Policy Briefs Local Tax Effects on the Business Climate1 No. 7 - 2008
Impact of Local Taxes The evidence regarding the impact of local taxation on the business climate is mixed. Certainly, tax burdens would not appear to be especially problematic. The aggregate revenue burden associated with local taxes is low relative to GDP; individual ﬁrms surveyed for this study report limited tax liabilities in relation to business revenues and costs. The amount of local taxes that a typical business pays is signiﬁcantly lower than its statutory tax liability. The short-fall is a function of ineﬀective local government tax administration and bribery of local oﬃcials, which buys down tax payments. On the other hand, the eﬀect of compliance costs is less clear. Mandated compliance costs associated with local taxation may be signiﬁcant for some larger ﬁrms, especially as related to business licensing. Compliance costs may be even higher than those oﬃcially authorized because of the need to pay top-oﬀs in order to expedite
procedures. On the other hand, (smaller, informal sector) ﬁrms surveyed for this study do not appear to ﬁnd compliance with tax and license regulations to be particularly onerous. Whatever the level of oﬃcial and unoﬃcial tax payments and compliance costs, associated public service delivery is very limited. Oﬃcial tax revenues that might be used to deliver services are diminished by ineﬃcient local government tax administration and by corruption attendant to the spending of funds. Bribes made in order to reduce a ﬁrm’s tax payments result in no public service delivery, of course. And strictly illegal fees paid by some ﬁrms to local administration oﬃcials oﬀer no services in return.
Policy Implications Forthcoming regional tax legislation will most likely claw back local governments’ authority to create their own taxes, charges, and fees. Local revenues will be conﬁned to those that appear
on a positive list of allowable instruments. The Ministry of Finance hopes that the new restrictions will help reduce some of the nuisance and economically harmful eﬀects of local taxation; the central government’s ability to monitor compliance with forthcoming legislation will be a key determinant in the
success or failure of the intended reforms. But new tax legislation will not address problems related to ineﬀective and ineﬃcient local tax administration, inadequate local public service delivery, and corruption. Progress in these areas is part of a much longer-term and more diﬃcult reform agenda.
Lewis, B. D. and Suharnoko, B. Local Tax Eﬀects on the Business Climate. DSF, July 2008. The full report can be downloaded from www.dsﬁndonesia.org. The views expressed in this paper are solely those of its author(s).
Local Tax Eﬀects on the Business Climate
Local Tax EďŹ€ects on the Business Climate
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