Closing Indonesia’s Tax Gaps: Fixing VAT and CIT for Better Revenue Collection

Indonesia's VAT and CIT gaps, averaging 6.4% of GDP between 2016-2021, are driven largely by non-compliance and tax policy inefficiencies, leading to significant revenue losses. Strengthening enforcement, digital monitoring, and adjusting tax thresholds are crucial to improving tax collection and closing these gaps.

A study conducted by the World Bank, in collaboration with the Indonesian Ministry of Finance’s Fiscal Policy Agency and international economic research institutes, has revealed a significant tax collection inefficiency in Indonesia. The Value Added Tax (VAT) and Corporate Income Tax (CIT) gaps collectively accounted for an average of 6.4 percent of GDP between 2016 and 2021. This shortfall highlights Indonesia’s struggles in enforcing tax compliance, leading to substantial revenue losses. The primary driver of these gaps is non-compliance, which contributed to 58 percent of total forgone revenue. Economic disruptions such as the COVID-19 pandemic worsened the situation, providing businesses with increased incentives to evade tax obligations. Despite the government's efforts, including the 2021 Tax Harmonization Law, the country’s tax-to-GDP ratio remains one of the lowest in the world, significantly below its regional peers.

VAT: A Leaking Revenue Source

Indonesia’s VAT system is plagued by inefficiencies, resulting in substantial revenue losses. The study found that the VAT compliance gap averaged 43.9 percent of its theoretical tax base from 2016 to 2021, translating to IDR 386 trillion in lost revenue annually. The worst year was 2020 when deferred payments and tax evasion pushed the compliance gap to 50.7 percent. Even in 2021, despite some recovery, VAT compliance remained well below pre-pandemic levels.

International comparisons highlight Indonesia’s weak VAT collection efficiency. The country’s C-efficiency ratio—an indicator of VAT performance—stood at just 52.8 percent, significantly lower than in countries like Thailand, where a similar VAT structure produces greater tax revenue. The study identified several factors behind this underperformance, including exemptions for financial services, healthcare, education, and hospitality, which accounted for a substantial share of forgone revenue. Another critical issue is the high VAT registration threshold of IDR 4.8 billion, which keeps many small and medium-sized enterprises outside the tax system. These businesses not only avoid VAT payments but also contribute to tax evasion and underreporting of revenue.

CIT Compliance: A Challenge for Businesses and Authorities

Corporate Income Tax (CIT) faces similar collection challenges. The study estimates that between 2016 and 2021, Indonesia’s CIT compliance gap averaged 33 percent of total CIT liability, leading to an annual revenue loss of IDR 160 trillion. The situation deteriorated in 2020, with compliance dropping to just 48.5 percent due to payment deferrals and economic disruptions.

Unlike VAT, where non-compliance is the primary driver of revenue loss, CIT shortfalls are evenly split between compliance issues and policy decisions. The study found that Indonesia’s policy-driven CIT losses stem largely from tax exemptions and preferential tax treatment for small businesses. These include reduced tax rates for companies with annual turnover below IDR 50 billion and complete exemptions for firms opting into alternative tax regimes. While these measures aim to support small enterprises, they significantly erode the tax base and limit the government’s ability to generate revenue from corporate profits.

Tax Thresholds and the Underground Economy

One of the major contributors to Indonesia’s tax revenue shortfall is the high VAT and CIT registration threshold. The study found that many businesses deliberately underreport revenue or artificially split operations to stay below the taxable threshold. This behavior creates both compliance and policy gaps, as these firms neither pay VAT nor contribute adequately to CIT.

A significant portion of Indonesia’s economic activity remains informal, further complicating tax collection efforts. The underground economy is estimated to account for 18–22 percent of GDP, meaning a large share of business transactions occur outside the tax system. Informality is particularly prevalent among small enterprises and service providers, many of whom are taxed at lower effective rates or exempt altogether. Without improved enforcement measures, these businesses will continue to evade taxes, exacerbating Indonesia’s fiscal challenges.

Fixing the Tax System: Policy and Enforcement Solutions

Despite recent tax reforms, the study emphasizes that closing the tax gap requires more than just policy changes. The 2021 Tax Harmonization Law, which increased VAT from 10 percent to 11 percent and eliminated certain exemptions, is expected to improve revenue collection. However, without significant improvements in compliance monitoring and enforcement, the full potential of these reforms may not be realized.

To address tax compliance issues, Indonesia must invest in digital tax monitoring and third-party reporting systems. Many countries with successful VAT and CIT collection strategies have adopted e-invoicing, real-time transaction reporting, and stricter audit mechanisms to ensure compliance. Indonesia, however, still relies heavily on manual tax reporting, limiting its ability to detect fraud and enforce tax regulations effectively.

Lowering the VAT and CIT registration threshold could also play a crucial role in improving tax compliance. The study found that countries with lower tax thresholds tend to have higher compliance rates, as businesses are gradually integrated into the tax system rather than remaining in the informal sector. Additionally, phasing out alternative tax regimes, such as the Alternative Final Tax (AFT), and transitioning businesses into the standard VAT and CIT frameworks could help narrow the policy gap. However, these reforms must be paired with stronger enforcement measures, as merely lowering thresholds without addressing compliance could lead to continued underreporting and tax evasion.

The report concludes that Indonesia’s tax system faces structural challenges that require comprehensive solutions. While policy changes, such as reducing tax exemptions and adjusting thresholds, can help, they must be supported by aggressive compliance measures to yield meaningful revenue gains. Strengthening digital monitoring, integrating third-party data sources, and increasing enforcement actions against tax evasion are critical steps toward a more efficient tax system. Without these measures, Indonesia risks continued revenue shortfalls, limiting the government’s ability to fund public services and support economic development.