Report No. 70017e Indonesia Selected Issues of Public Resource Management Mach 11,1988 Country Department V Asia Region FOR OFFICIAL USE ONLY ,. .~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~I , N C Documet of th .rld Bank This document has a res'tricted distribution and may be used by recipient only in the performance of their officia duties. Its contents may not othewise be disclosed wMitout Vi%bdd Bank authorization. - .,~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~- 4~~ ~ ~~~~~~~~ -ˇ/ CURRENCY EQUIVALENTS Before November 15, 1978 US$1.00 = Rp.,415 Annual Average 1979-86 1979 US$1.00 = Rp. 623 1980 US$1.00 - Rp. 627 19dl US$1.00 = Rp. 632 1982 US$1.00 = Rp. 661 1983 US$1.00 = Rp. 909 1984 US$1.00 = Rp. 1,026 /a 1985 US$1.00 = Rp. 1,111 1986 US$1.00 = Rp. 1,283 /b 1987 US$1.00 = Rp. 1,644 March 10, 1988 US$1.00 = Rp. 1,660 FISCAL YEAR Government - April 1 to March 31 Bank Indonesia - April 1 to March 31 State Banks - January 1 to December 31 /a On March 30, 1983 the Rupiah was devalued from US$1.00 = Rp. 703 to US$1.00 = Rp. 970 /b On September 12, 1986 the Rupiah was devalued from US$1.00 = Rp. 1,134 to US$1.00 = Rp. 1,644 1O1 OFFICIAL UeK ONLY TITLE : Indonesia: Selected Issues of Public Resource Kanagement COUNTRY s Indonesia REGION s Asia SECTOt s Country Economic RBPORT TYPE CLASSIFICATION Mm/yy LANGUAGE 7007-IND ERA Official Use 3188 English PUBDATE M March 1988 ABSTRACT s The Report reviews the macroeconomic adjustment process of the Indonesian economy over the last decade and the role that public resource management has played in it. It then focuses on three key areas of public resource management: non-oil taxes, local government finances and operations and maintenance (OM) expenditures. The work on the non- oil tax system analyses the nee. and the means by which the Government should partially replace lost oil revenues. It (a) assesses the implementation of the tax reform; (b) analyzes the revenue potential of the present tax system and the policy measures needed t. achieve it; and (c) reviews a selected number of taxation issues that are relevant to the consolidation and improvement of the new tax system. The work on local government finances (a) examines the structure and evolution of local government revenue; (b) assesses the role of central transfers, local resource mobilization and loan finance; and (c) evaluates possible changes in financing patterns of local governments and the appropriate strategy for achieving these changes. Finally, the Report (a) assesses the importance and magnitude of the 04M problem in Indonesia; (b) ascertains the main weaknesses in the planning and budgeting process that lead to inadequate outlays for 0&M; (c) determines the main institutional constraints for adequate and efficient O0M; and (d) defines the necessary strategy and policy measures that are required to address the problem. This document has a retd distibutin d may be wd by recintsony in the pefomnue of th offcl dutis. Its contents may nt othrsbe be dicked wihout Wodd Bank authrkiztIn INDONESIA SELECTED ISSUES OF PUBLIC RESOURCE MANAGEMENT Table of Contents Page No. SUMKARY AND CONCLUSIONS............................................. viii-xv CHAPTER I. THE ROLE OF PUBLIC RESOURCE MANAGEMENT IN THE INDONESIAN ECONOMY e................................... 1 A. Introduction. ..........I................... .......... 1 Major Challenges in Public Resource Management ...... 3 B. Macroeconomic Adjustment and the Role of Government, 1978-86 ...... 7.......... @ 7 The Second Oil Shock, 1978-81....................... 8 Adjustment in the Downturn, 1982-85................. 9 The New Adjustment Challenge, 1986-87 ............... 11 C. Government Revenue and Expenditure Trends: An Oeve ...., ...... 13 Government Revenue.................................. 13 Government Expenditure............ ............ ... ... 16 This Report was prepared by a team led by Ernesto May (Country Operations Division). Willem van Eeghen (Young Professionals Program) and Mukul Asher (Consultant) contributed a background paper for Chapter II. Jaime Biderman (Urban and Water Supply Division), James Alm and Brian Binder (Consultants) were responsible for the background paper for Chapter III. And Peter Heller (IMF# Government Expenditure Analysis Division) and Theodore Smith (Consultant) contributed the background paper for Chapter.IV. Other contributions were made by Robert Calderisi and Amar Bhattacharya (Country Operations Division), Paul Stott (Urban and Water Supply Division) and Steen Jorgensen (Young Professionals Program), Arif Zulfiqar, Peter Sun and Sushma Ganguly (Agriculture 4 Division), Nicholas Prescott (Population, Health and Nutrition Division II) and Mark Wheeler (Consultant), Sigfus Sigfusson (Transportation Division), and Cecilia Valdivieso (Education Division). The extensive assistance provided by the Ministry of Finance, BAPPENAS, and the Central Bureau of Statistics is gratefully acknowledged. A draft of the Report was discussed with the Government in January/February 1988. - ii - Page No. CHAPTER II. MON-OIL TAX SYS..M .... ........... 21 A. The Tax Reform................................ . 21 B. Enforcement of the Tax System a....................... 25 The Case for Enforc nt................................... 25 Indicators of Low Compliance...................... 26 Potential Tax Revenues. .-. ........*..... ........... 29 Revenue Projections With and Without Enforcement.. 32 Reco _ ndations ......ee....... ******oo* 37 Co Selected Tax Issues... 38 Indexation of Deductions and Thresholds for Marginal Tax Rates ........39 Extension of VAT 41 Tax Treatment of In t e r e s t 41 Suspension of VAT on Capital Goodsoo ds............ 43 VAT Borne by the Government..............e.rn...n 45 Treatment of Income Derived from Foreign-Aid Projectsoo*oooo*oo******eo*o 45 Reo cmmdationsooooooooooommentati*eo ns*****o*oooo 46 CHAPTER III* LOCAL GOVERNMENT FINANC ........ 47 A Inn... . I nr ou ci o 47 Structure and Role of Local Governments........... 47 Local Governments: Consolidated Expenditures and Sources of Finamcing..a n c i ng.................... 48 B. The Role of Central Transfersansfers................ 52 Structure and Evoluition of the Grant Systeme...... 52 The Grant System: Problems and Issues************ 55 Reform of the Grant Sytt e m 56 C. The Role of Property Taao. i o. 57 Reform of IPEDA: PBB......... 58 Revenue Potential of the PBB.... 60 r. Local Government Taxes.... .................... 63 Level I Taxes..................................... 63 Level II .a.es .......................... 64 Increasing Local Tax Revenue..................... 65 -iii- Pae No E. Other Sources of Financing for Local Governments.... 69 User ......... ...................... ........ 69 Loan Finance .......... .... ...... 71 CHAPTER IV. GOVERNMENT EXPENDITURES: A FOCUS ON OPERATIONS AND MAINTENANCE IN INDONESIA. .............. ........ 74 A. nrdcin.......* 74 B. The Economics of Operations and Maintenance*......... 74 C. O&M Problems in Selected Sectors.................... 77 General Sources of the Problem.................... 80 Stctor-Specific Features of OU14................... 84 D. Planning and Budgeting for Oas...................... 88 E. A Strategy for Action............................... 94 APPENDIX 1. Indonesia: Sources and Uses of Funds Framevork........ 100 APPENDIX 2. The Non-Oil Taz System ................................. 134 APPENDIX 3. Calculation of the Theoretical Potential Tax Revenue... 152 APPENDIX 4. Local Government Finances: Statistical Appendir....... 165 APPENDIX 5. The Economics of Operations and Maintenance............ 189 NAP Text Tables Table No. Chapter I 1.1 Non-Wining GDP Growth Trends in some Oil Exporting Countries, 1967-84................e.e.o.c 2 1.2 Sectoral Savings-Investment Balances, 1978-86. -8.... e6.e... 10 1.3 Interest Rates of Commercial Banks, 198285. 2-850ee...ee.e.c 12 1.4 General Government Accounts, 1978-86 7 8 -8..................6 14 1.5 Structure of Government Expenditure, 1978-86..8-86.......... 17 1.6 Performance Indicators of Non-Financial Public Enterprises.. 19 Chapter II 2.1 Central Government Non-Oil Tax Revenueg 1978/79-1986187...... 22 2.2 Tax Efforts in Selected Asian Countries, 19868 6ee.e *.cee* 24 - iv - Page No. Table No. 2.3 The 1987/88 Bugt..................................25 2.4 Indonesias Number of Taxpayers Registered, Personal and Corporate Income Tax, 1984-86 ............................. 27 2.5 Indonesia: Number of Taxpayers Registered and Types of Returns Filed for the Value-Added Tax, April 1985 - June 1986................................................8 2.6 1985/86 Non-Oil Tax Revenue, Actual and Theoretical Potential Revenue......................................... 30 2,7 Personal Income Tax 1985/86: Discrepancies Between Actual and Theoretical Potential Revenue and Taxpayers.... 31 2.8 Estimated 1985/86 Theoretical Potential Revenues from Various Setr ..............................33 2.9 Estimated Non-Oil Tax Revenue 1986/87-1990/91 Without and With Enforcement ........... 35 2.10 Central Government Budget Projections, 1987/88-1990/91...... 36 2.11 Estimated Non-Oil Tax Revenue 1986/87-1990/91 Without and With Indexation of Deductions......................... 40 2.12 Extension of VAT: Estimated Revenue Under Alternative 42 Chapter III 3.3 Provincial and Local Government Accounts, 1978-86 ........... 49 3.2 Main Sources of Local Government Finances, 1978-86.......... 52 3.3 Grant System, 1979/80-1987/88 ............................... 54 3.4 Property Tax: Estimated Revenues With and Without an Increase in Official Assessment Ratio..................... 