ASEAN Economic Community 2015 - A Framework for Taxation

HERTIE SCHOOL OF GOVERNANCE

ASEAN ECONOMIC COMMUNITY 2015

A Framework for Taxation

Francisco Bächler Paulyn Duman

Priscilla Gray Hermann Georg Wagner

5/16/2014

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ASEAN ECONOMIC COMMUNITY BLUEPRINT 2 1. REVENUE 3 1.1 TAX BREAKDOWN 4 1.2 SHADOW ECONOMY 6 1.3 FOREIGN DIRECT INVESTMENT 8 1.3.1 COUNTRY LEVEL 9 1.3.2 ASEAN LEVEL 10 1.4 TAX COMPETITION 10 1.5 TAX INCENTIVES 11 1.6 WITHHOLDING TAXES AND EFFECTIVE TAX RATES 12 2. REDISTRIBUTION 13 2.1 PERSONAL INCOME TAX 14 2.2 RELIANCE ON VAT 14 2.3 ENERGY SUBSIDIES 15 3. REPRICING 17 3.1 TOBACCO 17 3.2 TAX BASE 18 3.3 TAX RATE 18 4. REPRESENTATION 19 4.1 TAX ADMINISTRATION CAPACITIES 20 4.2 FACTORS AFFECTING TAXPAYER AND REGULATORS 22 4.2.1 TAX PROCEDURE COMPLEXITIES 23 4.2.2 ECONOMIC AND SOCIAL FACTORS 24 4.2.3 CORRUPTION PERCEPTION AND TRUST-BASED APPROACH 24 4.3 SEMI-AUTONOMOUS REVENUE AUTHORITIES 29 5 ORGANIZATIONAL FRAMEWORK 30 5.1 ISOMORPHISM 30 5.2 CHAMPIONS VS. DISTRIBUTED AGENTS 31 5.3 PROBLEM-DRIVEN LEARNING 31 5.4 BROADER AGENTS ENGAGEMENTS 32 6. POLICY RECOMMENDATIONS 33 6.1 REVENUE 33 6.1.1 TAX COMPOSITION 33 6.1.2 SHADOW ECONOMY 34 6.1.3 FOREIGN DIRECT INVESTMENT: COORDINATION AND TRANSPARENCY 35 6.2 REDISTRIBUTION 35 6.3 REPRICING 36 6.4 REPRESENTATION 37 6.4.1 TAX COMPLIANCE PROGRAM 37 6.4.2 TRANSPARENCY AND ACCOUNTABILITY 39 7. BIBLIOGRAPHY 40

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ASEAN 2015 is fast approaching. The implications for taxation are diverse, touching not only upon tax composition, but also revenue, redistribution and repricing, and the representation of and relationship between tax regulators and taxpayers. Based on this framework, this study provides the following recommendations for the Philippines, Indonesia, and Singapore, which are derived from both qualitative and quantitative analysis. Revenue

§ Harmonize upper and lower bounds of corporate income tax, value-added tax, and excise tax § Coordinate regional foreign direct investment tax incentives and establish public-private

dialogue with relevant business stakeholders through transparent information portal

Redistribution § Raise awareness of redistributive effects of overreliance on indirect taxation § Eliminate VAT exemptions on high-end goods, particularly in Indonesia

Repricing § Standardization of tax base for excise taxation

Representation § Establish trust-based tax compliance model § Build internal administrative capacity through employee professionalization § Institutionalize assistance to taxpayers

ASEAN ECONOMIC COMMUNITY BLUEPRINT

The ASEAN Vision 2020 seeks to establish the ASEAN Economic Community (AEC), The

ASEAN Security Community, and the ASEAN Socio-Cultural Community, which will be the three

integral pillars of the ASEAN Community. This was the vision of the ASEAN Leaders at the 1997

Summit in Kuala Lumpur. The establishment of the ASEAN Economic Community has been the

focus since 2003 and aims to achieve regional economic integration by 2015 with clear targets and

timelines for implementation of various measures as well as pre-agreed flexibilities to accommodate

the interests of all ASEAN member countries (Secretariat, 2008). The key characteristics envisaged

are (a) a single market and production base, (b) a highly competitive economic region, (c) a region

of equitable economic development, and (d) a region fully integrated into the global economy.

To: Professor Mark Hallerberg and GIZ From: Francisco Baechler, Paulyn Duman, Priscilla Hermann, Georg Wagner Topic: Economic and Administrative Implications of ASEAN Economic Community 2015 Date: 16 May 2014

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Ultimately, the goal is to transform ASEAN into a region with free movement of goods,

services, investment, skilled labor, and free flow of capital (Secretariat, 2008). Critical to this

discussion are the implications of this integration on tax administrations across the ASEAN region.

This paper analyses the possible implications of the AEC on the 4 Rs of taxation: Revenue,

Redistribution, Repricing, and Representation across Singapore, Indonesia, and the Philippines.

Section 1 addresses revenue, specifically providing the breakdown of the tax composition and tax

revenues as well as the tax implications associated with shadows economies and foreign direct

investment. Section 2 will discuss the redistributive effects with regard to personal income tax,

value added taxes, and energy subsidies. Section 3 deals with repricing in the context of excise

taxation using the example of tobacco across the three countries. Section 4 will discuss

representation analyzing the factors that affect the taxpayers and tax regulators. Lastly, Section 5

will provide this study’s recommendations across each of the four R’s.

This paper does not aim to discuss all taxation areas that are affected by the AEC, but only

to provide a framework on some key issues, which the authors deem important in economic

integration.

1. REVENUE In general terms, developing countries systemically collect less tax revenues than OECD countries

if measured as a proportion of GDP. This observation also holds true for the three countries that

are examined in this paper, even though Singapore should not be seen as a developing country.

According to the World Bank, Singapore’s tax revenues amounted to 14.5 percent of GDP in 2012,

outperforming the Philippines (12.9 percent of GDP) and Indonesia (11.4 percent of GDP, latest

data from 2009). As taxes are the main source of revenue for any state, and the described countries

are facing significant challenges with regard to social policy and infrastructure, an increase of the

tax revenue to GDP ratio is a legitimate and sensible policy goal. With respect to ASEAN 2015, the

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importance of tax collection becomes even more urgent, as the elimination of tariffs constitutes the

loss of a reliable source of income (even if not extremely high when intra-ASEAN trade is

considered). In the following chapter, we will outline the major sources of revenue for these three

countries, discuss the implications of shadow economies, and take a closer look at foreign direct

investment as it relates to corporate income tax and withholding taxes on dividends.

1.1 Tax Breakdown In developed countries the majority of government revenue is collected through the direct taxes on

personal income from labor, payroll taxes as well as indirect taxes on consumption such as value-

added taxes (VAT). In developing countries, however, the sources of revenue generation do not

follow this logic and analysis shows that the corporate income tax constitutes a much larger

component of the tax system. This difference in taxation strategy is often linked to regulation

enforceability and implementation challenges as well as the size and scope of informal economies

(Gordon and Li, 2005). The ASEAN member states are not isolated from such challenges.

