Muhamad Chatib Basri: Fiscal and Growth
History, perhaps, is a gloomy account of dissension, of rivalry and of conquest. Including disputes between emerging forces and established forces.
The ancient Greek historian Thucydides once wrote how the Peloponnesian war broke out because of the increasingly strong power of Athens, which caused the concern of the Spartans. The tension between China and the United States (US) is a repeat of this history. Harvard academics, Graham Allison, called it the Thucydides trap.
The tension between China and the US is indeed not just a trade war. He is concerned that the US will increasingly develop the dominance of China. Therefore, it seems that we must prepare for a long tension. And the world economy also feels its effects. In Asia, Singapore only grew 0.5 percent, Thailand 2.35 percent and Malaysia 4.37 percent. From this aspect, Indonesia is still quite good. We can still grow 5.02 percent in the third quarter of 2019. But of course we cannot close our eyes: Vietnam and the Philippines grow 7.31 percent and 6.18 percent, better than us.
The decline in commodity and mining prices due to the economic slowdown in China has an impact on us. We are still fortunate, although slowing down a little, household consumption can still grow 5 percent. And consumption is the main pillar of our current Gross Domestic Product (GDP). The phenomenon of relatively steady household consumption was explained by economist James Duesenberry in his book Income, Saving and the Theory of Consumer Behavior, published in 1949. He wrote: Our consumption is not only determined by current income, but also by our consumption patterns in past.
The tension between China and the US is indeed not just a trade war. He is concerned that the US will increasingly develop the dominance of China. Therefore, it seems that we must prepare for a long tension.
The simplest example: someone who is a fan of good coffee will find it difficult to suddenly reduce his coffee consumption to a lower quality when his income falls. Consumption is easy to go up, but not easy to go down.
On the other hand we note: falling tax revenue. Ministry of Finance data shows, the January-October 2019 period total tax revenue only grew 0.23 percent compared to the same period in 2018. The non-oil income tax itself only grew 3.3 percent, while the Domestic Value Added Tax (VAT), which reflects purchasing power , instead experienced negative growth (-2.42 percent). These data confirm that an economic slowdown is taking place.
Counter-cycle fiscal policy
Then what can be done to anticipate it? Bank Indonesia has indeed lowered the interest rate by 100 basis points. Unfortunately a decrease in the interest rate does not encourage investment as quickly as expected. Even undisbursed loans as of September 2019 increased by 5.07 percent compared to the same period in 2018. This phenomenon reminds me of what economist John Maynard Keynes wrote 90 years ago: demand is what drives production.
If demand for goods and services is weak, why should the business world ask for credit and expand production? Although licensing is simplified, if there is no demand, why do business expansion? The implication: simplifying licensing, revising the Manpower Act, reducing interest rates will not necessarily boost the economy. In the short term, it is the increase in consumption that will drive production. That is why we need a counter-cyclical fiscal policy. The problem is, with the condition of decreasing tax revenue, fiscal space is limited. Then what can be done? There are several things that can be done.
First, my study by Sjamsu Rahardja from the World Bank (2011) shows that our fiscal policies tend to be pro-cyclical. That is, when tax revenues fall due to an economic slowdown, the government tends to make savings. Though we need more spending to drive the economy. Therefore, it is very natural for the government to increase the budget deficit, and even encourage spending. The budget deficit is expected to reach 2.2 percent this year. In my opinion, even increasing the budget deficit to 2.5 percent is nothing to drive the economy.
In the short term, it is the increase in consumption that will drive production. That is why we need a counter-cyclical fiscal policy
Of course we still have to be careful if the budget deficit is too high. Why? There is a risk of crowding out. What does it mean? Greater budget deficits must be funded by issuing Government Securities or bonds. Because yields on government bonds are more attractive than deposit rates, there is a transfer of savings from banks to government bonds. As a result, resources for credit expansion in the banking sector are limited. The implication: private investment stagnates
or slow down.
Interestingly, the relationship between budget deficits and banking liquidity is not linear. To some extent, deficit financing through domestic bonds has a positive effect on the growth of third party funds in banks, because people have investment options. But after passing a certain level, he will absorb third-party funds in banking. In conclusion: budget deficits are needed to stimulate domestic demand, but must be maintained at an optimal level.
Secondly, if there are limited sources of domestic funds, why don’t we just take foreign sources? I must remind you here: if the government bond market is dominated by foreign investors, the Indonesian economy will be vulnerable to fluctuations in capital flows. An increase in the budget deficit will increase the current account deficit because the savings and investment gap increases. If the increase in the current account deficit is largely funded by the portfolio, every time there is a surprise abroad the financial market will fluctuate and the rupiah will be hit.
I must remind you here: if the government bond market is dominated by foreign investors, the Indonesian economy will be vulnerable to fluctuations in capital flows.
Improved shopping quality
Third, with such fiscal constraints, the government must focus on improving the quality of spending. It must be ensured that spending spent has a positive impact on economic growth and welfare. A study conducted by Joppe de Ree, Karthik Muralidharan, Menno Pradhan and Halsey Rogers (2017) shows: teacher professional allowance has no impact on improving the quality of education, even though the amount is very large.
Another example, transfers to local governments. We know that the funds deposited in the regional general cash account are so large that they have no impact on economic growth. Allocation of spending for various ministries certainly needs to be seen which ones are priorities and have an impact on economic growth and welfare. This is important, because Basri and Rahardja (2011) show that government expenditure excluding salaries and subsidies is actually counter-cyclical. What does it mean? If the quality of spending is improved by allocating more budget to expenditures beyond salaries and subsidies (for example capital expenditure), then fiscal policy becomes counter-cyclical.
Fourth, when demand has occurred, the business community will respond by increasing production. To increase production, the business world needs low interest, easy permits, and various economic deregulation. Therefore we must look at this policy in full.
Fifth, we know that our fiscal space is limited. Although in the short term fiscal policy must be counter-cyclical, in the medium to long term, fiscal must be maintained to be sustainable. Under these conditions, tax revenue must be increased. But this is not possible by increasing tax rates or pursuing compliant taxpayers. Why? Because this will make the economy more and more contracted.
Then, how? My treatise with Ben Olken, Mayara Felix of the Massachusetts Institute of Technology (MIT) and Rema Hanna from Harvard, at the National Bureau of Economic Research (NBER) (2019), shows: for every increase of one rupiah increase in tax rates, taxpayers will get a burden additional 0.51 rupiah. Because it must be considered another way that does not burden taxpayers but still raises the total government tax revenue. The trick is to improve tax administration by moving business services from the regular tax office to the Intermediate Tax Office (MTO). Why?
Because it must be considered another way that does not burden taxpayers but still raises the total government tax revenue. The trick is to improve tax administration by moving business services from the regular tax office to the Intermediate Tax Office (MTO).
We suspect that the limited resources in the regular tax office make them tend to focus on several taxpayers with high income potential. As a result, large business entities will be targeted. It is possible that they will increasingly avoid paying taxes as the company’s scale grows. When transferred to MTO, with more staff, the treatment of business entities becomes more uniform. The tax burden is not only “borne” by several large companies. As a result they can still grow and pay taxes.
Ironically, the world economy must pay tensions between China and the US. History always repeats itself. And we painted it moody. I remember the writer Albert Camus who wrote bitterly: if there is the most important part of human history to be written, it is a record of remorse and incompetence. Camus might be too moody.
Muhamad Chatib Basri, Lecturer in the Faculty of Economics and Business, Universitas Indonesia.