Taxing high-net-worth individuals: experience from Indonesia

Abstract

With high levels of inequality and a rising share of capital income in total income, as Gabriel Zucman's piece in this symposium pithily highlights, there are several reasons why tax authorities in developing countries should place a special focus on high-net-worth individuals (HNWIs). First, progressive tax system structures, combined with high levels of income concentration, mean that even a small increase in tax avoidance and evasion amongst the ultra-wealthy can lead to a substantial drop in overall tax revenue. Second, HNWIs tend to have highly complex tax arrangements, income and wealth scattered across the world, and access to tax planning experts, which facilitates tax avoidance and tax evasion. Research from Scandinavia1 and the US2 has found that, on a cost-weighted basis, tax evasion is concentrated at the top of the distribution. Finally, the integrity of the tax system as a whole is contingent on taxpayers believing that the ultra-wealthy pay their fair share in tax. Survey evidence3 has found that taxpayers at the bottom and middle of the distribution are more willing to pay tax when they are informed that the tax system is progressive, and less willing to pay tax when they are informed that the tax system is not progressive. Low- and middle-income countries have especially struggled in raising revenue from the rich, due to high levels of informality, high levels of self-employment amongst top earners, and low tax rates on capital gains and wealth transfers.4

If the case for focusing on HNWIs is clear, the steps governments should take to do so are not, especially for low- and middle-income countries with more limited financial and technical resources. In his article in this symposium, Zucman argues for improved international cooperation, multilateral tax agreements, and potentially new forms of taxation, such as wealth taxes or stock market capitalisation taxes, to increase tax collection from HNWIs. Even if these reforms are desirable (see the article by Anne Brockmeyer and David Phillips in this symposium), they would take years or even decades to be fully achieved. Indonesia's recent experience in taxing HNWIs provides some direct case-study evidence on what low- and middle-income countries can potentially achieve in the short term.

For Indonesia, the initial challenge was to define what an HNWI is. International organisations typically define HNWIs as having net asset values ranging from USD 1 million to USD 30 million. Indonesia adopted its own definition, of IDR 10 billion (USD 664,000), to be in line with other tax thresholds in its domestic tax system. In addition, individuals are also classified as HNWIs if they have an income greater than IDR 1 billion (USD 66,000) per year, are a shareholder/owner of a business group, or are noted as having high net worth in national or international media such as Forbes or Globe Asia. Despite representing 0.35 per cent of Indonesia's population of registered taxpayers, HNWIs contribute 5 per cent of overall tax revenues.

In an effort to streamline supervision of HNWIs, Indonesia moved all wealthy taxpayers into dedicated large and medium tax offices in 2021. The creation of these dedicated offices was accompanied by tax policy and administration reforms. The top marginal tax rate was increased from 30 per cent to 35 per cent for those with incomes greater than IDR 5 billion (USD 333,000). A voluntary disclosure programme, in place from January to June 2022, offered taxpayers immunity from prosecution for non-disclosure of assets, in addition to a significantly reduced tax rate on income derived from those assets, set between 6 per cent and 11 per cent compared with the standard 30 per cent rate.5

Indonesia also leveraged the automatic exchange of information (AEOI) provisions, an OECD-established framework enabling access to offshore financial data of HNWIs without necessitating formal data requests. In 2021, Indonesia exchanged information with 70 jurisdictions and received data from 86 jurisdictions.

The programme led to the declaration of IDR 596 trillion (USD 39 billion, or about 4 per cent of GDP) in assets, resulting in IDR 61 trillion (USD 4 billion) in additional tax revenue, between January and June 2022. It is important to remember that Indonesia's reforms to tax HNWIs are recent, and further work will need to be done to evaluate the true impact on tax revenue both in terms of looking at the longer-run revenue effects and in terms of evaluating the causal effects of the tax reform and separating out the roles played by each of the key elements.

Relatively little evidence has been published on the effectiveness of HNWI tax office units in developing countries. One exception is Uganda, where the creation of an HNWI unit led to a higher probability that wealthy taxpayers filed a return, but did not lead to substantially increased tax revenues.6 Voluntary disclosure programmes can also be challenging to successfully implement, as they require governments to determine the correct level of the tax rate that encourages HNWIs to declare their assets, without making the tax rate too low so as to lose revenue, whilst also not diminishing the perceived fairness of the tax system. However, evidence from Argentina suggests these programmes have high potential if they are well designed.7

Indonesia's approach may still offer valuable insights for other developing countries. One lesson is the importance of coordinating efforts between tax policy and tax administration. In Indonesia's case, policy efforts to increase tax revenue amongst HNWIs, such as the higher marginal tax rates and the voluntary disclosure programme, were likely made more effective by administration efforts that made evasion and avoidance amongst HNWIs more difficult, such as the creation of dedicated HNWI offices, and the use of AEOI. The relative roles of the administrative changes and the headline tax rate changes will be important to separate when seeking to apply lessons from the Indonesian experience to other countries seeking to increase tax revenue from their wealthiest individuals.