As countries across the ASEAN region work towards completion of the AEC 2015 noticeable

trends in taxation have arisen. In particular, corporate income tax (CIT) rates have been decreasing

over the last 15 years. Today the average rate hovers at around 23 percent. These decreasing CIT

rates are largely the result of countries seeking to attract greater foreign direct investment (FDI), a

topic, which will be examined in Section 1.3. With declining regional corporate tax rates, countries

will need to rely on other forms of taxation for revenue generation. Taxes on consumption are

predicted to help shoulder this revenue burden. Nevertheless, as Table 1 below illustrates, large

variance continues to exist across the different tax rates on a country-specific level. There is a 13

percent spread in CIT rates between Singapore and Philippines, respectively as well as 12 percent

spread between personal income tax rates. Although more marginal, differences in VAT rates are

also present. In all three tax categories, Singapore has the lowest rates of all three countries.

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Table 1: Cross-country Comparison of CIT, PIT, and VAT Rates

Singapore Indonesia Philippines

Corporate Income 17% 25% 30%

Value-Added 7% 10% 12%

Personal Income 20% 30% 32%

Source: KPMG Corporate Tax Tables

Figure 1, below, provides a closer look at the tax revenue generation by tax category in 2012. At

the macro level, the following pie charts immediately indicate the heavy reliance on both corporate

and personal income taxation in all countries. A breakdown is provided for both Singapore and the

Philippines, yet for Indonesia “income” revenue is generated via taxes on “gas and oil” and “non-

gas and non-oil”, therefore greater comparative analysis of this tax category is not possible.1 In

Singapore, the CIT tax revenue accounted for a 31 percent share (there are no corporate withholding

taxes), while personal income and personal withholding taxes claimed a 21 percent combined share.

Withholding taxes will be discussed in greater detail in Section 1.6. In the Philippines, the

breakdown is significantly different with both corporate and personal withholding tax shares

exceeding revenue generated through standard PIT and CIT rates. In fact, personal income tax only

generated an approximate 2 percent of total revenue. In total, withholding taxes in the Philippines

accounted for a combined 39 percent of total 2012 tax revenue.

All three countries equally show heavy reliance on indirect forms of taxation. Notably, in Singapore

Goods and Services Tax (GST) accounted for 22 percent of total revenue. Meanwhile, in the

Philippines and Indonesia the VAT claimed respective shares of 22 and 33 percent.

1 Tax revenue generation provided by the Bank of Indonesia does not provide greater granularity into the tax breakdown. No corporate income or personal income revenue is provided.

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Figure 1: Tax Revenue Generation 2012, by Tax Category

Sources: Inland Revenue Authority (Singapore); Bureau of Internal Revenue (Philippines): Bank of

Indonesia (Indonesia).

The following tax categories were subsumed under “Other” for the purposes of this analysis:

Singapore included Property Tax (9%), Stamp Tax (10%), Betting Tax (6%), and Estate Tax (0%).

In the Philippines included was Percentage tax (5%) and Other category (10%). Lastly, for

Indonesia the Other category combined Land and Building Tax (3%), Other Domestic Taxes (5%),

and Internal Trade Taxes (5%).

1.2 Shadow Economy Much of the economic activity in AEC countries is untaxed as it is not officially recorded or, to put

it differently, part of the shadow economy. Although exact numbers are very difficult to pin-point,

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current estimates from Bloomberg suggest that the informal sector amounts to 48.8 percent and 14.3

percent of GDP in the Philippines and Singapore, respectively. The German-Indonesian Chamber of

Commerce estimated a percentage of around 50 percent of GDP for the size of informal economy in

2008. Keeping this estimation constant over the time period 2009 to 2012, 2 the following estimated

values are produced for Indonesia’s informal economy.

Figure 2: Missed Opportunities – Untaxed Economic Activity

Source: Bloomberg (2014), Deutsch-Indonesische Außenhandelskammer, 2009; World Bank (2014) A key insight from the above graph is that a huge amount of economic activity remains untaxed and

is therefore a missed opportunity for tax collectors in the respective countries, as is depicted in

Figure 2. Another primary takeaway of Figure 2 is that Singapore outperforms both the Philippines

and Indonesia with regard to the approximate size of its shadow economy.

As Figure 2 provides a very rough approximation of the respective sizes of the informal economies,

these absolute values are not provided with the intent to enable a calculation of potential additional

revenues, rather to indicate the levels of untaxed economic activity. The latter should not be

confused with forgone tax revenues, which would equate to a certain percentage of the untaxed

2 In fact, there is little evidence that the level of the shadow economy has decreased significantly since 2008; as shall be discussed later in this paper, the corruption perception index has even increased in recent years, which might be interpreted as a sign of a large proportion of unrecorded activity in the Indonesian economy.

81 96 108 120

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activity. However, the implied relationship between a large shadow economy and loss in revenues is

backed by economic theory and econometric studies and models (Cobham, 2005; Slemrod, 2007).

Even though ASEAN 2015 is not likely to trigger any major changes with regard to the shadow

economy, this study seeks to emphasize the fact that it is a substantive problem that should be

addressed in the light of the tax collectors’ interest to increase their tax revenue. What is more,

ASEAN 2015 provides an excellent window of opportunity to introduce changes in tax

administration and tax policies. Particularly, as shadow economies across the region are in large part

attributed to both voluntary efforts of tax avoidance and evasion as well as involuntary behavior. To

the extent that tax avoidance and evasion are voluntary, the efforts of individuals and companies are

often supported by corrupted structures in the administration, particularly in Indonesia and the

Philippines. These issues will be addressed in greater detail in Section 4.

1.3 Foreign Direct Investment

The following section will discuss regional and country-specific trends in FDI as well as expand

upon the discussion of corporate income tax variation across the region in the context of tax

competition and tax incentives.

FDI is a key enabler of export competitiveness. It enables the transfer of capital, production know-

how, distribution logistics, and marketing. Furthermore, it generates productivity and efficiency

gains through competition, and boosts employment (Bhaskaran, 2013). For ASEAN, FDI holds

extreme importance as the influx of new firms serves as a primary driver of increased revenue

collection. Since 2000, ASEAN’s share of global inflows has increased from 1.6 to 8.2 percent in

2010 reaching a total of 111.3 billion (US dollars). FDI inflows of stock have also vastly increased

from roughly $257 billion in 2000 to $1.3 trillion in 2012, which as a share of global FDI stock

inflows was 5.8 percent.

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1.3.1 Country Level ASEAN’s dominant FDI actor remains Singapore, which attracts nearly half of its total 2012 FDI

stock with approximately 52 percent of total FDI inflows, followed second by Indonesia with 16

percent, third by Thailand with 12 percent, and sixth by the Philippines with just over 2 percent.3

Illustrated in Figure 3 are the net inflows of FDI across the three countries examined for the period

2003 to 2012, in US billions, as well as the corresponding fluctuations in CIT rates. For instance,

the 5 percent decrease in the Philippine’s CIT rate from 2008 to 2009 occurred at the same time as

an 89 percent increase in FDI. Equally, Singapore’s FDI underwent a sharp nose dive in 2007 to

2008, in the lead up to the US financial crisis, which coincides with a 2 percent decrease in the CIT

rate from 20 to 18 percent.

