Cracking the Code on Tax Evasion: Indonesian Firms Under the Microscope

A recent report titled "Revealing Tax Evasion: Experimental Evidence from a Representative Survey of Indonesian Firms" by the World Bank uncovers that around 25 percent of firms in Indonesia evade taxes, leading to a potential revenue loss of 2 percent of the country's GDP. Through a novel double-list experiment, the study identifies the key traits of non-compliant firms, such as those facing stiff competition from the informal sector and businesses viewing tax administration as a major hurdle. This article breaks down the findings, the economic impact of evasion, and what it means for policymakers.

Tax evasion is a hidden but persistent challenge for governments worldwide, and Indonesia is no exception. In an eye-opening report by the World Bank titled Revealing Tax Evasion: Experimental Evidence from a Representative Survey of Indonesian Firms, the widespread evasion among Indonesian firms is laid bare, with approximately 25 percent of companies indirectly admitting to not fully complying with their tax obligations. This groundbreaking report, based on a nationally representative survey of 2,955 firms, highlights the scale of the problem and the specific characteristics of businesses more likely to avoid paying taxes.

But why is tax evasion so prevalent, and how is it being measured? The study’s findings offer insights not only for Indonesia but for other middle-income countries that struggle with low tax compliance and revenue collection.

A Novel Approach to Measuring Tax Evasion

Measuring tax evasion is difficult because businesses are unlikely to voluntarily disclose their illegal activities. The World Bank researchers overcame this hurdle by employing a double-list experiment, a method that cleverly allows respondents to maintain anonymity while revealing whether they engage in tax evasion.

The double-list experiment works by presenting two groups of firms with lists of statements, some of which are sensitive, such as admitting to not paying all taxes owed. Each group only reveals the number of statements that apply to them, not which ones specifically, thereby protecting their identity while allowing researchers to gather accurate data. This approach led to the discovery that a quarter of Indonesian firms evade taxes, a figure that is consistent across multiple experiments.

This innovative technique sheds light on the underreported issue of tax evasion and provides policymakers with a clearer understanding of how widespread the problem is.

The Characteristics of Tax-Evading Firms

Not all firms evade taxes equally. The study found distinct traits common among businesses that were more likely to evade their tax obligations. These traits include:

Non-exporting firms: Companies that operate solely within Indonesia are more likely to evade taxes. In contrast, exporting firms tend to be more compliant, possibly due to increased scrutiny from customs and international regulations.

Firms facing competition from the informal sector: Businesses that feel threatened by unregulated, informal competitors are more inclined to evade taxes to stay competitive. The presence of informal firms puts additional pressure on registered companies, forcing them to cut corners, including tax evasion.

Perceived obstacles in tax administration: Companies that see tax administration as a significant obstacle to their operations are more likely to dodge their tax responsibilities. The study suggests that simplifying the tax system could encourage higher compliance rates, as firms would find it less burdensome to meet their obligations.

These findings are essential for policymakers, as they highlight the areas where enforcement and education efforts should be focused. By targeting these types of firms, tax authorities may be able to reduce the overall level of evasion and increase revenue collection.

Economic Impact and Policy Implications

Tax evasion has far-reaching consequences for Indonesia’s economy. According to the World Bank report, the country loses about 2% of its GDP annually due to tax evasion by registered firms. Given that taxes paid by businesses make up a significant portion of the government's revenue, this loss is substantial. More alarmingly, these estimates likely represent a lower bound, as actual evasion may be higher due to underreporting.

For middle-income countries like Indonesia, which rely heavily on domestic revenue mobilization to fund infrastructure and public services, tackling tax evasion is a crucial step toward sustainable development. Improving tax compliance could help the country bridge its revenue gap and meet its growth targets.

The study's findings suggest several policy interventions. First, efforts to increase compliance should focus on simplifying tax procedures and reducing administrative burdens. Second, enforcement activities should be targeted at non-exporting firms and businesses facing stiff competition from the informal sector. Finally, enhancing third-party reporting and monitoring systems could help the government more effectively track non-compliance.

A Global Issue with Local Solutions

While the report focuses on Indonesia, its insights apply to many middle-income countries grappling with similar challenges. The innovative use of the double-list experiment offers a new way of understanding tax evasion, and the study’s findings can inform enforcement strategies beyond Indonesia’s borders.

For Indonesia, the message is clear: improving tax compliance is key to unlocking much-needed revenue for the country’s development. By focusing efforts on firms most likely to evade taxes, and by simplifying the tax system, the government could make significant strides in reducing tax evasion and boosting its revenue.