Indonesia: Reforming fiscal policies to remedy land use woes

Jane Wilkinson and Tiza Mafira, Jakarta Post 29 Dec 15;

President Joko “Jokowi” Widodo’s administration has been busy this year, announcing several new policy packages to strengthen the economy in a few months. Then in November the President declared a radical shift in peatland management, with policies designed to halt agricultural expansion into peat forests while facilitating the rehabilitation of already degraded peatlands.

In December, Indonesia made a commitment at the Paris climate change negotiations to reduce emissions by 29 percent by 2030.

This tension between economic growth and environmental protection requires skillful balancing across Indonesia’s economy and particularly, in the expanding agriculture sector.

The proposed economic packages offer tried and true approaches to encouraging business growth. But they lack consideration of how fiscal adjustments could encourage environmental protection while encouraging growth.

Our analysis shows big potential, uncovering inefficiencies in fiscal policies in the land use sector, and suggesting that reforms in this area may be a win-win for better, cleaner growth.

For example, currently, 93.5 percent of all government revenue related to land use comes from levies based on production volume instead of land size.

The more you produce, the more you pay, and there are neither penalties nor rewards to use less land. Only for the land and building tax and a few state taxes are levied in proportion to land used — the more land in play, the more tax you pay.

However, even these taxes create little correlation between the value of the land and the amount paid. So, for now, with land undertaxed, businesses have every reason to use more land to increase production, rather than improving the productivity of land already in play.

The business sector is not the only party influenced by fiscal incentives. Regional governments also stand to gain or lose when fiscal policies change.

A key component of Indonesia’s fiscal system is the revenue sharing fund or Dana Bagi Hasil, which allocates a certain percentage of state revenue back to the region from which it originated.

One of the ideas behind this system is to encourage regional governments to develop key sectors, such as natural resource extraction.

However, current arrangements support some very diverse outcomes. A mandatory 80-90 percent of revenues from land and building Tax, mining royalties, and forestry fees must be allocated back to the regional government. On the other hand, revenue from agricultural production is only minimally disbursed back to regions.

This means that while regions with resource extraction sectors share relatively well in the wealth extracted, regions focused on agriculture, and palm oil production in particular, do not.

As a result, the palm oil industry contributed more than Rp 10 trillion to national tax revenues in 2012/2013, but only 11-14 percent flowed back to producing regions.

Local officials, strapped for cash, must instead turn to other revenue sources, where they can gain more from granting new land permits than they can from discouraging land expansion.

In short, the message the fiscal system sends to investors is, “we will give you plenty of tax breaks for production, and as a bonus, land expansion is always cheap.”

The message it sends to the regional governments is, “the only way to gain from your agriculture sector is by granting more land permits.” Both messages are in direct opposition to the government’s environmental goals.

This is not to say that the solution is more taxes. Rather, if the government is serious about achieving environmental and economic goals, it needs to consider how fiscal systems could better encourage businesses to optimize their land use, while still growing economically.

The good news: There are plenty of options. The government could tax land use rather than production volumes or profits. It could introduce environmental indicators into tax rates or tax holiday eligibility criteria.

It could make better use of earmarking mechanisms to support local sustainability targets — something common in other sectors, but unseen in land use to-date.

Finally, it could increase tax revenue allocation to local governments in a way that encourages more productivity instead of more land expansion.

Indonesia needs to grow economically. But to do so long-term, President Jokowi is right to also prioritize natural resource protection. Innovative adjustments to the fiscal system may be the solution needed to do both.

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