Figure 3: FDI Inflows and CIT Rates by Country, 2003-2012

Source: Data compiled from the World Bank DataBank and KPMG.4

3 UNCTADSTAT. Foreign direct investment flows and stocks, annual, 1980-2012 4 The World Bank DataBank: Development Indicators; Foreign Direct Investment, net inflows (BoP, current US$); KPMG, Hong Kong Tax Competitiveness Series; KPMG Corporate Tax Rates Table

0%

10%

20%

30%

40%

50%

-$10

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$20

$30

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$50

$60

2003

2004

2005

2006

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2008

2009

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FDI Indonesia FDI Philippines FDI Singapore

CIT Indonesia CIT Philippines CIT Singapore

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However, this imbalance is not exclusively caused by CIT differentials. Also of importance are

discrepancies in the regulatory framework governing FDI. The assessment by the World Economic

Forum’s Ease of Doing Business 2012 report, which ranks Singapore as the most open economy to

FDI, followed second by the Philippines, and Indonesia sixth, substantiates this assertion

(Bhaskaran, 2013).5

1.3.2 ASEAN Level The recent development of the ASEAN Comprehensive Investment Area (ACIA) however signals

new efforts at creating a common framework for FDI attraction. Specifically, the ACIA is a

combination of two previous investment-related initiatives, the ASEAN Investment Area (AIA) and

the Investment Guarantee Agreements (IGA). Where the ACIA differs is in its expansion of these

previous agreements in its efforts to create more open investment climate in line with the ASEAN

economic integration. Specifically, it places renewed focus on the adoption of international best

practices in investment protection, recent trends in international investment practices to reduce

investment restrictions, strengthening third-party participation and benefits in investment projects,

as well as calling for higher levels of transparency in investment regulations. These initiatives

represent only a handful of investment-related efforts as part of the ACIA. Although this is a step in

the right direction, implementation, monitoring, enforcement of the practices outline in this

framework will be key for regional FDI growth and eventual coordination. (ASEAN

Comprehensive Investment Agreement Guidebook, 2013)

1.4 Tax Competition Corporate tax competition generates market distortions as it promotes the leveraging by foreign

firms of the tax differentials in various countries.6 Current efforts at tax policy coordination remain

5 Although reports by the World Bank and the World Economic Forum show a correlation between high levels of FDI and countries who rank highly in their respective indices (Ease of Doing Business and Global Competitiveness Index), it is important to emphasize that FDI liberalization in the form of tax incentives can produce significant economic distortions. 6 Asia Development Bank. Asia Regional Integration Center. Database on Tax Incentives.

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problematic, as many ASEAN member states are not eager to forgo their competitive tax advantage.

Furthermore, tax rate setting remains up to the discretion of individual ASEAN member states. As

the push toward AEC 2015 becomes more of a reality, the region will continue to see the

development of negative externalities as countries with low tax rates lure capital investment from

neighboring countries with high tax rates. The result of this market manipulation on behalf of

multinational corporations (MNCs) is also seen on an internal structural level. MNCs are

increasingly relying on transfer-pricing schemes to shift corporate profits to their foreign

subsidiaries located in countries with more favorable tax systems. This gaming of the tax system by

MNCs is a problem faced by many ASEAN member states whose internal regulatory frameworks

prove to be inadequate in restricting the private sector’s use of advanced pricing agreements.

Furthermore, many countries lack the trained staff and necessary level of expertise in this field to

curtail the growing transfer pricing schemes (International Tax Compact Workshop, Bangkok

2013).

1.5 Tax Incentives Another method of FDI attraction involves the use of tax incentives whose size and scope of differ

by country. However, the most widespread incentives include export-processing, creation of special

economic zones (SEZ) and tax reductions or holidays for particular/protected industries

(International Tax Compact, 2013). Despite facilitating higher levels of FDI and promoting general

economic integration, tax incentives negatively affect revenue generation, reduce the tax base, and

raise taxes for the non-exempt taxpayers. Indonesia, for instance provides a 3-8 year CIT tax

holiday for foreign firms across 22 different economic sectors, while Singapore provides full tax

exemptions for certain firms for the first 3 years, and the Philippines 3-6 years depending on a

firm’s project status of “pioneer or non-pioneer” or “new or expansion”.7 The World Bank

estimates a 20 percent tax differential in the Philippines between firms benefiting from tax

incentives and those who do not (International Tax Compact, 2013). Tax incentives are a viable 7 Asia Development Bank. Asia Regional Integration Center. Database on Tax Incentives.

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means of attracting FDI to specific industry sectors. In light of the completion of the AEC 2015,

which will open intra-ASEAN borders to the free movement of capital, coordination is of

fundamental importance, as is the harmonization of CIT rates. This is particularly true for countries

like the Philippines and Indonesia, whose respective manufacturing sectors generate the largest

respective inflow of FDI, or 17 and 38 percent of total FDI. In the case of Indonesia and the

Philippines, coordination of tax incentives in this sector might serve as an example of how a more

coordinated approach to FDI tax incentives in a specific sector could enable the promotion of the

“ASEAN-brand” as it relates primary industry FDI.8

1.6 Withholding Taxes and Effective Tax Rates Withholding taxes can come in the form of income withheld from personal labor wages, which are

then paid directly to the government by the employer or taxes levied on interest, certain services,

royalties and dividends. Such taxes are often levied in addition to the underlying corporate or

personal income tax and thus represent a second, or double layer of taxation, in the country wherein

profits were made. Furthermore, in certain countries profits made from activities abroad can also be

subject to a third layer of taxation upon reentry to the home country. These multiple layers of

taxation penalize financial engagement and disincentive investment and the movement of capital

and services. (KPMG, 2006).

This is particularly relevant when discussing the variance in CIT rates, as illustrated in Table 2,

which shows the effect of withholding taxes on dividends and the resulting increase in the effective

payable tax rates corporations must pay on income. Withholding taxes on dividends arguably have

the greatest effect in the Philippines causing an increase in the effective tax rate to 40.5 percent, up

from the standard rate of 30 percent. Singapore, on the hand, has zero withholding taxes on

dividends and as a result their CIT remains the most competitive of the region at 17 percent

8 Asia Development Bank Institute, 2012 (Indonesia); Bank of Philippines, 2014

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(KPMG, CFO Forum, 2012). Brunei Darussalam and Malaysia equally have no withholding taxes

on dividends. (KPMG, 2006).

Although expansion of the withholding tax structure as a means of broadening the tax base is

outlined as a primary goal of the AEC 2015, more can be done to address this issue. Elimination of

corporate withholding tax rates among businesses in member states is one proffered solution as is

the development of a multilateral tax treaty led by Singapore, the corporate taxation leader of the

region (KPMG, 2014 Tax Alert). However, these will be addressed in greater detail in Section 5. It

is important to note that elimination of withholding tax rates across the region has the potential to

significantly destabilize capabilities of revenue generation in countries such as the Philippines

wherein corporate withholding taxes accounted for as much as 20 percent of total tax revenue, see

Figure 1

Table 2: Cross-country Comparison: Withholding Tax on Dividends and Effective Rates

Singapore Indonesia Philippines

Corporate Income 17% 25% 30%

Withholding on Dividends 0% 14% 15%

Effective Rate 17% 36.3% 40.5%

Source: KPMG, Corporate Tax Tables

2. REDISTRIBUTION One of the most essential features of taxation is redistribution. Any tax reform must therefore be

concerned with the redistributive consequences of changes to the tax breakdown. This section will

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discuss issues related to personal income taxation, the effect of greater reliance on indirect

taxation, such as the VAT as well as point to energy subsidies in Indonesia.

2.1 Personal Income Tax One of the characteristics of the AEC will be the free movement of skilled labor. In Indonesia and

the Philippines, this may result in a brain-drain of the most skilled part of the population to

Singapore. From an economic standpoint, this will curtail potential labor productivity as well as

result in the disappearance of the upper strata of the tax pyramid.9 This brain drain will largely

offset the redistributive effects inherent in progressive personal income taxes wherein high-income

earners shoulder the burden of the poor.

