Jakarta. The Center of Economic and Law Studies (Celios) estimates that the government’s plan to increase the Value Added Tax (VAT) rate to 12 percent will worsen the economic conditions, especially for lower-middle income groups.

The VAT hike is expected to increase the spending of the poor by Rp 101,880 ($6.3) per month and the middle class by Rp 354,293 ($22) per month. According to Celios, this could potentially lead to more people falling from the middle class into the vulnerable middle class.

Media Wahyudi Askar, the Director of Public Policy at Celios, said that although the government and the House of Representatives claim the policy is progressive with VAT exemptions for staple goods, in reality, many items consumed by low-income households are still subject to VAT.

According to Media, high VAT rates are more commonly applied in high-income countries with stable economies, such as Norway, Denmark, and Germany, where there is strong purchasing power. In contrast, Indonesia’s economy remains weak, particularly for the middle class, and the VAT hike will place additional burdens on the public.

“The problem in Indonesia is that the economy, especially of the middle class, is struggling. To be fair, the government should compare Indonesia with other ASEAN countries, and Indonesia has the highest VAT rate,” Media added.

Bhima Yudhistira, the Executive Director of Celios, said the VAT increase would have a broad impact on various goods, including electronics and automotive spare parts.

He believes the policy will not significantly contribute to tax revenue because the weakening purchasing power will reduce the turnover of businesses, which in turn will decrease other tax revenues, such as corporate income tax (PPh Badan) and individual income tax (PPh 21).

“Even detergent and soap are considered essential goods for the less affluent. The government’s narrative is increasingly contradictory regarding tax fairness. Additionally, the VAT hike to 12 percent will not contribute much to tax revenue because the weakened consumption will affect business turnover, which will impact other tax revenues like corporate income tax, PPh 21, and customs duties,” Bhima said. The government estimated that the VAT hike would generate Rp 75 trillion of tax revenue.

Bhima mentioned that the government’s economic policy package tends to focus on short-term measures and lacks significant innovation. Government incentives and stimulus are almost identical to previous ones. VAT exemptions for housing, electric vehicles, and a 0.5 percent final income tax for MSMEs were already in place before.

“The forms of assistance are also temporary, like electricity discounts and 10 kg rice aid, which only last for two months, while the negative effects of the VAT hike will have long-term impacts,” he said.

Nailul Huda, the Director of Economics at Celios, assessed that the policy to provide VAT incentives for hybrid vehicles shows inconsistency, as these vehicles are more affordable for upper-middle-class groups, not the middle class. Additionally, temporary incentives that can be revoked at any time create uncertainty for consumers.

“The impact of the VAT hike on household consumption growth is also negative. When the VAT rate was at 10 percent, household consumption growth was at 5 percent. After the rate increased to 11 percent, growth slowed from 4.9 percent in 2022 to 4.8 percent in 2023. It is predicted to slow further in 2024,” he said.

Overall, Celios argues that the government’s economic policies are short-term oriented and do not provide effective long-term solutions.

To ease the economic burden from the VAT hike, the government has prepared a Rp 827 trillion ($51.65 billion) stimulus package targeting various sectors, including households, workers, small businesses, and labor-intensive industries. Households will receive food assistance and discounted electricity bills, while VAT exemptions will be applied to flour, industrial sugar, and subsidized cooking oil. Workers will be offered access to job loss protection schemes to mitigate the risks of layoffs. Small businesses are expected to benefit from the extension of the 0.5 percent final income tax rate, while labor-intensive industries will receive wage tax incentives, financing assistance, and subsidies for work accident insurance.

The government will also introduce VAT incentives for electric and hybrid vehicles to promote cleaner transportation options. In the housing sector, VAT exemptions will apply to homes priced between Rp 2-5 billion, although buyers will still need to pay VAT on the portion exceeding Rp 2 billion.