62 Chapter IV 4.1 Indonesia: Backlog of Special Maintenance and Rehabilitation Required: Roads and Irrigation Sectors................... 78 4.2 Indonesia: Additional Outlays Required to Provide Adequate O&M on Selected Sectors................................... 79 4.3 Indonesia: Division of Responsibilities and Sources of Financing for O&M in Five Sectors ......................... 89 4.4 Central Government: Recent Budget Trends, 1985/86-1987/88.. 93 Working Papers (Available on Request) 1. Fiscal r"iicy in Indonesia 2. Non-Oil Tax Revenue 3. Local Government Finance Sector Report 4. Operations and Maintenance Issues in Indonesia ABBREVIATIONS, ACRONYMS AND INDONESIAN WORDS ASP - Administrative efficiency factor APIN - National GOI Budget APBD-I - Provincial Budget APBD-II - Kabupaten and Kotamadya Budget ASKES - The health insurance scheme compulsory for all government empioyees BAKU - National Civil Service Agency BAPPEDA - Regional Developrent Planning Board BAPPENAS - National Development Planning Board BI - Bank Indonesia Bina Marga - Directorate General of Highwaye in the Ministry of Public Works (DCl) BKPK - Investment Coordination Board BPAM - Water company under Cipta Karya supervision BPS - Biro Pusat Statistik (Central Statistical Bureau) Bupati - Chief Executive of Rural Authority Daerah - The district office Dalam Negeri - Department of Home Affairs Desa - Village Dati - LeveL of Regional Government (Dati I, II) DGBangda - Directorate General Bangunan Daerah (Regional Development) DGBM - Directorate General Bina Marga (Roads) DGCK - Directorate General Cipta Karya (Human Settlements) DCMDS - Directorate General Moneter Dalam Negeri (Domestic Monetary Affairs) DGP - Directorate General of Taxation DGPUOD - Directorate General Permerintah Umun Otonomi Daerah (Local Administration) DIK -' Proposed activities for routine budget Dinas - Departments of regional,governments DIP - Daftar Islan Proyek (development budget allocation), list of projects included in APBN Development Budget DIPENDA - Dinas Pendapatan Daerah (local revenue office) DGWRD - Directorate General of Water Resource Development DUP - Daftar Usulan Proyek, proposed projects for developmeat budget DPU - Public Works Department GOI - Government of Indonesia IKI - Small local water enterprise INPRES - Instruksi Presiden (&rant by presidential instruction) INPRES Dati I - A comprehensive development grant from central to provincial governments (also called INPRES Propinsi). It has two components: ditetapkan: fixed element diarahkan: discretionary element INPRES Dati II - Development grant from central government to kabupaten and kotamadya governments INPRES Desa - Grant from central government to villages - vi- INPRES Jalan - Kabupaten road support grant INPRES Kesehatan - Sectoral grant for construction of health centers, drugs, and -illage water supply INPRES Pasar - Systm of loans by Bank Rakyat Indonesia for construction of shops and markets INPRES Sekolah Dasar - Grant for construction and rehabilication of primary schools IPEDA - luran Pembagunan Daerah (Regional Development Contribution), old property tax IUIDP - Integrated Urban Infrastructure Development Program Jalan - Road Jasa Marga - Toll Road Authority Kanwil - Kantor Wilayah, regional office of central government agency Kabupaten - Second level regional districts Kesehatan - Health Kotamadya - Second level regional municipalities LKP - Certificate of inspection, report of clean findings LNG - Liquid Natural Gas MENPAN - Ministry for the Operation of the State Apparatus MHA - Ministry of Home Affairs MOF - Ministry of Finance MPO - Witholding tax payment based on tax liabilities of previous year MPS - Monthly tax payment based on tax liabilities of previous year MPW - Ministry of Public Works NPCS - New Payment Control System NA - Not avealable OAR - Official assessment ratio P4BM - Management Center for Import Duty Exemption and Restitution PAIK - Computer Center reporting to the Ministry of Finance Pajak - Tax, sometimes also refers to the Director General of Taxation PBB - Pajak Bumi dan Bangunan (property tax, replaced IPEDA) PD - Perusahaam Daerah (regional enterprise) PDAM - Perusahaan Daerah Air Minum (regional water supply enterprise) Pertamina - National Oil Company PPh - Income tiz PPN - Value-added tax and sales tax PTKP - Family size-related deduction Puskesmas - Health center Puskesmas Pembantu - Sub-health center RDA - Regional Development Account (precursor to RGLF) RGLF - Regional Government Loan Fund REPELITA III - Third five-year development plan (1979/80-1983/84) REPELITA IV - Fourth five-year development plan (1983/84-1988/89) REPELITA V - Fifth five-year development plan (1989/90-1994'95) - vii - S W - Subsidi Daerah otonom, -outine expenditure grant mainly for payment of civil service salaries at the regional level Sekolah Dasar - Primary school Seksi - Section office sGS - Societe General de Surveillance SKP - Tax assessment letter SKPT - Additional tax assessment letter SM - Program Planning and Budgeting System in the Directorate General of Higher Education SPP/DPP - Sumbangan Pembiran Pendidikan/Dara Penunjang Pendidikan, Education Development Contributions/ Educational Suptec.-t Funds (i.e., income from student fees) STP - Collection lcter TIN - Taxpayer identification number Tingkat II - Local government Tingkat I - Provincial government VAT - Value-added tax - viii - SUKMARY AND CONCLUSIONS i. Over the past decade and throughout the oil cycle, Indonesia's economic performance has proven to be one of the most successful among oil exporting countries. During the upturn of the oil cycle, between 1972 and 1981, Indonesia's non-mining economy grew at an average of 8.2X p.a. This was the second highest growth rate of oil exporting countries including Algeria, Ecuador, Nigeria, Trinidad and Tobago, and Venezuela. More importantly, Indonesia outperformed most of these countries during the cycle downturn. During 1981-84, Indonesia's non-mining economy grew at an average of 4.8Z p.a. while almost all the rest of the countries experienced mild to severe recessions. ii. Among the policy features that underscored Indonesia's more successful performance were: (a) A policy of restraint during the upswing of 1978-81. The Government kept its absorption well below its available resources, channeling part of the surpluses to the private sector aod using the windfall revenues to buildup reserves and reduce external indebtedness. (b) A countercyclice. response to the 1982-83 downturn followed by macroeconomic adjustment in 1983-85. While the Government used foreign borrowing to smooth out the contraction of aggregate demand curing the cycle downturn, it took a comprehensive program of fiscal and macroeconomic adjustment beginning in 1983. By 1985 these measures had succeeded in largely restoring macroeconomic F-ability. (c) A prompt and comprehensive policy response to the large decline in oil prices in 1986. The stabilization program involved measures aimed at maintaining balance of payments and fiscal stability, as well as promoting structural change in the economy by supporting the growth of non-oil tradable sectors in order to reduce the economy's dependence on oil revenues. iii. Although fiscal policy has been quite responsive in Indonesia to changing economic circumstances, the fiscal adjustments so far have focussed mainly on the central government budget and have relied largely on government expenditure reductions, in particular, cuts in investments, to reduce fiscal imbalances. The magnitude of the decline in oil revenues (from 14.5% of GDP in 1981 to 5.61 of GDP in 1986) has highlighted weaknesses in other revenue sources and underlined the importance of more efficient use of scarce public resources. Despite recent improvements, the non-oil tax effort in Indonesia is still weak compared to other countries in the region. Local governments have very few revenue sources of their own, and reLy on central government transfers to finance almost three quarters of their total spending. A number of public enterprises continue to make losses, and require budgetary subsidies or equity contributions to stay in business. In the use of public resources, there is an urgent need to strike a proper balance between capital expendi- tures and operations and maintenance (O&M), and strengthen the institutional - ix- capacity to assess, finance and undertake O0M. Accordingly, the Covernment's focus has to now shift from short-term macroeconomic adjustment to longer term concerns of public resource mobilization and efficiency of resource use, so that the public sector can contribute most effectively to economic recovery in the medium term. iv. This Report is intended to provide insights on some of the key challenges ahead on public resource management. Chapter I provides a suimmary of macroeconomic developments including the role of the government sector in Indonesia, and an overview of the major public resource management issues. Chapter II ir devoted to the non-oil tax system, focussing on the need and the means by which the government should partially replace lost oil revenues. This Chapter (a) assesses the implementation of the tax reform; (b) analyzes the revenue potential of the present tax system and the policy measures needed to achieve it; and (c) reviews a selected number of taxation issues that are relevant to the consolidation and improvement of the new tax system. Chapter III focuses on local government finances. In particular, this Chapter (a) examines the structure and evolution of local government revenue; (b) assesses the role of central transfers, local resource mobilization and loan finance; and (c) evaluates