At this point, it is worth mentioning that there is another dimension in which labor mobility has

implications on taxation: countries have to guarantee that incomes are not taxed twice if a citizen

from one country resides and works in another country. By the same token, governments must also

ensure that there are no loopholes for these individuals, which might lead to them not paying PIT at

all. In order to overcome this, an efficient system of double taxation agreements is needed. There is

already a system in place, however, enforcement remains weak10 and some treaties are

incomplete.11

2.2 Reliance on VAT To counter the trend of decreasing revenues, there is an incentive for governments to rely on

indirect taxation, and especially on VAT, which has some obvious advantages compared to direct

taxation: it is relatively easy to collect, enables a “pass the buck” situation from businesses to

consumers and is generally more ‘growth-friendly’ (De Wet, 2013 and PwC, 2013).

9 Interesting: which decile contributes how much to overall revenues? 10 Courts have not consistently applied double taxation agreements as exemplified in Thailand’s court decisions. (Wichit, 2012) 11 Indonesia has yet to finalize two of its double taxation agreements, meanwhile Cambodia has not signed a single one.

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These advantages are promoted by institutions like the IMF, the OECD and the European

Commission, all of which recommend stronger usage of indirect taxation vis-à-vis direct taxation.

These recommendations correlate with the general shift towards more indirect taxation observed all

around the world in recent years (PwC, 2013).

Although, as outlined by the IMF (2014), the VAT is a regressive tax 12 it also argues that if there is

a differentiation in VAT between certain types of products, the regressive characteristics are not as

strong (IMF, 2011).13 Keen (2013) discusses this in more detail, examining the conditions under

which a system with different VAT rates can serve as social policy tool. However, his conclusion is

that even a differentiated VAT system cannot eliminate the regressive character of VAT: although

'the poor' tend to consume more of the goods with reduced VAT rates (e.g. food) in relation to other

goods, high income earners still consume more of these goods (food) in absolute terms, which

means that these parts of society are most favored by such a policy.

Besides, the example of Indonesia reveals that VAT exemptions are not only applicable for

products of importance to the poor, but instead also exist for meals in restaurants or hotels and the

sale of gold ingots (KPMG 2012).

In this context, it is essential to raise awareness of the following tradeoff: the price for “easy”

revenue generation via VAT may result in growing income disparities and inequality. This is not

only problematic from a normative standpoint, but there is also empirical evidence that this might

be harmful to economic development (IMF, 2014).

2.3 Energy Subsidies A closer look at energy subsidies in Indonesia serves as a prime example of the ill-directed

redistributive effects of government subsidies. In February 2014, a liter of Premium bensin (low-

12 This view is supported by O’Donoghue et al. (2004) and Snowdon (2013). 13Indonesia and the Philippines have such a system in place, (KPMG, 2012; KPMG, 2014)

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octane gasoline) at Pertamina sold for Rp 6,500 (55 US cents) and automotive diesel oil for Rp

5,500. Unsubsidized fuels are based on market prices that are in excess of Rp 10,000.14

To understand the overall cost of this subsidy, these numbers from the OECD provide more clarity:

Figure 4: Energy subsidies in Indonesia as a percentage of GDP

In the context of the Indonesian central government budget, energy subsidies account for nearly a

quarter of total funds. Despite the fact that the subsidy enables all parts of society to benefit from

cheaper fuel and energy prices, the World Bank finds that the subsidy is highly regressive in

character: As a share of total gasoline subsides, 40 percent go to the richest 10 percent of

households, while only 1 percent of the subsidy goes to the bottom 10 percent (World Bank,

2013,OECD, 2012).

The OECD suggests that money spent in this area could be used in a much more efficient way,

instead of distorting consumer behavior and encouraging carbon emissions. However, Indonesian

14 The Jakarta Post, February 3, 2014, http://www.thejakartapost.com/news/2014/02/03/indonesia-s-fuel-subsidy-monster-the-root-problems.html-0

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government officials and political leaders have acknowledged that there is a need to reform with

regard to energy subsidies (World Bank, 2013, Jakarta Post, 2014).

3. REPRICING One of the main elements and functions of taxation is the repricing of goods. From a tax

perspective there are two primary reasons for repricing: to generate revenue and to change

consumer behavior to achieve public policy goals, such as public health and safety. However, there

still exist huge differences among the ASEAN member countries in terms of excise taxation. This

part of the paper will focus on excise taxation and use the example of tobacco to illustrate the main

weaknesses in the current excise tax arrangements across Singapore, the Philippines, and

Indonesia.

3.1 Tobacco There are only five products in the ASEAN economic community, which are all subject to excise

taxation: beer, wine, liquor, motor vehicles and tobacco (Hallerberg, 2013). This means that

virtually all other products can be subject to excise taxation in country A, but not in country B,

which may distort consumer incentives and possibly those of producers. However, even for

products for which there are excise taxes in place across all ASEAN countries, such as tobacco,

distortions are equally possible.

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Table 3: Excise Taxation of Tobacco in Three Countries

Tax Rate as % of Retail Price

Excise Tax Rate Tax Base for Domestic Products

Tax Base for Foreign Products

Singapore 69% SGD 0,32 per stick

No domestic production

Weight and type of tobacco product

Philippines 53% PHP 12 or 25 per package (2 tier)

Net retail price (before tax)

CIF

Indonesia 46% (avg.) IDR 80-380 per stick

Production cost price

Transaction value of tobacco product

Source: Southeast Asia Initiative on Tobacco Tax, 2012

3.2 Tax Base As illustrated in Table 3, all countries differentiate their excise taxation between domestic and

foreign products (except for Singapore, which does not produce tobacco). In the Philippines and

Indonesia, the tax base for domestic products is lower than the tax base for foreign products.15 This

obviously generates an artificial advantage for domestic products.16 What is more, the tax base also

differs insofar as the excise tax rate is levied on different units (stick v. package).

3.3 Tax Rate The actual tax rates also significantly differ across countries. The total tax rate is shown as a

percentage of the retail price; see Table 3, which includes the excise tax, tariffs, VAT and other

taxes. Some of these taxes are specific (excise tax) and others are ad-valorem taxes (tariffs, VAT),

which complicate the process of excise tax administration in these countries. Excise taxes are a

15 Indonesia: production cost v. transaction value; Philippines: net retail price v. Cost, Insurance and Freight price, which is the net retail price plus these positions. 16 In Indonesia, cigarettes from other countries constitute merely one percent of all consumed cigarettes. Even though it is impossible to predict how large the share would be in a counterfactual situation, the described difference in excise taxation gives at least hints that this fact is related to the excise tax regime for cigarettes.

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specific tax in all three observed countries, even though large differences exist. Singapore has by far

the simplest model of levying SGD 0.32 on each cigarette stick, while the Philippines have a two

tier system and charge either PHP 12 or PHP 25 per package. This specific tax is derived from the

retail price for cigarettes in 1996 and has remained constant. Indonesia, however, implements a

complicated multi-tier system with a specific tax amounting from IDR 80 up to IDR 380.

As the example of tobacco has shown, excise taxation across ASEAN member states varies

substantially. Hence, distortions in consumer and producer behavior are likely to occur, particularly

because of the removal of tariffs envisaged by the ASEAN 2015 integration process. Some

observers project that this may lead to large flows of cheap cigarettes from producer countries such

as Indonesia to other AEC member states.17 This increases the necessity to standardize the tax base

across countries, as it has been the case in the EU, for instance, and achieve a certain degree of

harmonization in the tax rates.

