, in 2022, among 180 countries worldwide, Sri Lanka scored 36, ranking in 101. Meanwhile, Indonesia scored 34 and ended up in 110 in rank. The position is not much different in the three previous years. Both countries landed on points ranging from 30-39, placing them into tend to highly corrupt countries.

How Tax Gets Into The Triangle

The proper investment will also help the business flourish. It acts as an instrument leveraging business capacity to develop. Following it comes tax, a compulsory contribution the government requires. The dots between the three create a dynamic and unholy trinity simply because corruption distorts the dynamic relationship between tax and investment.

Tax policy, especially in tax rate determination, may alter investment behavior; this is what economists and policymakers believe. Some recent research also stands with this perspective. Shanmugam and Sankarganesh (2022) indicate in their article “Effect of Corporate Income Tax on Investment Decisions of Indian Manufacturing Firms“ that the deduction rate positively impacts investment. What they declare is that the inverse is impacting the investment decision. Chen et al. (2023) also show that policies directly reducing the likelihood of firm inaction are more effective at stimulating investment. We can comprehend that tax affects investments in obvious ways. Forchmann et al. (2012) find that sometimes, it also affects in a more subtle, psychological way if investors' perception of the financial consequences of taxation is biased.

Given that tax is inadvertent. Businesses position tax as a burden and look for rationalization, not to pay it. Here is where corruption perception is at play. Rosid et. al. (2018) declare that different forms of perceived corruption can adversely influence individual taxpayers' behavior. Perception can be defined as "a belief or opinion, often held by many people and based on how things seem".

Corruption Makes It Worse

Business operation is adjacent to procedures stipulated by the government. We know that the government has never been a single entity. It regards some executive offices, supervisory boards, and regulatory entities. To some extent, any expenditures the business runs must comply with the rules issued by one of those offices. It is good if all the officials the business is dealing with are professional and accountable. The situation is far from ideal in a country like Indonesia, where corruption perception is high; business gets a double burden through the money they spend on corruption-related things (e.g., bribery, gratification, fraud, and vested interest) and pay taxes. Funding attained from investment sometimes covers the need to meet the culprits in the government. From investors’ perspective, this practice is inefficient and threatens business sustainability.

In the United States of America, the Internal Revenue Service (IRS) anticipates the possibility of deducting unrelated expenses from taxpayers’ financial statements. I.R.C. § 162(c) defines that no deduction shall be allowed for expenditures to satisfy Illegal Bribes, Kickbacks, And Other Payments. This prohibition promotes anti-corruption and encourages businesses to grow so that they will only pay any income-generating expenses. Investment needs this assurance from the government to secure their expected return. It is a legal model to emulate in developing countries like Indonesia and Sri Lanka. Unfortunately, Indonesia has not yet declared this policy in taxation law. It means that tax could be seen as a tool to avoid fair-share payment by allocating and deducting under-table costs and any irresponsible expenses that have been paid.

Any practice maintaining corruption is a menace to investors’ trust. The money will never be able to generate profit and income since there is always a possibility for it to be shifted. It is then hazed under the name of any expense fabricated in the financial statements. The businesses and the state suffer loss as a legal entity taxing them. Tax paid by them seems far from the fair-share portion; it also could end up in zero tax payment since unprecedented expenditures to fund the corruption may consume a big part of the operational costs.

Conclusion

Investment plays a vital role in supporting a country's economic growth goal. It supports businesses by providing sufficient funds to maintain their sustainability. However, tax may impede the decision to invest. It is not a single factor making it happen. Another one contributes to this and puts tax in a bias. It is corruption. Indonesia and Sri Lanka share a common condition of not moving forward to a better rank in the CPI for the last three consecutive years. Both countries landed on points ranging from 30-39, placing them into tend to highly corrupt countries. Knowing that corruption is a handicap preventing investment, Indonesia could imitate what some developed countries, like the USA, apply to mitigate corruption. Neglecting this issue may lead to more significant cumulative loss by businesses and the country. By this, what Jacque van den Bos has suggested to count on tax to reduce budget deficit could be realized.

*) This article represents the author's personal views and does not represent the stance of the institution. 

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