possible changes in financing patterns of local governments and the appropriate strategy for achieving these changes. Chapter IV is designed to complement the recently completed Public Investment Review (World Bank, December 1985), focussing the analysis of government expenditure on the issues of OM expenditures. The work on OM (a) assesses the importance and magnitude of the OM problem in Indonesia; (b) ascertains the main weaknesses in the planning and budgeting process that lead to inade- quate outlays for OM; (c) determines the main institutional constraints for adequate and efficient O&M; and (d) defines the necessary strategy and policy measures that are required to address the problem. The following sections summarize the main conclusions of the Report in the three key areas covered: non-oil taxes, local government finances and OM issues. Non-Oil Tax System v. Indonesia has implemented one of the most far reaching tax reforms in the Asian region. It consisted of a new income tax, introduced in 1984; a replacement of the old sales taxes by a value added tax (VAT) and a sales tax on luxury goods in 1985j and a new property and stamp duty tax, introduced in 1986. Three years have now passed since the introduction of the first tax law and it is clear that the tax reform has already been successful in mobilizing additional resources. Between 1983/84 and 1986/87, non-oil tax revenue increased 87%, raising its share in GDP from 6% to 8.2%. Most of this increase in revenue can be attributed to the introduction of the VAT, although the tax reform also led to significant improvements in income tax collections as well as property tax revenues. vi. Despite these significant gains, the tax effort in Indonesia still riamains low compared to other countries in the region, and given the drastically altered outlook for oil revenues, additional improvements in tax mobilization are needed to reduce the fiscal deficit to a more sustainable level while maintaining current and capital expenditures at a level that would support economic recovery. The Government recognizes the urgency of raising the non-oil tax effort, but is attempting to do so through improved tax enforcement and without raising tax rates or introducing new taxes. Given that a major tax reform has been recently enacted, such a strategy has important merits. At this stage of implementation of the tax reform, a change in structure could significantly erode the base of the tax system: increased tax rates are likely to lead to greater tax avoidance; and an extension of the tax base will overburden an already weak tax administration. The study estimates that actual revenues from taxes is only half of the theoretical potential given the existing coveragc and tax rates. With a gradual improvement in administrative efficiency, non-oil taxes could reach 1OZ of GDP by 1990/91. Improvements in tax compliance is thus a feasible way of raising the additional tax revenues needed, while consolidating the foundations of a sound tax system. vii. To help improve tax administration, the Government is preparing various organizational reforms, including computerization, more emphasis on audits, staff training, and increasing the number of tax offices in the regions and municipalities. In some areas, implementation has already started. For example, 800 auditors are being trained ard seven new district offices have been opened. The Government has also initiated various technical assistance schemes to strengthen tax planning. These are positive steps and the Government should now seek to accelerate the implementation of other planned organizational improvements, through a number of further actions. First, crucial data related to tax administration--such as the number of active taxpayers, the filing to registration ratios, the number of audits undertaken, and revenues from penalties--need to be collected, standardized and shared between the different Directorates involved with tax administra- tion. Second, the number of registered taxpayers can be increased by applying existing penalties for non-registration. The cross-checking of information on taxpayers can be extremely helpful in identifying non-registered taxpayers. Third, filing ratios can be improved by fully imposing the penalty clauses of the new tax laws, including a 2Z interest payment per month for taxes not paid or underpaid. Finally, underreporting can be minimized by effective audits on a selective basis. Adequate budgetary support should be given for further long-term upgrading of specialized technical skills and trained staff should be redeployed along functional lines. viii. In addition to improved tax administration, there are a number of other policy measures that the Government can undertake to further increase tax revanue and improve the present tax system. Among others, it is suggested: (a) deductions and marginal tax rate thresholds should not be adjusted for inflation for the time being, although for equity and tax administration considerations this option should be reviewed periodically in light of the overall revenue situation and inflationary conditions; (b) interest received on time and savings deposits should be taxed in the same way as dividends and capital gains; (c) the suspension of VAT peyments on capital goods should be removed, to avoid interrupting the audit trail as well as revenue losses, and an adequate and efficient mechanism should be set up to refund excess taxes paid; (d) VAT on government purchases should be collected and, to avoid any associated revenue loss, the Government should require sellers to provide tax registration numbers as well as receipts with VAT clearly specified; (e) no exemptions for corporate income tax should be given to suppliers of goods and - xi - services for foreign-aid-financed projects, and taxpayer identification numbers and receipts of income derived from these projects should be required as part of project implementation procedures; and (f) the extension of the VAT to cover electricity, gas and water would have limited revenue impact. Ultimately, an extension to the retail level can be reverie-effective when administered efficiently. In the short run, such an extension should not be considered. Local Government Financea ix. Approximately 752 of local expenditures are financed by transfers from the central government. Local governments also receive "assigned revenues" from central taxes, the most important being the property tax. This pattern of dependence on the central budget has led to a lack of incentives for efficient local resource mobilization and borrowing for development purposes. It has also contributed to distortions in the allocation of local expenditures. The recent decline in oil prices and central budget revenues has made more urgent the need to strengthen and diversify the sources of local government finance. Accordingly, further reforms need to be taken in a number of areas. x. Central Government Grants. The most important of the central government grants are the Subsidi Daerah Otonomi (SDO) for routine expendi- tures, and the Instruksi Presiden (INPRES) programs for development expendi- tures. During the last two years, the Government has increased the share of grants provided in the form of block grants, and relied more on broad functional guidelines, rather than physical targets, in determining the use of specific grants. This trend should continue. In addition, there is the need to change the distribution formulae of grants to recognize differences in local government needs, costs and resourne potential, and to provide an incen- tive for local resource mobilization. To make grant allocation more respon- sive to differences in regional circumstances, it is recommended to include the following factors as criteria for grant allocation: (i) population; (ii) area; (iii) equal shares; (iv) cost variations; (v) revenue potential compensation; and (vi) revenue collection incentive. The specification of each of these factors as well as the relative importance attached to them should be considered independently for each of the different grant programs, and implemented only after an assessment of the effects of alternative distribution formulae on a representative sample of local governments. xi. Property Taxation. The new property tax (PBB) represents a significant improvement over the old IPEDA system. The rate structure is simplified, the base is expanded, the incentives for evasion are reduced, and penalties for nonpayment are increased. Despite a late start with actual implementation, revenue from PBB has already shown a significant increase. The medium-term revenue potential of this tax is quite large so that it could become a cornerstone for local government finances. The first priority is to improve PBB administration: identify and register properties, value them properly, and assess and collect tax liabilities in a timely manner. Such improvements are being supported by technical assistance provided under the World Bank-financed Urban Sector Loan. Consideration should then be given to increasing the maximum effective tax rate, which at 0.1% is among the lowest in the world. - xii - xii. Local Government T&xes. In addition to assigned taxes, like PBB, local governments also impose nearly one hundred taxes of their owvi. However, few of these taxes are significant sources of revenue (and often do not even recoup their administrative costs of collection). It would therefore be desirable to eliminate a large number of unproductive levies. The elimination of the less productive taxes would reduce tax-induced distortions, alleviate the costs of collecting and administering the