4. REPRESENTATION

“No taxation without representation” is a famous slogan emanating from the United States that

calls for the representation of the people on whom taxes are levied in the goal of generating

government revenue and the delivery of public services. The ability to collect taxes is affected by

several factors including political feasibility and the capacities of both the taxpayer and the tax

administration agencies. For instance, political pressures from the executive power may put strains

on tax collection especially if it favors certain sectors in exchange for political support or other

vested interests. Also, the capacities of the personnel in the tax agencies are an important factor,

which directly relates to the concentration of the tax officers, efficiency of the tax system, and to the

17 Southeast Asia Tobacco Control Alliance

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level of cultural integrity and professionalism of the administration and its employees. This section

seeks to address these issues in greater detail with a particular focus on tax administration

capacities, tax procedure complexities, and the implementation of Semi Autonomous Revenue

Authorities in Singapore and the Philippines as one approach to tax administration. It will also

address the ongoing challenges associated with corruption and tax generation.

4.1 Tax Administration Capacities As we can see in Table 4, the three countries present different capacities in their tax administration

systems and have different ICT-integration levels. Many of the cross-country differences can be

explained by different factors such as the average taxpayers ease of registration, which includes

obtaining a tax identification number. For, instance in the Philippines, citizens are required to obtain

a tax identification number prior to getting a driver’s license. Other factors such as geographical

considerations also play a role, especially in the case of the Philippines, which has more than 800

inhabited islands and Indonesia, which has more than 6,000 inhabited islands. On an economic

level, tax registration in some countries can also require the payment of a fee which has the

potential to be detrimental to the tax registration of the self-employed and actors in the informal

sector should the fees be too prohibitive.

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Table 4: Tax Personnel Capacity and ICT Integration

Personnel Capacity and ICT-Integration

Singapore Philippines Indonesia

Number of Tax Personnel 1,899 10,387 32, 741

Number of Tax Payers 3,800,000 18,900,000 19,112,590

Registered Taxpayers as % of Population

72% 18% 8%

Can Register Online? Yes Yes Yes

Can Pay Tax Online? Yes Yes Yes

Can Pay Tax With Mobile Phone?

Yes No No

Source: Own elaboration based on DGT Annual Report 2010 (Indonesia), BIR Annual Report 2012 (Philippines) IRAS Annual Report 2012/13 (Singapore).

As Table 4 illustrates, there are huge discrepancies in the number of government tax personnel

across the three countries. However, analyzing the number of total tax personnel as a percentage of

the total respective populations, each one-government tax employee deals with nearly 10,000

individuals in the Philippines, around 7,500 in Indonesia, and only 3,000 in Singapore. As these

figures suggest, some tax administrations may lack the staff necessary to fulfill the job, irrespective

of efficiency and or internal organizational structure. Taken a step further, a look at the number of

registered taxpayers as a percent of the total population indicates that 72 percent of Singapore’s

population is registered in the tax system. This is exceptionally high when compared to only 18

percent in the Philippines and 8 percent in Indonesia. Relatively speaking, the Philippines and

Indonesia have significant potential to expand their tax base.

It is interesting to note that all three countries provide ICT technology for online registration and tax

payment despite high levels of corruption in the cases of Indonesia and the Philippines, which will

22

be addressed in Section 4.1.3. In countries where corruption in tax administration is rampant, it can

be argued that the use of computer technology, which generates a paper trail (Gordon Li, 2005),

might encounter opposition.

4.2 Factors Affecting Taxpayer and Regulators During the last decade, tax experts have started to realize that behavioral economics is a necessary

component in order to better understand the conduct of taxpayers. The central contribution of this

approach is to more clearly pinpoint the reasons for which some individuals pay their taxes and

others do not. As a consequence, the possibility of increasing revenues by modifying to the

managerial behavior can be a real option for Indonesia and the Philippines18.

The standard and most widely applied model of tax compliance considers that people will act as

rational actors. Rational actors in the context of tax payment are those who seek to assess the costs

and benefits of evading taxes in their decision-making process. This rational actor model however,

has not proven to be effective in all the cases (Sanchez, 2011; Serra, 2005; Walsh, 2012). The

“deterrence” model seeks to influence the behavior of rational actors and states that, “if the

expected benefits (less income ‘lost’ to tax payment) outweigh the costs (the chances of

noncompliant tax behavior being caught and the sanctions incurred) then the taxpayer will evade

tax” (Walsh, 2012). Therefore, approaches based only in increasing the possible sanctions of

evading taxes or the difficulty of dodging them is not necessary sufficient. Walsh (2012) discusses

five factors that impact compliance with tax payments: norms, fairness and trust in tax

administration, complexity of the tax system, broader economic and social factors, and interaction

between factors each of which will be addressed in greater detail below.

Norms have in an important impact on individual behavior. Wenzel states that ethical concerns

appear to be based on the internalized social norms of the reference group, and tax ethics motivate 18 Singapore has introduced several reforms in this direction.

23

taxpaying behavior. Conversely, ethical concerns as well as perceptions of social norms are

influenced by an individual’s engagement in tax evasion (Walsh, 2012; Sanchez, 2011)

4.2.1 Tax Procedure Complexities

“For many people, tax is a complex subject and this complexity has been shown to contribute to

non-compliance (GAO, 2011)” (Walsh, 2012). Walsh (2012) and Sanchez (2011) propose that lazy

non-compliant taxpayers would pay if the process were easy. Therefore, if tax agencies de-

complicate the tax paying procedures, then taxpayer behavior will change towards greater

compliance. Nevertheless, it is not only about simplifying laws and regulations, but also bring about

direct assistance to the taxpayer in order to address instances of unintentional non-compliance due

to lack of knowledge or understanding of the tax system.

If we analyze the case of the three countries in terms of complexity, the view appears to be very

different between them. In Indonesia, on average, it requires 259 hours for a standard firm to

prepare and file their taxes within on calendar or fiscal year. In contrast, in Singapore, the same

process only takes 82 hours. The number of times that a firm has to file and pay taxes differs

between the countries, in Singapore the mean is 5 times a year, while in the other two countries it is

more than 35 times (PwC, 2014). As a result, compliance is expected to be higher in Singapore than

in both the Philippines and Indonesia.

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Table 5: Tax Performance 2014

Source: Own elaboration based on PwC, 2014

4.2.2 Economic and Social Factors In tax administration literature, there is a call for considering the context and specific situations of

firms and individuals (Walsh 2012, Torgler 2004-05). At a macroeconomic level, elements that

promote growth also encourage tax compliance. In addition, higher tax rates are correlated with

evasion if they promote taxpayers to move to the shadow economy (Walsh, 2012).

4.2.3 Corruption Perception and Trust-based Approach In Singapore, Philippines, and Indonesia corruption plays a role in the ability of each country to

generate tax revenue. Singapore ranks 5 among all the countries in the Corruption Perception Index,

the Philippines ranks 94 and Indonesia ranks 114 (see Table 6), which can affect the willingness of

the taxpayers to comply with tax rules. As a matter of fact, Torgler (2004-05) states that tax morale

is inversely correlated with the perceived size of corruption.

