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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


Policy Briefs

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

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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


Policy Briefs

Local Tax Eects on the Business Climate

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