large array of taxes, and allow tax officials to concentrate on improving the administration of a few revenue effective taxes, such as on motor vehicles and entertainment. Two new taxes are proposed for level II governments: a tax on diesel consumption and a betterment tax. Only the former should be considered for immediate implementation. A diesel tax can be an important source of additional local revenue, and ranks favorably on grounds of efficiency, equity and ease of administration. As in the case of central government non-oil taxes, there is substantial scope for increasing local tax collections by more efficient tax administration. xiii. User Charges. User charges in aggregate constitute the largest single source of locally generated revenue for level II governments, and almost double the revenue of local taxes. The number of user charges tend to be prolific, partly because new charge proposals are more easily approved than new tax proposals, ard are often expensive to collect. Legislation to rationalize the structure of charges and implement more effective control is under consideration. The Government should also consider proceeding with more specific steps including the collection of comprehensive information on charges and the formulation of guidelines for setting and reviewing user charges. xiv. Loan Finance. The aggregate contribution of loan finance to regional governments' total resources is very small. There are, however, a large number of disparate loan schemes, most of which are narrowly earmarked and on highly subsidized terms. This has led to overinvestment in some areas, for instance in the building of markets with the use of INPRES Pasar funds. With the present constraints on central government grant finance and the prospect of a continuing scarcity of such funds, access to a reliable source of loan finance will become increasingly important for regional governments in order to maintain overall development spending. This is particularly the case for projects which have significant future benefits and could therefore ensure service of the loans from associated future local revenues. The establishment of a consolidated central source of loan finance for use by all regional governments is therefore recommended. Technical assistance should be obtained to met up the detailed institutional, operational, financial management and accounting procedures for such "Regional Government Loans Fund". It is important that this Fund be established as an independent financial entity, use consistent lending terms, including a realistic lending rate, and require project appraisals based upon stardard criteria. As a first step, GOI has established the Regional Development Account which is being supported under the Urban Sector Loan by GOI and UNDP-financed technical assistance for policy formulation and operationalization. - xiii - Operations and Maintenance (O1)) in Indonesia xv. As a result of its strong development efforts, the Government has been highly successful in establishing an extensive system of physical infrastructure and social services. This very success has stretched the Government's capacity to adequately operate and maintain public infrastructure and programs. In recent years, there have been signs of a deterioration in public infrastructure (roads, irrigation networks, government buildings), and of lower efficiency and quality of operations. xvi. By sampling five selected public activities--roads, irrigation, health, education, and urban infrastructure--this Report generated information bearing on both the magnitude and sources of the O&M problems found at the field level. In the first instance, there is a backlog of special maintenance and rehabilitation required for much of the existing infrastructure in irrigation and roads, so as to raise it to a level adequate for productive OEM. These needs are estimated at about Rp 4.7 trillion, equivalent to 4.7% of GDP and about 22% of general government consolidated expenditures in 1986. As this rehabilitation takes place, it is estimated that the average annual expenditure required, over and above current outlays, to adequately provide for O&M on the five sectors examined is about Rp 921 billion, or about 1Z of GDP in 1986. This estimate is quite conservative, as it assumes that the average cost of maintenance per unit of capital is invariant to the volume of maintenance. xvii. Although these figures underline the magnitude of the shortfall in OM expenditures, the O&M problem is not solely one of inadequacy of funds. Other systemic weaknesses aiise from the planning and budgeting process, limited technical and management capacity to undertake O&M, particularly at the local level, and institutional biases against maintenance. Planning and budgeting for OM is weak in the central government and even more so at local levels. Investment planning has given inadeouate attention to the O&M implications of new projects as well as to the question of whether priority should be given to the backlog of O&M needs. The budgeting of O&M outlays has been biased towards additional staff at the expense of non-personal inputs as well as rigid in the allocation of resources between activities. The emphasis on a project format in budgeting and the patterns of financial compensation of civil servants have created a bias towards investments at the expense of routine activities such as O0). Resources for O&M are provided through a large number of separate channels which leads to the lack of a coherent approach to OM financing. Coordination is further confused by the lack of clarity in the division of responsibilities for O&M implementation between the central government and local authorities. The latter are being asked to assume increased responsibilities for completed infrastructure and expanded programs, but often lack the technical and managerial capacity to operate and maintain complex systems of infrastructure and social services. Moreover, the regions remain largely dependent on central budgetary support, but such funding is not linked to the magnitude of local O0M responsibilities. xviii. In addition to these general causes, there are specific factors in the individual sectors which have contributed to inefficiencies in the funding or carrying-out of O&M. In the roads sector, until recently, when a Road - xiv - Maintenance Management System for national and provincial roads was established, the absence of a comprehensive Road Inventory has precluded the possibility to plan, schedule and budget maintenance works appropriately. This problem still prevails in the district road network. Delays in project implementation several months into the fiscal year crowd out maintenance close to or into the rainy season, which is an inefficient period for road maintenance. In the irrigation sector, allocations within O&M budgets appear inefficient, with only half of the outlays actually spent at the field level given the high share spent on administration overhead at the central and provincial levels of Government. In the urban setting the problem of planning, budgeting, managing and implementing O&M is further complicated by the need to coordinate the effort in different urban subsectors. Informal "user charges" are said to be prevalent in the health sector, indicating inadequata salaries for staff employed. This leads government health workers to seek additional private employment, at the expense of their regular duties, or to limit their incentive to participate in preventive health activities. Personnel incentives also play a critical role in the higher education sector as faculty devote less than 30X of the work-week to the needs of their students. xix. Given the constrained budgetary situation, the increased emphasis that the Government is currently placing on O&M can contribute significantly '-. improving the productivity of existing capital and the quality of public services. A broad-based and concerted strategy is needed to deal with systemic and sector issues related to O&M. As a first step, the Government should develop and promote a national policy on OM stressing the importance of maintaining the quality of public infrastructure and of realizing the highest productivity in its use. For this policy to prove successful there is the need to reform the current planning and budgeting process for O&M at the central, sectoral and regional levels, as well as to build-up the institu- tional capacity to do O&M. Furthermore, the Government should indicate that the population at large will be expected to participate in this effort to deal with the "O&M problem" by sharing some of the costs when they derive direct benefits from improved programs. xx. Reform in the planning and budgeting of O0M at the central government level must begin with the: (a) establishment of a locus of responsibility for O&M; (b) identification of the O&M content of budget outlays; (c) rationalization of the budget allocation to O&M; (d) development of an "indicative" macro budgetary planning model to assess the medium-term O&M implications of the investment program; (e) formulation of proposals (including a timetable) for developing sectoral asset registries of the amount and condition of public infrastructure; (f) exploration of the feasibility of the "project format" for essential routine maintenance activities; (g) consi- deration of how O&M issues can be integrated into the project evaluation process; and (h) development of a computerized system of "project profiles". xxi. Improved OM procedures and data collection at the central government level will only have significant effects if corresponding changes occur at the sectoral