Philippines Singapore Indonesia

Overall ranking (1-183, 1=highest)

131 5 137

Frequency of filing and paying Tax

36 5 52

Number of hours it takes to prepare taxes

193 82 259

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Table 6: Comparative Corruption

Global Corruption Barometer 2013 Singapore Philippines Indonesia

Corruption Perception Index (0-100, 100=cleanest) 86 36 32

Corruption Perception Index Rank (1-177, 1=highest) 5 94 114 Source: Own elaboration based on Transparency International, 2013.

On the other hand, the Global Corruption Barometer in 2013 found that in Indonesia, 71 percent of

the population perceived that the level of corruption increased from the previous year. Though in

the Philippines only 31 percent felt the same way (Transparency International).

Another factor that impacts the probability of paying taxes is the perception of fairness. Norms and

the drive to pay taxes are influenced by this variable (Walsh, 2012). If taxpayers do not trust tax

administration to collect taxes fairly, this will increase non-compliance (Torgler, 2004-05;

Carasciuc, 2005). Walsh (2012) discusses three types of fairness in taxation: distributive fairness or

the perception that government acts as a wise spender of tax revenues; procedural fairness or the

belief that tax organization adheres to processes that are fair in dealing with tax payers; and

retributive fairness or how fair the official agency is when punishing rule-breaking behavior. The

two last points are more related with tax agencies.

Another important consideration is the engagement of individuals in alternative political

technologies, such as bribery, when the institutions are weak, which erodes the citizen’s trust in

their government. In the context of tax administration authorities, 7 percent of the population in the

Philippines has paid a bribe to a tax officer. In Indonesia only 6 percent have. Moreover, in the

26

Philippines 10 percent have paid a bribe to a judicial officer and 14 percent to registry services;19

meanwhile, in Indonesia 66 percent of people declared to have bribed a judicial officer and 37

percent registry and permit services officers. (Transparency International, 2013). There is no

information about Singapore on these factors.

4.3 Paradigms for Tax Compliance

The above-mentioned factors converge at different stages in tax administration and implementation

and it is their interaction that contributes to the willingness of taxpayers to comply at the individual

and collective level.

An example of how these dimensions can be combined is illustrated by the tax compliance

strategies in Chile and Argentina in the 1990s. As depicted in Figure 5, Indonesia20 has largely

adopted a similar approach to Chile’s, which relies on a trust-based approach. While in the

Philippines, the adopted model is very similar to Argentina’s approach of name-and-shame

campaigns, see Figure 6.

19 These percentages are self-reported. Therefore, it has to be expected that reality could present higher rates of bribes. 20 Dissemination and education activities carried out in 2010 are as follows in Indonesia: interactive radio talk show, information through national TV, publishing of children’s storybook, development of online site for DGT library book catalogue.

27

Figure 5: Tax Compliance Campaigns, Indonesia and Chile

Carrot Style Approach The Chilean Tax bureau’s (Servicio de Impuestos Internos) strategy was first to improve its

methods through gathering, managing, and analyzing data on tax collection which were also used to

improve the quality of its services. They did this primarily by constantly professionalizing the

quality of their human resources. In the 1990s, a full merit-based system of recruitment and

promotion was installed. Other measures were bringing salaries in line with market levels,

implementing constant training courses, and installing a zero tolerance policy on corruption

(politicization was considered also a breach). From the perspective of the provided service, this

agency implemented periodical surveys to indicate where service improvements were necessary.

For instance, results were gathered on the time required to complete tax obligations and the level of

attention and service provided by officers. Another measure against evasion was to improve

transparency in the allocation of public expenditure. These measures aimed to increase the public’s

trust in the Tax Administration Bureau and to promote the collaboration of taxpayers. All these

reforms, among others, impacted VAT evasion levels increasing revenues from around 30 percent

in 1990 to 18.3 percent by 1993. It also enabled the total estimated share of tax evasion to remain

28

fairly stable at 23 percent of theoretical tax collection through 1995 (Walsh, 2012; Servicio de

Impuestos Internos, 2014).

Figure 6: Tax Compliance Campaign in the Philippines

Stick-Based Approach

On the other hand, Argentina adopted the typical “stick” based approach to address their tax

evaders. Their strategy was based on the improvement of the agency’s legal, political, and technical

tools. However, they omitted the necessary reparation of citizen’s trust and the construction of

administrative capacity. For instance, they adopted, at the beginning of the 1990s, an aggressive

public campaign to intimidate tax evaders by letting them know that the Federal Tax Bureau had

more tools than before to penalize and pursue them. The phrase of the Argentinian Undersecretary

of Public Revenues, Carlos Tacchi, illustrates the spirit of that period “I promised God to crush tax

evaders” (El tiempo, 1995). As a matter of fact, they created a group of officers, Los Intocables,

which investigated large taxpayers. This method produced successful results between 1991 and

1993 decreasing total estimated tax evasion by 30 percent. However after 1998 tax evasion levels

returned to pre-reform standards (Walsh, 2012).

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Walsh (2012) and Sanchez (2011) postulate that a “service and client” formulation by tax

administrations is more probable to encourage trust than a “cops and robbers” approach based on

sanctions.

4.3 Semi-Autonomous Revenue Authorities

Semi-autonomous revenue authorities (SARAs) perform tax collection for the central government

but have features that distinguish them from other tax collection agencies. SARAs enjoy autonomy

from centralized executive power, which shields them from direct political influence. However,

they are not as autonomous as a central bank. Moreover, SARAs have independent financing and

personnel rules that usually govern the public sector, which means that they may not be part of the

budget appropriation cycle in that they fight for annual allocations. They are also not subject to the

hiring and firing rules of the central civil service authority. Lastly, SARAs are single-purpose

agencies where all the tax functions are integrated and all tax collection is centralized as opposed to

being located inside the ministries of finance where they are separated into departments and

function as separate entities. The SARAs across the world vary in each feature and may also operate

differently as their supposed level of independence may only exist on paper.

In general, SARAs assume tax collection under their jurisdiction and move away from the central

powers of the ministry of finance. SARAs are established with two objectives: increase tax

revenues and increase the authority of the central state. The public justification for the presence of

SARAs are: 1) signaling political autonomy, indicates to the taxpayer that the power to tax will not

be abused; 2) creating managerial autonomy serves as a means of establishing a team with

excellence capabilities; and 3) facilitating reform makes the implementation of reforms in tax

administration easier. Nevertheless, it has not yet been proven that SARAs improve tax recollection

or the system’s efficiency (Fjeldstad & Moore, 2009).

30

Singapore and Philippines have adopted SARAs into their tax administration system yet still receive

supervision from their respective governments (Asian Development Bank, 2012). This suggests that

although these entities exist they in fact do not operate in an autonomous fashion. Meanwhile, tax

collection in Indonesia directly depends on its Ministry of Finance and thus no such independent

agency exists.

5. ORGANIZATIONAL FRAMEWORK

Before proceeding to Section 6, Recommendations, it is necessary to establish a framework of the

political feasibilities and organizational changes. Andrews (2013), on which the following section is

based, provides a detailed look at several fundamental concepts and approaches that provide insight

as to how best to enact administrative reform and ensure on-the-ground implementation.

