ANALYSIS; Tax amnesty: Repatriated money and economic growth

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Moekti P. Soejachmoen

Wed, August 10 2016 | 09:26 am

The government has promulgated the Tax Amnesty Law since July 1 and issued a number of implementing regulations afterwards. As a result of the implementation, state revenue in the short term is expected to increase from the payment of penalties imposed on those who apply for the tax amnesty. In the long run, economic growth is expected to accelerate as an impact of the inflows of repatriated funds.

To ensure that the economy can benefit from the repatriated money, the law requires that such funds be locked in Indonesia for at least three years and invested in both financial instruments and real sectors.

The repatriated money can be seen as exogenous capital inflows to Indonesia both in the form of portfolio investment and direct investment. Following the standard model of Mundell-Fleming, the impact of capital flows can be contractionary to the economy. Inflows in the form of bonds decrease the rate on non-bonds and reduce the cost of financial intermediaries. However, this positive impact will be offset by the impact of currency appreciation on external demand, which results in lower net exports and translates into lower domestic output. In the end, capital inflows will lead to slower economic growth.

On the other hand, emerging economies experience different impacts in which capital inflows have an expansionary effect on the domestic economy. In emerging economies, especially those with relatively underdeveloped financial systems, capital inflows will increase liquidity in the economy that translates into lower rates, more credit and more domestic output. This impact is more dominant than the impact of currency appreciation on net exports. Meanwhile, in more advanced countries, the impact of currency appreciation can outweigh the impact of lower rates and result in slower economic growth.

The impact of repatriated funds also depends on the type of investments. Direct investment has a more stable and long-lasting impact on the economy than portfolio investment because the nature of the former — typically used to acquire or establish manufacturing facilities or infrastructure — makes it more difficult to liquidate or pull out from the country. Meanwhile, portfolio investment — referring to investments in financial assets, such as bonds and stocks — has shorter investment periods and is easier to pull out. Therefore, the larger the portfolio investment compared to direct investment will make the economy more uncertain and vulnerable.

Prior to the implementation of the Tax Amnesty Law, casual surveys conducted by banks on their high-net worth customers suggested that many taxpayers intended to repatriate their assets to Indonesia as direct investments as they wanted to use the money to either expand an existing business, establish new ones or invest in property. These people were reluctant to invest in the financial sector because of the limited options of financial instruments in Indonesia and because the rate of return is not competitive enough compared to holding their assets abroad.

However, until last week, the implementing regulations on the investment of repatriated money did not cover direct investment or real sector investment. The only option for those who apply for the tax amnesty is investing their repatriated funds in the financial sector. The existing financial instrument is able to accommodate taxpayers’ need to reinvest in their own businesses or create new businesses through discretionary funds managed by investment manager companies.

Investing in property through the financial sector is also possible by using the Real Estate Investment Trust (DIRE). However, these instruments are more complicated than directly investing money in a company or buying property and can discourage taxpayers from repatriating their assets.

Another concern surrounding the impact of repatriation money on economic growth relates to what will happen to the money when the three-year period ends in March 2019. Will there be a massive capital outflow? Has the government prepared any mitigation efforts to anticipate this?

If a massive capital outflow does occur, the domestic economy will be hit hard and economic growth could sharply decline. Moreover, 2019 is an election year and therefore the economic crisis that could occur because of a massive reversal capital outflow could be a double hit along with political uncertainty. The worst-case scenario is that the 1998 economic and political crisis could reoccur in Indonesia. We do not want that to happen.

The risk of massive capital outflows can be minimized if more repatriation money is invested in the real sector than in the financial sector. To increase taxpayers’ preference for real sector investment, the government should ensure that the development of infrastructure and priority sectors occurs as planned and that the investment and business climate in Indonesia is conducive. In addition, prudent macroeconomic policy is needed along the way so that the Indonesian economy in 2016 is strong enough to overcome any hiccups.

As the future depends on what we do today, it is necessary for the government to issue implementing regulations on real sector investment as soon as possible. Not only will it affect taxpayers’ decisions on whether to just declare their offshore assets and pay higher rates or to repatriate their money to Indonesia and pay lower rates, but it will also affect their decisions on whether to invest their money in the financial sector or real sector.

With different penalty rates applied for different time periods of the tax amnesty, the window for taxpayers to pay the lowest penalty rate is until Sept. 30 and certainty on real sector investment will help taxpayers make a decision.

As funding for infrastructure and the priority sector is urgently needed, the success of the tax amnesty, mainly represented by a large amount of repatriated money, is very important and we still have eight weeks until the first window of the policy ends.

The writer is head of the Mandiri Institute.

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