level. Sectoral agencies are the source of technical expertise on O&M needs and are ultimately responsible for meeting them. Among others: (a) sectoral OM objectives need to be defined, with sectoral - xv - strategies developed for striking an appropriate balance of operations, routine and periodic maintenance, rehabilitation and investments; (b) detailed erstimates on the magnitude of O&M requirements by sector should be developed; (c) unit costs and staffing requirements should be defined for different programs and infrastructure; (d) the possibility of transferring funds directly to "operational" units responsible for O&M should be explored; and (e) privatizacion of some O&M activities should be considered. xxii. Resolution of the O&M problem will be a medium-term process. The emphasis must be placed on increasing the capacity to do O&M rather than simply doing O&M. This will require the Government to focus on the related technical and management capacity to undertake O&M. To build-up this institutional capacity: (a) the organizational structure and status of O&M needs to be strengthened; (b) incentives and disincentives in the civil service compensation system need to be addressed; (c) support units should be established in provincial, district and municipal offices to provide technical and policy guidance to line units responsible for O&M and policy guidance on O&M needs to budgeting and planning units; (d) monitoring and supervision of O&M needs to be strengthened; and (e) manpower planning, which identifies both technical and managerial personnel required for O&M, needs to be part of both central and local government responsibilities. xxiii. The preparation of the next five-year development plan provides a timely opportunity to introduce many of the recommendations of this Report. An "O&M" Improvement Program" could well be an important thrust of the plan, reflecting the Government's commitment to the productivity of investments already made, as well as its desire to shift priorities slightly toward new standards of quality relative to some degree of quantity. In fact, if O&M is to achieve higher priority in Indonesia, its seem necessary that this theme be an integral part of REPELITA V. CHAPTER I THE ROLE OF PUBLIC RESOURCE MNAGEMENT IN THE INDONESIAN ECONOMY A. Introduction 1.1 Over the past decade and throughout the oil cycle, Indonesia's economic performance has proven to be one of the most successful among oil exporting countries.- During the upturn of the oil cycle, between 1972 and 1981, Indonesia's non-mining economy grew at an average of 8.2% p.a. (see Table 1.1). This was the second highest growth rate of oil exporting countries including Algeria, Ecuador, Nigeria, Tr'nidad and Tobago, and Venezuela. More importantly, Indonesia outperfot ied most of these countries during the cycle downturn. During 1981-84 Indonesia's non-mining economy grew at an average of 4.8Z p.a. while almost all the rest of the countries experi- enced mild tg,severe recessions. To a large extent, the successful performance _/ of Indonesia can be attributed to its public resource management as well as the supporting macroeconomic policies pursued. 1.2 Analyzing the 1978-86 period, it is clear that the government sector played a key role in determining Indonesia's choices both to absorb the oil windfall gains and to adjust to the shortfall, as a significant part of the oil revenue was directly captured by Government. During the upswing, 1978-81, the Government restrained its absorption well below its available resources; its savings-investment gaps increased and part of the surpluses were channeled to the private sector in the form of subsidies, direct current and capital transfers, or through the banking system. During the downturn, 1982-85, the Government relied on foreign borrowing to smooth the contraction of aggregate demand at the same time that expenditure switching policies were pursued; its savings-investment gaps turned negative, but showed steady improvements almost throughout the period as a complete stabilization program was put into place in 1983. In all, between 1978 and 1985, the government sector effectively behaved as a shock absorber that smoothed the relatively wide fluctuations in the external environment. Supported by complementary macroeconomic policies, 1/ See A. Gelb, et. al., Windfall Gains: A Blessing or a Curse? A Comparative Study of Six Oil Exporting Countries, 1973-84, World Bank, manuscript, December 1986. 2/ In addition to the growth of overall non-mining economy, the successful performance of Indonesia also relates to the behavior of the non-oil tradable sectors through the period of the oil price booms. Effectively, Indonesia managed to strengthen its non-oil tradable sector over the period under analysis and avoided some of the adjustment problems associated with the "Dutch Disease." - 2 - Table 1.1: NON-MINING GDP GROWTH TRENDS IN SOME OIL EXPORTING COUNTRIES, 1967-84 (Percent) 1967-72 1972-81 1981-84 Indonesia 8.5 8.2 4.8 Algeria 9.5 8.6 7.0 Ecuador 4.7 7.6 -1.0 Nigeria 9.2 5.3 -5.6 Trinidad and Tobago 5.3 5.4 -2.9 Venezuela 6.5 5.1 -2.0 Source: Alan Gelb, et. al., Windfall Gains: A Blessing or a Curse? A Comparative Study of Six Oil Exporting Countries, 1973-1984, World Bank, manuscript, December 1986. this succeeded in restoring macroeconomic stability to the Indonesian economy by the end of 1985. It placed Indonesia, relative to other oil exporting countries, in a better position to undertake further adjustment measures in response to the unexpected collapse of oil prices in 1986. 1.3 The weakening of the oil market during 1986 represented another challenge to Indonesia's policy makers. Indonesia's crude oil export price collapsed from an average of US$25 per bbl in 1985 to US$13.10 per bbl in 1986. The loss of related oil revenues was equivalent to 19X of domestic budget revenues and 36X of merchandise exports. The Government's response to this critical situation was rapid. It involved measures aimed at maintaining balance of payments and fiscal stability, as well as promoting structural change in the economy by supporting the growth of non-oil tradable sectors in order to reduce the economy's dependence on oil revenues. Major initiatives included: (a) austere budgets for 1986/87 and 1987/88; (b) devaluation of the Rupiah by 312 in September 198 and (c) structural reform measures in May and October 1986 and January 1987._ While these measures are having their desired impact, the very large loss of resources over the past year has resulted in severe macroeconomic imbalances. The current account deficit deteriorated from 1.9X of GDP in 1985 to 5.7Z in 1986; the Government savings- investment gap widened from -12 of GDP in 1985 to -4.22 in 1986. And even though policy actions already taken, including the devaluation, trade reforms and the recent austere budget, are likely to have an impact on che balance of payments in 1987, it is clear that to attain macroeconomic balance in the economy further adjustment is required. As in the past, a key element in the 3/ These included measures designed to provide internationally-priced inputs to exporters, and to remove or relax import and industrial license restrictions. adjustment effort will be the government sector. By focussing on the issues of public resource management then, this Report attempts to provide a contribution to the analysis and formulation of economic policy at this turning point in the Indonesian economy. Major Challenges in Public Resource Managemen. 1.4 Fiscal policy has been effective in reducing the budget deficits resulting from the sharp fall in oil revenues over the past two years, and in doing so, it has contributed to the reduction of the balance of payments disequilibrium. Nevertheless, although fiscal policy has been quite respon- sive in Indonesia to the changing economic circumstances, the fiscal adjust- ments so far have focussed mainly on the central government budget and have relied largely on government expenditure cuts, and in particular investment cuts, as its main policy instrument. Looking ahead to define the policy agenda in the area of public resource management, the approach to fiscal policy needs to broaden the scope of policy to the overall public sector, including both provincial and local governments, and public enterprises. And, it needs to explicitly recognize both the demand and the supply management aspects of fiscal policy. In that regard, policymakers need to pay much more attention to structural (supply side) elements, recognizing that there is complementarity between the macro objectives of stability and growth, and the micro objective of economic efficiency. The effect of changes in the public sector fiscal deficit on economic growth depends to a considerable extent on the efficiency of the fiscal instruments employed. The challenge ahead is to define what might be called a growth-promoting adjustment strategy--a strategy that sets the ground for economic recovery by achieving its deficit-reducing objective with the least possible inhibition of economic growth. The main policy issues that need to be addressed in the design of such a strategy are discussed below. With regard to public resource mobilization, policy makers need to pay particular attention to three distinct areas: non-oil taxes, local government revenues, and public enterprise finances. With respect to the use of public resources there is the need to focus on two areas of expen- diture that so far have received limited attention: operations and maintenance (OM) expenditures and subsidies. 