5.1 Isomorphism One important consideration as to why many reforms fail is that countries commonly adopt reforms

to signal intent rather than commit to change (Andrews, 2013). For example, the adoption of the

double taxation agreements, the signing of the UN Convention Against Corruption, and the passage

of certain laws to comply with international agreement requirements have to be put under strict

scrutiny within this framework. First, the adoption of reforms may fail to take into consideration the

degree to which context matters. Second, reforms may promote interventions that are too content

specific and demanding for some countries. Lastly, these reforms may be entered into by specific

agents and or single individuals, rather than a collective bottom-up groups, and therefore they

cannot ensure implementation (Andrews, 2013). The danger of these types of reforms is that this

only leads to change at the margins, which is visible to the outside world, but is actually irrelevant

to changing the core operations that aims to make government function better. In the context of

ASEAN reforms such as double taxation agreements, whether bilateral or multilateral, must be

31

implemented with country-specific feasibility in mind. As an example, Global Integrity shows

many developing countries with legal systems can compete with the developed countries in anti-

corruption law, which includes the Philippines and Indonesia. However, when their implementation

is evaluated, there are ranked comparatively low, signaling a meaningful disconnect (Andrews,

2013).

5.2 Champions vs. Distributed Agents Institutional reforms are often carried-out by champions, or individuals from the top political strata.

Such individuals are usually within the executive power. However, reforms that are brought by

champions are usually regarded by the other agents as programs of the central government only,

which are too far removed from reality. This is because champions who are mostly politicians lack

the professional affinity required to understand the value of new information. Therefore, it is

important to rely on distributive agents as they work at the frontline of tax collection, which often

remains opaque to the outside world and where changes are more difficult to implement (Andrews,

2013). This requires problem-driven analysis to understand the informal institutions, the norms,

customs, values, and cognition of the officers who are tasked with implementing the reforms and

why at the grassroots level, the changes are not often made.

5.3 Problem-driven Learning Problems are the windows to the opaque parts of an issue and give light to the realities on a level

that may be too far away from the central government or external actors. Thereby problem-driven

learning, provides a certain degree of flexibility with regards to the solutions adopted through a

combination of formal and informal reforms. By understanding the problems on the individual

level, this study strives to consider the behaviors, psyche, and cultural-cognitive structures that

permeate the tax administrative systems in Singapore, Indonesia, and the Philippines.

32

In order to address these issues, the following questions serve a constructive starting-point: why are

the tax collectors not enforcing compliance among the informal sector? Why don’t running micro-,

small- and medium-enterprises declare earned income? Why do people bribe tax officers less and

bribe judicial officers more? The seemingly obvious things are not as what they appear to be and

the rigid application of copied laws on a highly specific context would only produce meager results.

5.4 Broader Agent Engagements Andrews (2013) purports three lessons for purveyors of externally influenced institutional reforms

in the development context: First, instead of focusing on the lone champions, reformers should

establish broad-based engagements. Second, instead of emphasizing agents who provide authority

and ideas, reforms should cultivate mobilizers, motivators, conveners, and connectors. Third,

external agents themselves should be aware of the limited roles they can play in facilitating

institutional change and play these roles as effectively as possible.

It is important to consider that leaders of reforms are needed at different stages of the reform

process. For example, leaders who provide formal authority are important at the start of the reform,

but are less so during the implementation phase. Leaders who convene and connect actors relevant

to the reform are of particular importance during the implementation stage (Andrews, 2013). In fact,

these conveners and connectors accounted for more than 25% of the identified leaders at both the

start of the reform and in its implementation (Andrews, 2013). Mobilizing is an essential leadership

function in any and all institutional reforms. There are three approaches identified by Silvia Dorado,

which are integral to change. These approaches are leveraging, accumulating, and convening.

Identifying who these actors are in the respective countries and the stage at which they are needed

in the reform process are critical for success.

The importance of this discussion is that external agents do not provide the primary leadership in

defining problems or ideas. This must originate from local agenda-setting (Andrews, 2013).

33

External agents are not a source of authority and do not bring implementation know-how according

to recent studies. By contrast, their primary role is to provide initial financing (Andrews, 2013).

This nevertheless, does not necessarily equate to wielding broad influence. However, externals

agents can develop on-the-ground capacity by stationing representatives in the concerned countries

(Andrews, 2013).

Ultimately, it is through domestic problem identification and national ownership of reforms that

governments and its citizens can truly embrace and ensure the changes they deem important.

6. POLICY RECOMMENDATIONS The 2015 AEC deadline is quickly approaching. Integration steps are undoubtedly moving in the

right direction, yet many obstacles remain spanning internal politics, economic development, and

historical and cultural heritage. The following section outlines recommendations specific to the four

R model of the study: Revenue, Redistribution, Repricing, and Representation.

6.1 Revenue 6.1.1 Tax Composition

CIT: As a primary starting point, this study recommends the harmonization of the upper and lower

bounds of CIT rates across the region. Such a coordinated tax strategy will stimulate the growth of

total ASEAN-wide FDI and strip foreign firms of the ability to shop for the most advantageous CIT

rate and engage in transfer pricing schemes to the same extent as today. This strategy will,

combined with our recommendations for administrative reforms, also broaden the tax base and

improve compliance.

34

VAT: This study also recommends the harmonization of the upper and lower bounds of VAT as the

use of this indirect tax is growing in importance as countries seek to offset declined revenue from

corporate income.

6.1.2 Shadow Economy As outlined in the ‘Revenue’ part of this paper, the main assumption with respect to untaxed

economic activity is that many individuals are not paying taxes because of administrative failure

and the complicated system without assistance. What is more, it is important to recall that Indonesia

and the Philippines are states formed by over 6000 and 880 inhabited islands, respectively. If we

combine this fact with the notion that filing of tax records is a daunting task in these countries and

oversight as well as assistance is rather weak, the problem of the shadow economy could be

substantially reduced by simply making paying taxes less cumbersome to the average person.

Approaches on how to go about administrative reforms will be outlined in more detail below.

However, when considering the ‘voluntary’ part of the shadow economy, making compliance easier

will not solve the problem. Yet, again, the prosecution of tax evasion or the enforcement

mechanisms in general can be assumed to be either very costly or very inefficient, due to the

disbursed geographical features of the countries. A possible, but controversial method to reach all

islands simultaneously would be inflation. The shadow economy is cash-based, which means it is

highly sensitive to inflationary pressure. The opportunity costs of not being in the real economy

thereby increase, as the formal economy hedges against inflation through the interest rate channel

(Gordon, Li 2005). If banks are forced to reveal details of their clients transactions to the state or at

least report suspicious patterns of monetary flows (Gordon, Li 2005), the shadow economy could be

substantially reduced by the combination of these two measures – but at the cost of higher inflation,

which may cause long-term economic growth to suffer. With regard to this proposal, the political

feasibility must also be considered. As the Central Bank’s mandate in both countries is price

35

stability, central bank officials may not support a voluntary increase in inflation to combat the

shadow economy. However, depending on how close the political ties between government and

central bank are, this approach should still be considered a policy option.

6.1.3 Foreign Direct Investment: Coordination and Transparency Although FDI rivalries will likely remain, it will be imperative that ASEAN members design

strategic and comprehensive approaches to FDI attraction. Initiatives designed to increase FDI

policy transparency, streamline business processing times, reduce business startup costs are

important initiatives. The development of an internet information portal for FDI activities across the

region would not only significantly increase transparency but also allow for the inclusion of

stakeholder communication with key business players. Such an approach would also enable the

promotion of an “ASEAN brand” for potential external FDI stakeholders. A recent survey

conducted by the ISEAS-ADB has concluded that there continues to be a general “lack of

awareness” regarding the AEC, which places the economic integration of the region at a significant

disadvantage (Bhaskaran, 2013).

