Central Government Budget

In addition to regulating many aspects of economic activity, the government plays a direct role in the economy through its implementation of the central government budget. Early each year, the president presents to the House of People's Representatives (DPR) the propÍÍÍÍosed annual budget prepared by the Department of Finance for the upcoming fiscal year (see Legislative Bodies , ch. 4). Total government expenditures, including both routine expenditures and development projects, averaged about 22 percent of GDP during the 1980s (see table 16 table 17, Appendix). The broad outlines of government spending were framed in five-year plans prepared by Bappenas. The five-year development plan, or Repelita (see Glossary), described overall economic objectives, including the desired growth rates to be achieved in major economic sectors such as agriculture, mining, and industry, and more detailed proposals for selected activities that were of particular concern during the planning period. Repelita V (fiscal years 1989 to 1993 fiscal year--FY--see Glossary), emphasized the objective of continued export diversification and the reduction of foreign aid and foreign borrowing as sources of government revenue. However, the annual central government budget provided a more concrete set of priorities than the broad Repelita guidelines and allowed for adjustments in total spending to meet unforeseen changes in revenue.

Government finance in developing countries is often constrained by the ability to collect taxes tax collection in these countries is often hindered by the lack of accounting information on many informal businesses, the difficulty in imposing income tax withholdings among the millions of self-employed in agriculture and services, and extensive corruption. Indonesia was no exception to this rule, but during the 1970s the government was able to compensate for the limited domestic tax base by relying on taxes from the formal corporate sector, especially from foreign oil and gas operations. From 1979 to 1983, tax revenues from the oil and gas sector accounted for about 56 percent of total government revenues. Unfortunately, this bountiful resource undermined efforts to address serious problems in domestic tax laws and collection efforts (see table 18, Appendix).

The prospect of declining oil sector taxes because of the oil market collapse in the mid-1980s, together with a growing recognition of the flaws in domestic tax laws, motivated a comprehensive tax reform in 1984. The cornerstone of the 1984 tax reform was a simple value-added tax (see Glossary) to be levied on domestic manufacturing and imports to replace the previous sales tax that encompassed eight different 100tax ratrates and many types of exemptions. The new valueÍÍÍÍ-added sales tax applied a uniform tax rate to all manufacturing firms and importers the rate was initially set at 10 percent but the tax law permitted the rate to be altered within the range of 5 to 15 percent if revenue needs were to change. The tax was not applied to basic staples such as unprocessed foods, and so did not rely heavily on taxing poorer income groups who spent a large share of their income on such nonmanufactured products. The tax reform included a new income tax that imposed a three-tier rate of 14, 25, and 35 percent on both business and personal income. However, around 85 percent of households fell below the minimum income subject to tax, equivalent to US$3,000 in 1984.

The government also maintained its commitment to a balanced central government budget in part by counting foreign borrowing and foreign aid as part of government revenues, labeled as development funds. During Repelita III (FY 1979-83), development funds accounted for about 15 percent of total government revenues and for about 30 percent of total development expenditures. When oil tax revenues declined by 15 percent per year when controlled for inflation from 1984 to 1986, the government responded by both curtailing expenditures and increasing the reliance on foreign borrowing.

During this adjustment period, total government expenditures did not increase, compared with an average annual increase of 9 percent during Repelita III, but development funds continued to grow at 10 percent per year. In the late 1980s, the effects of the tax reform began to be felt, and a combination of increased domestic non-oil tax revenues, the restoration of oil tax revenue growth as the oil market slowly improved, and continued growth in foreign borrowing permitted the restoration of a 10 percent annual growth in government expenditures from 1987 to 1990.

The structure of the government budget was greatly altered by these adjustments. During Repelita IV (FY 1984-88), non-oil domestic tax revenues accounted for 38 percent of total revenue, compared with 28 percent in Repelita III. However, development funds came to account for 57 percent of development expenditures. This increasing reliance on foreign funds contributed to a sharp rise in government debt service obligations, which rose to account for 24 percent of government expenditures, compared with about 9 percent under Repelita III. The budgetary concerns of the 1990s reflected these dramatic developments.

The proposed budget for FY 1992 highlighted the government's efforts to manage the foreign debt and to increase reliance on nonoil domestic tax revenues. Overall, government expenditures were not expected to increase when adjusted for the anticipated inflation of about 10 percent. The value-added tax on manufacturing activity was to be extended to apply to retailers with annual turnover of more than Rp1 billion. The interest earnings on bank deposits owned by corporations was to be taxed as normal income at a higher rate than the previous 15 percent tax on interest earnings introduced in 1988, and luxury taxes on some items would be increased. While development expenditure was to increase somewhat, the increase was to be funded entirely by the anticipated higher domestic tax revenues.

These specific measures embodied in the FY 1992 budget reflect the continued effort to meet the Repelita V guidelines. Repelita V predicted a decline in the nation's debt service ratio (total debt service as a percent of merchandise export earnings) from the 35 percent level prevailing in 1989 to 25 percent by 1994. This was to be achieved both by the decline in government foreign debt and by a decline in foreign funds to finance private sector investment. Overall, Repelita V targeted almost 94 percent of total investment to be funded by domestic sources, compared with 81 percent in the previous plan. The plan's overall level of investment remained the same, about 26 percent of GDP, as in Repelita IV. Repelita V also targeted inflation-adjusted GDP gr 3cc owth at 5 percent per year the same target was achieved during Repelita IV.

Data as of November 1992