1.5 Non-Oil Taxes. Over the past three years, the Government has introduced a comprehensive package of tax reforms. The initial phase of the tax reform has been successful in mobilizing additional resources; between 1983/84 and 1986/87 central government non-oil tax revenues increased 87X. Nonetheless, it is estimated that actual revenue from taxes covered by the reform amounts to only half of the theoretical potential revenue under existing tax provisions. To tap some of these potential resources, it is necessary to improve tax compliance substantially. This requires a continued and simultaneous effort in registering new taxpayers, ensuring that those registered actually file their returns, conducting selective and effective audits, and adhering to the penalty clauses of the tax laws. A lack of compliance with the tax laws is not only an issue of foregone government revenues but also of efficient resource allocation. As tax laws are only partially applied, distortions arise from the fact that similar goods and services are taxed de facto at different rates. Non-compliance and a lack of punitive actione are perceived by existing taxpayers as unfair and provide an -4- incentive for further tax avoidance. If unchecked, this lack of compliance will continue to erode the newly established tax system and the very princi- ples of the tax reform effort. 1.6 On the policy front, the Government therefore faces two distinct, and in the short run, conflicting objectives: rapidly increasing non-oil tax revenues by raising tax rates or broadening the statutory tax base, on the one hand, and consolidating the existing tax system by enforcing the currer.t tax law, on the other. At this stage of implementation of the tax reform any change in its structure can significantly erode the base of the tax system. An increase in tax rates per se would lead to greater tax avoidance; an extension of the tax base will overburden an already weak tax administration; and any change in tax structure will impose an additional burden in a society that has still to assimilate the original tax laws. There is a clear trade- off hetween increasing tax revenues quickly and broadening the base of the tax system through better tax compliance. The issue is one of timing and of the level of government expenditure that is to be financed in the coming years. For the Government to able to make the necessary policy choices it is therefore necessary to address the following issues: (a) What is the revenue potential of the present tax system? What policy measures are required to achieve it? (b) What other tax policy options does the Government have to further increase revenue and improve the present tax system? What are their revenue implications? 1.7 Local Government Finances. Approximately 75% of local expenditures are financed by transfers from the central government. Local governments also receive "assigned revenues" from central taxes, the most important being the property tax. This pattern of dependence on the central budget has led to a lack of incentives for efficient local resource mobilization and borrowing for development purposes. It has also contributed to distortions in the alloca- tion of local expenditures. The recent decline in oil prices and central budget revenues has dramatized the need to reform the present system of local government finance. Some of the main issues that need to be resolved are: (a) The role of central transfers. In the current tight resource environment, what level of central budgeting support snould be provided? What changes are required in the structure of central grants to correct the current fragmentation of resource trarsfers and reduce the control in their use by central government? How should they be linked to local resource mobilization? (b) The scope for local resource mobilization. What has been the performance of the new property tax? What is the medium-term revenue potential of this tax? What are the policy measures needed to achieve it? What other potential revenue sources need to be tapped? Should some taxes/fees be eliminated or consolidated? (c) Loan finance issues and constraints. What is the potential debt service capacity of local governments? What legal, institutional a.d financial constraints exist to the expansion of loan finance? - 5 - 1.8 Public Encerprises. The public enterprise sector in Indonesia has expanded rapidly over the past two decades and now comprises 220 enterprises in virtually all sectors of the economy. While some enterprises have performed well (e.g., P.T. Pusri), many others have become a major burden on the central budget requiring regular operating subsidies (e.g., PJKA, the national railway) or equity contributions (e.g., P.T. Krakatau Steel). It is clear that by improving public enterprise performance, the growth impact of scarce public resources could be greatly enhanced. The performance of public enterprises reflect a variety of factors, internal and external to the enterprise. Some of the relevant issues in the sector are: (a) What short-term actions--e.g., operating practices, investment planning, financial management--can public enterprises take to improve profitability? (b) To what extent is progress in these areas dependent upon iastitutional changes in the system of public enterprise supervision and control and longer-term improvements in management and staffing? (c) What other measure'--e.g., pricing policies, restructuring, ownership--can be taken to reduce the budgetary impact of the public enterprise sector? (d) What are the implications of these proposals for the future financial performance of public enterprises? What impact can this have in the overall adjustment process of the economy? 1.9 O&M Expenditures. In the face of sharply reduced fiscal resources, more efficient use of public resources is clearly a necessary complement to domestic resource mobilization efforts. This is true with equal force for new investments and existing capacity. While the Government has paid 4onsiderable attention to investment priorities and the rephasing of projects,-4 an issue that has received little attention is O&M expenditures and financing. For the past 15 years the Government has succeeded, through its emphasis on develop- ment expenditure, in establishing (or renewing) an extensive system of public infrastructure (e.g., roads, irrigation systems, air fields, t'lecommunication networks) and social services (e.g., education, health, family planning). With each development project has come the need for larger and larger recur- rent funding to maintain and operate what has been built or developed. Never- theless, government expenditures hare not provided a concommitant increase in resources for O&M. The correspondir.' inadequacy of O&M funds has resulted in a rapid deterioration of infrastructure and a real decline in the quality of some social service programs. In all cases, the failure to adequately operate and maintain public infrastructure and programs has resulted in low productiv- ity of existing capital, much of which was financed by borrowing, and frequent and costly investment for the rehabilitation of the existing capital stock. 4/ See Indonesia: Public Investment in REFELITA IV, World Bank, Report No. 5849-1IND, December 27, 1985. - 6 - These implicit costs indicate that current O&M outlays could have very high rates of return, and should correspondingly be given top standing in government expenditure priorities. 1.10 The complex and numerous sources of the OM problem reflect not only a general inadequacy of outlays but also serious inefficiency in the use of the limited funds available. To address the O&M problem properly in Indonesia, the following issues need to be dealt with: (a) What is the magnitude, in terms of tinancial resources, of the OM problem in Indonesia? (b) Why have the planning and budgeting mechanisms failed to consider 14M adequately? Who is responsible for OM? (c) What are the distortions and inefficiencies in the funding, allocation and implementation of O&M? 1.11 Subsidies. Another important aspect of government expenditure policy is subsidies. Since expenditures need to be curtailed, there is the need to reassess the benefits of subsidies. As in the case of taxation, any change in subsidies involves trade-offs between growth, equity and fiscal restraint. Currently, the most important budget subsidies are the fertilizer and pesticide subsidies. These subsidies consume considerable amounts of government resources (e.g., Rp 600 billion in 1986/87) and while they were instrumental in the rapid adoption of these inputs by farmers when those modern inputs were first introduced, there is the need to reassess their current relevance. Issues to be resolved are: (a) Should the pesticide subsidy be removed immediately or phased out gradually? Is the subsidy redundant now that strict use-controls have been placed on pesticides and a program of integrated pest management has been initiated? (b) Should the fertilizer subsidy be phased down? At what rate should it be removed? To what extent would this require increases in farm prices? What would be the impact on agriculture production and on farmers' income? 