Furthermore, coordination of withholding taxes should be addressed so as to reduce the wide

discrepancies between effective corporate tax rates in the ASEAN region. This is particularly

relevant in incentivizing investment and the movement of labor, capital, and services.

6.2 Redistribution Labor mobility and the general trend to rely more heavily on indirect taxation can have

redistributive consequences. As a result, this study recommends raising awareness of this fact

among the respective tax authorities, legislators and other parties involved in the process of

redesigning tax policies in light of AEC 2015.

36

As research has shown, the regressive character of VAT cannot be abolished by tax exemptions or

‘cascading taxes’ (Keen, 2013). However, a closer look at the goods and services exempt from VAT

in Indonesia shows that many products not relevant to the poor are exempt from VAT, such as

meals in restaurants and hotels or the sale of gold ingots (KPMG 2012). A sensible solution towards

a more equitable VAT structure in this country would thus be the elimination of the tax exemptions

for products, which clearly benefit certain industries or wealthier parts of population.

However, some experts also stress that it would be even more beneficial to remove VAT

exemptions altogether and provide direct transfers to poorer parts of the population. Yet, due to the

administrative difficulties and political infeasibilities of this approach, this study proposes of the

removal of VAT tax exemptions for goods primarily consumed by upper parts of society.

6.3 Repricing As outlined in Section 3 of this paper, excise taxation is a major issue in the AEC integration

process. This study suggests a two-step process to achieve an excise taxation framework, which will

prevent economically harmful distortions in consumer and producer behavior: First, standardization

of the tax base is essential. Even though the EU is not a model in many respects when discussing

reforms in ASEAN tax issues, the establishment of common standards in terms of taxation is

generally considered a good solution (Hallerberg, 2013). This first step can be assumed to be rather

politically uncontroversial, and a multinational framework or international agreement on common

standards could be achieved without major political resistance. The second step would then be the

harmonization of excise tax rates across country. This study recognizes the difficulties associated

with this recommendation, as the setting of the tax rates remains one of the most important national

competencies that member countries are unlikely to surrender. However, in the light these

challenges, should standardization of the tax base be achieved, a certain degree of excise tax

37

harmonization might still be possible. One solution could be to install an upper and lower bound for

excise taxation for certain products in order to limit the distortions caused by large differentials.

6.4 Representation

6.4.1 Tax Compliance Program Different types of taxpayers exist as a result of their knowledge of the rules and their willingness to

comply with tax regulation, all of which are affected by the different factors discussed in Section 4.

It is recommended that these factors are considered in the creation of an effective tax compliance

program, which integrates an awareness campaign based on trust as exemplified in the Chilean and

Indonesian example.

Simplification of tax procedures, which reduces transaction costs should be adopted coupled with

ICT integration, which could also address the lack of tax administration capacities in the Philippines

and in Indonesia. However, it is important to consider that the political feasibility of adopting a

measure that includes ICT may face challenges as well because of the entrenched norms and

practices among tax collectors who would not be amenable to altering practices either because of

lack of training in using the available technology or because of resistance to having a digital or

paper trail, which could also be linked to the issues of corruption as discussed.

Another example to facilitate tax compliance is to provide free assistance to taxpayers in filling out

the correct tax return and providing information on different issues related to taxes. The Taxpayers

Advocacy Panel (TAP) in the US can be taken as an example. It was established in 2002 after only

very few individuals approached the Taxpayers Advocacy Services (TAS) composed of lawyers and

accountants offering free of charge services. It was decided that volunteers from the ordinary public

who are knowledgeable in filling out tax returns and filing may be more effective in facilitating

38

assistance to the average taxpayer. Since 2002, there are about 70-100 volunteers who provide

between 300-500 hours for a term of 3 years to taxpayers. They are not paid, except for per diem

when they travel to different states (2011 TAP Annual Report). TAP receives around 500

applications for volunteers and the applicants go through rigorous interviews. Although each

volunteer’s term expires every 3 years, former volunteers continue their services outside TAP where

they can charge a small amount for their help to their previous “clients”. Some volunteers maintain

blogs, Facebook pages, and websites where citizens contact them.21 This provides the IRS a solid

group of experts outside of the formal framework IRS and helps citizens in filling out their tax

returns.

It can be argued that the small number of volunteers in this program significantly undermines the

extent to which it can serve as a broad-based tool nation-wide. However, should attracting

volunteers be the root cause of the programs low level of civic engagement, this study recommends

appealing to the public’s sense of community through the establishment of regional tax information

hubs. This may generate greater volunteer participation as it is more accessible and joins together

members of the same social community.

Lastly, this study recommends updating the ASEAN tax treaties, but suggest that there should be an

agreement as to the model of the framework to be adopted in the updated treaties. Institutionalizing

a coordinating body for the different agreements in the AEC, like the ASEAN Integration

Monitoring Office, is desirable. But it is important to consider the reasons why the existing treaties

have not been updated in the last 15 years. This can be influenced by intra-ASEAN trading, which,

as measured as a percentage of total trade, is comparatively low (GIZ, 2013).

21 List of names of volunteers are published at the TAP website http://www.improveirs.org/tap-members/.

39

6.4.2 Transparency and Accountability

Corruption is one of the major challenges in the Philippines and Indonesia as it relates to informal

economic activity, tax compliance, capacity building, and the lack of resources spent on tax

administration. Corruption might also be entrenched in the political system, leading to certain

sectors being not taxed or enjoying tax incentives. However, we can draw answers from Indonesia’s

experience in fighting corruption through their Corruption Eradication Commission (KPK), which

was created in 2003. This was modeled after Hong Kong’s Independent Commission Against

Corruption (ICAC), but the KPK is unique in a sense that its creation was specifically tailored to the

experiences in Indonesia. It developed a problem-driven framework, which considers not only the

context of Indonesia but also options, which are politically feasible (Andrews, 2013). However,

with Indonesia’s 2013 ranking in the Global Perception Index and the percentage of the population

that believe corruption to have increased, KPK still has much work to be done. Nevertheless, such

an initiative could also be pursued in the Philippines, which also suffers from comparatively high

levels of corruption in its tax administration.

Improvement of the tax administration office is also important not only in professionalizing the

personnel, but also establishing performance management mechanisms where targets are set not

only for tax collection efforts, but also for human resource management. Chile provides a good

example of strategies to simultaneously improve tax capacities while building trust with the

taxpayers and serves a good model for the case of Philippines.

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Asia Development Bank. Asia Regional Integration Center. Database on Tax Incentives. Bhaskaran, Manu. (2013) "The Investment Climate." Institute of Southeast Asian Studies (ISEAS): The ASEAN Economic Community a Work in Progress Bloomberg: “The Countries with the Biggest Shadow Economies”, Bloomberg Businessweek, http://images.businessweek.com/ss/10/07/0729_worlds_biggest_shadow_economy/26.htm

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Cobham, Alex: “Tax evasion, tax avoidance and development finance”, QEH Working Paper Series QEHWPS129, Finance and Trade Policy Research Centre, Queen Elizabeth House, University of Oxford, 2005 Deutsch-Indonesische Außenhandelskammer: “Wirtschaftspartner Indonesien”, 2009 De Wet, Charles (PwC Africa): “Shift from Direct Taxes to Indirect Taxes Set to Continue”, http://www.thesait.org.za/news/146168/Shift-from-Direct-Taxes-to-Indirect-Taxes-Set-To-Continue.htm Directorate Generate of Taxes. (2010). Annual Report 2010. Jakarta: Ministry of Finance of the Republic of Indonesia.

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