1.12 In all, the policy issues outlined above point clearly to the fact that, in defining a growth-promoting adjustment strategy, GOI needs to go beyond the short-term stabilization needs and address the long-term concerns of public resource mobilization and efficiency of resource use. In an attempt to contribute in the definition of such a strategy this Report provides an in- depth analysis and related policy recommendations in three of the above distinct and critical areas of public resource management: (a) non-oil taxes; (b) local government finances; and (c) O&M expenditures. The Report does not address the issues with respect to public enterprises or subsidies. The information required to assess the performance and role of public enterprises is still rudimentary. A recently initiated Government review of public enter- prises should provide some answers to the questions raised before (para. 1.8). With respect to pesticide and fertilizer subsidies, the issues and suggested remedies are discussed in a forthcoming Bank report, Agricultural Policies: Issues and Options (Report No. 6983-IND). 1.13 The Report is organized in four chapters. The remainder of this Chapter reviews the historical role of public resource management in the macroeconomic adjustment of the economy. It provides a summary macroeconomic analysis of the 1978-86 period with particular reference to the role of the government sector. By doing so, it gives a sense of the nature and magnitude of the macroeconomic imbalances underlying the Indonesian economy, the impact of recent adjustment policy measures, the position the economy is now at to undertake further adjustments, and the task that lies ahead for Indonesian policy makers. The next three chapters are then devoted to the analysis of selected issues of public resource management: Chapter II and Chapter III focus on issues of government resource mobilization, while Chapter IV turns to issues of government expenditure. Chapter II is devoted to the non-oil tax system, focussing on the need and the means by which the government should partially replace lost oil revenues. The work on the non-oil tax system (a) assesses the implementation of the tax reform; (b) analyzes the revenue potential of the present tax system and the policy measures needed to achieve it; and (c) reviews a selected number of taxation issues that are relevant to the consolidation and improvement of the new tax system. Chapter III focuses on local government finances. In particular, this Chapter (a) examines the structure and evolution of local government revenue; (b) assesses the role of central transfers, local resource mobilization and loan finance; and (c) evaluates possible changes in financing patterns of local governments and appropriate strategy for achieving these changes. Chapter IV is designed to complement the recently completed Public Investment Review (World Bank, December 1985), focussing the analysis of government expenditure on the issues of O&M expenditures. The work on O&M (a) assesses the importance and magni- tude of the 06M problem in Indonesia; (b) ascertains the main weaknesses in the planning and budgeting process that lead to inadequate outlays for O&M; (c) determines the main institutional constraints for adequate and efficient 036M; and (d) defines the necessary strategy and policy measures that are required to address the problem. B. Macroeconomic Adjustment and the Role of 'overnment, 1978-86 1.14 Although the main attributes of the Indonesian economy are generally known and the adjustment process between 1978-86 widely studied, a systematic integration and analysis of the interrelations between the government sector and the rest of the economy has been lacking so far. To a large extent this was due to data limitations. In an effort to provide a historical perspective of the ongoing adjustment process and the specific role of the government sector, an attempt is made in this Report to reconcile the key macroeconomic accounts, notably the government budget, the balance of payments, the monetary accounts, and the national income accounts using a sources and uses of funds framework.51 Based on such framework this Section analyzes recent external shocks and the nature of the macroeconomic adjusvnegy process, focussing on the financial interrelation between the Government - and the private sectors, and the way in which their respective income, savings and investment patterns are dependent and linked with one another. Section C will then discuss in more detail the patterns and trerds in the use and mobilization of government resources. 1.15 During 1978-Z6 Indonesia experienced three major external shocks. First, real oil prices doubled during 1978-81, and as a result Indonesia experienced a large oil windall gain for the second time in six years. The second shock occure-ed during 1982-83, when bcth oil and commodity markets weakened sharply. The reversal in the oil market led to a reduction of Indonesia's production from 1.55 mbd in 1981 to 1.36 mbd in most of 1982, and the decline in its export price from US$34.50 per bbl to US$29.50 per bbl in 1983. Non-oil commodity prices also fell sharply from the peak levels of the late 1970s. Overall, Indonesia's external terms of trade fell by 10% between 1981 and 1983, and fell a further 6% between 1983 and 1985. The third major shock came in 1986, when oil prices dropped from an average US$25 per bbl in 1985 to US$13.10 per bbl as a result of OPEC determination to secure its share of the oil market. The magnitude and proximity of these shocks has imposed major adjustment problems on the economy. The analysis that follows evaluates Indonesia's policy responses to these external shocks, and their impact on the adjustment of the economy. It gives particular attention to the role of the government sector throughout the distinct phases of the adjustment. The Second Oil Shock, 1978-81 1.16 Early in 1978, the prospects for Indonesia's balance of payments started to deteriorate as the 1973-77 oil bonanza seemed to be coming to an end. However, real oil prices doubled in 1979-81 and Indonesia again experienced a massive oil windfall gain. This win Ifall was equivalent, on average, to 22.6% of non-mining GDP over 1978-81.7 The macroeconomic response to this sudden increase in resources was generally more cautious than other low- and middle-income oil exporters, and kept absorption well below the level of available resources. During 1979-81, only 22% of the windfall was 5/ The methodological iss-es involved as well as the detailed annual sources-and-uses-of-fu. .s accounts, and the aggregate accounts for the period 1978-86 are preiented in Appendix 1. 6/ The government sector, as referred to in this Chapter, comprises both the central government and provincial and local governments, i.e., the general government. The operations of the rest of the public sector (e.g., public enterprises) are consolidated into the private sector and are considered to the extent they involve transactions with general government. For the more disaggregated accounts of general government see Appendix 1. 7/ See A. Gelb (1986), op.cit. - 9 - consumed and 36% was invested. Accordingly, gross national savings rose from 20.8% of GDP in 1978 to 26.8X in 1981, while total invesEment increased from 23.5% of GDP in 1978 to 27.1% in 1981 (see Table 1.2). This strengthening of domestic savings allowed higher levels of investment to be financed with reduced recourse to foreign financing. Foreign savings actually turned negative as the current account swung from a deficit of 2.6% of GDP in 1978 to a surplus of 1.7% of GDP in 1979-81. By 1981, 42% of the windfall had been used to accumulate international reserves and reduce external borrowing. This outcome proved to be critical to maintaining Indonesia's international creditworthiness as it adjusted to a world wide recession accompanied by declining oil prices in the following years. Furthermore, the adjustment in external borrowing was fortunate, as it coincided with a sharp increase in .iternational interest rates (LIBOR went from 9.3% in 1978 to 16% in 1981). 1.17 The government sector played a key role in determining Indonesia's response to the oil windfall gain, as a significant part of the winefall gain was directly captured through government rcaenue. Government oil revenues increased from 9.2% of GDP in 1978 to 14.5% in 1981. The sudden increase in oil revenue enabled the Government to de-emphasize other sources of revenue at the same time that it increased total government expenditure. Non-oil tax revenues declined from 7.7% of GDP in 1978 to 6% in 1981, while consolidat $ government expenditure increased from 18.2% of GDP in 1978 to 22% in 1981., More than half of this increase in government expenditure in fact reflected transfers from the government sector to the private sector in the form of subsidies or direct current and capital transfers. Subsidies, for example, expanded more than twice as rapidly as GDP between 1978 and 1981._/ In addition to this direct channeling of resources from the Government to the private sector, significant amounts of resources were channeled through the banking system. During this period, pa-ticularly in 1979 and 1980, large government surpluses were accumulated in the banking system as government expenditure was kept well below the level of government revenue and foreign aid. The private sector, in turn, used these resources to finance a sub- stantial increase in private investment while reducing its reliance on foreign inflows. During this period, private investment increased from 18.7% of GDP in 1978 to 21.3% in 1981, mainly financed by an increased level of private savings which reflected the substantial transfer of resources from the Govern- ment to the private sector. Adjustment in the Downturn, 1982-85 1.18 Due to the weakening of the oil market, Indonesia's oil and LNG exports fell from US$19.2 billion in 1981 to US$15.9 billion in 1982 and the next year plunged to US$13.7 billion. Relative to 1981, the negative windfall effect for Indonesia during this period averaged -8.7% of non-mining GDP. To make matters worse, there was at the same time a sharp deterioration of the non-oil terms of trade as important markets for primary products collapsed. 8/ See Table 1.4. 9/ See para. 1.30. Table 1.2: SECTORAL SAVINGS-INVESTMENT BALANCES, 1978-86 (As percentage of GDP) 1978 1979 1980 1981 1982 1983 1984 1985 1986/a 1987/b Total Investment 23.5 23.7 24.1 27.1 25.8 24.8 20.3 19.1 19.5 19.7 Financed by: Gross national savings 20.8 25.5 27.7 26.8 20.2 17.0 18.1 17.2 13.8 16.4 Foreign savings 2.6 -1.8 -3.6 0.3 5.6 7.8 2.2 1.9 5.7 - 3.3 General Government Investment 4.7 5.0 3.5 5.8 9.1 9.5 6.3 6.9 6.4 6.1 Financed by: General Government savings 5.8 6.9 7.0 6.7 5.7 7.2 7.6 5.8 2.2 2.9 Minus capital transfers to private sector -0.6 -0.6 -0.9 -0.8 -0.6 -0.7 -0.5 -0.4 -0.3 -0.3 Banking system -1.9 -2.6 -4.5 -1.8 0.7 -1.7 -3.8 -0.3 0.3 -0.4 External borrowing 1.5 1.3 1.8 1.7 3.4 4.7 3.0 1.7 4.2 3.9 Private Investment 18.7 18.8 20.6 21.3 16.7 15.4 14.0 12.2 13.0 13.6 Financed by: Private savings 15.1 18.6 20.7 20.1 14.5 9.8 10.5 11.4 11.6 13.5 Banking system 6.7 3.2 3.9 4.7 4.9 3.1 4.3 3.8 3.8 2.4 Minus money holdings -7.6 -5.4 -5.8 -3.5 -3.1 -5.7 -4.7 -5.6 -6.8 -2.5 Capital transfers from Central Government 0.6 0.6 0.9 0.8 0.6 0.7 0.5 0.4 0.3 0.3 Rest of the world 3.9 1.8 0.9 -0.9 -0.2 7.3 3.4 2.3 4.2 -0.1 Summary Savings-Investment Balances -2.6 1.8 3.6 -0.3 -5.6 -7.8 -2.2 -1.9 -5.7 -3.3 Private sector -3.6 -0.2 0.1 -1.2 -2.2 -5.5 -3.5 -0.9 -1.4 -0.1 General Government sector 1.0 2.0 3.5 0.9 -3.5 -2.3 1.3 -1.0 -4.3 -3.2 Memo Items: DOD/XGS (ratio) 116.3 85.5 67.4 63.7 87.1 108.8 103.1 133.0 220.7 219.2 DOD/GNP (ratio) 26.2 25.2 20.0 17.7 20.5 28.0 26.5 33.4 44.7 59.6 International resources (US$ million) 2,663 4,167 6,500 6,076 4,196 4,814 5,720 5,880 5,411 5,782 /a Preliminary. 7T Staff estimate. Source: Sources and Uses of Funds Framework, Appendix 1. - 11 - However, the level of imports continued to rise, linked to the sharp rise in government investment during 1981 and 1982. As a result, the current account reversed abruptly; a surplus of US$2.8 billion in 1980 became a deficit of US$6.4 billion by 1983. The underlying imbala.ices that resulted during this period, clearly demonstrated that the previous economic growth pattern was no longer sustainable under the new circumstances. The private savings- investment gap deteriorated from -1.2% of GDP in 1981 to -5.5% of GDP in 1983. The government sector savings-investment gap deteriorated as well, as a pipeline of projects, initiated during the oil boom was now absorbing an increasing share of declining government resources. The drop in government savings had to be more than offset by increased foreign borrowing (and in 1982 even domestic borrowing) to finance government investment. Accordingly, the government savings-investment gap deteriorated from 0.9% of GDP in 1981 to -2.3% in 1983. 1.19 Recognizing these adverse trends, the government adopted a complete stabilization program in 1983, which included an austerity budget, a sharp reduction of domestic subsidies on petroleum products, a drastic rephasing of its public sector investment program, a 28% devaluation of the Rupiah against the US dollar, a major reform of the financial sector, and a tax reform. These wide-ranging measures, aided by the recovery of industrial economies, succeeded in restoring macroeconomic stability to the economy by 1985. 1.20 The major rephasing of the public sector investment program announced in May 1983, which saved US$1l billion in foreign exchange, had a significant impact on total investment in the economy. Government investment declined from 9.5% of GDP in 1983 to 6.9% in 1985. This adjustment largely explains the improvement in the government savings-investment gap from -2.3% of GDP in 1983 to -1% in 1985, and the corresponding reduced reliance on foreign borrowing and renewal of the Government's net lending position with the banking sector. On the other hand, the set of stabilization measures which altogether resulted in a sharp increase in real interest rates (see Table 1.3) had a positive impact on the private savings-investment gap which improved from -5.5% of GDP in 1983 to -0.9% in 1985. This improvement came about through both a fall in private investment, which dropped from 15.4% of GDP in 1983 to 12.2% in 1985, and an increase in private savings, which rose from 9.8% of GDP in 1983 to 11.4% in 1985. Altogether, the current account deficit was sharply reduced from 7.8% of GDP in 1983 to 1.9% in 1985. By 1985 then, Indonesia seemed by and large to have overcome its balance of payments problems and macro adjustment problems and was set on a path which could potentially restore stable growth to the economy. The New Adjustment Challenge, 1986-87 1.21 Indonesia's terms of trade deteriorated by about 34% during 1986, mainly as a result of the sharp drop in oil prices. This worsening of the external environment posed a major threat to Indonesia's macroeconomic stability. As compared with the situation faced in 1982-83, the challenge was now amplified by several factors. First, the drop in oil prices was more drastic and accompanied by an apparent change in the structure of the global oil market. The prospects for rapid recovery of oil prices in the future appeared unlikely. Second, the adjustment had to be undertaken in an economy *- 12 - which, even before the new external shock, was characterized by considerable sluggishness. During 1985, the economy grew at only 1Z with non-oil GDP at 3.5X. The previous adjustment effort had already resulted in low rates of Table 1.3: INTEREST RATES OF COMMERCIAL BANKS, 1982-1985 (In percent p.a., end of period rates) 1982 1983 1984 1985 Nominal Deposit Rates /a State banks 8.6 14.8 17.1 14.6 Private banks 17.1 17.4 20.7 15.9 Real Deposit Rates /b State banks -1.3 2.5 7.3 9.8 Private banks 6.5 4.8 10.6 11.0 Nominal Lending Rates /c State banks 13.5-21 17-23 18-24 17-22 Private banks 16-28 18-28 24-30 18-27 Real Lending Rates /b State banks 3-10 4-10 8-14 12-17 Private banks 5-16 5-14 14-19 13-22 /a Nominal rates on three-month time deposits. Tb Deflated by the Consumer Price Index for the relevant year. Tc Nominal rates on working capital and term loans. Source: Bank Indonesia and World Bank staff estimates. capacity utilization and emerging financial problems in many industrial and construction firms. And third, policy options were more constrained. On the one hand, the scope for external borrowing was more limited because of Indonesia's high level of indebtedness--$28 billion in public MLT at the end of 1985--and a major bunching in debt servicing during 1988-90. On the other hand, cutting government expenditure this time was more difficult than in 1983, since much of the excess had already been eliminated. 1.22 The Government's response to this critical situation was rapid. It involved measures aimed at maintaining balance of payments and fiscal stability, as well as promoting structural change in the economy by supporting the growth of the non-oil tradable sectors in order to reduce the economy's dependence on oil revenues. As a first step, an austere budget was adopted for 1986/87. This resulted in a fall in government investment, which dropped from 6.9% of GDP in 1985 to 6.4% in 1986, and a constant level of current expenditures. This tight fiscal policy was supported by a conservative monetary stance. During 1986, total Rupiah liquidity grew 14% and domestic - 13 - credit 22%. This represented a considerable slowdown from the previous year, when Rupiah liquidity rose by 27% and domestic credit by 42%. 1.23 But reliance on fiscal and monetary policies alone for the adjust- ment would not have beer. appropriate given the need for structural change. Accordingly, the Government devalued the Rupiah by 31% on September 12, 1986. This measure, in addition to strengthening the balance of payments in the short run, was essential for supporting appropriate structural change in the medium term. Other policy reforms were also undertaken to address the structural problems in the economy. Particularly important were the steps relating to trade policy reform. The first step came in May 1986, when Government announced a package of measures designed to provide internatio- nally-priced inputs to exporters, and was followed by more fundamental reforms in October 1986 and January 1987, which removed or relaxed import license restrictions. 1.24 While these measures are having their desired impact,-0/ the large loss of resources over the past year has resulted in severe macroeconomic imbalances. The current account deficit deteriorated from 1.9% of GDP in 1985 to 5.7% in 1986; the Government savings-investment gap widened from -1% of GDP in 1985 to -4.3% in 1986. Even though policy actions already taken, including the recent devaluation and trade reforms, are likely to have a lagged effect on the balance of payments in 1987, it is clear that to attain macroeconomic balance in the economy further adjustment is required. Accordingly, the 1987/88 Budget is aimed at further reducing the existing fiscal imbalance. Pursuing this fiscal stance is projected to reduce the Government savings- investment gap to -3.2% of GDP in 1987, providing an important contribution to the ongoing adjustment process and the gradual recovery of macroeconomic balance in the economy. C. Government Revenue and Expenditure Trends: An Overview 1.25 As is clear from the macroeconomic analysis presented in the previous Section, fiscal policy has played a central role in the adjustment process of the Indonesian economy and will be critical for future economic developments. This Section provides a more disaggregated assessment of government revenue and expenditure trends during 1978-86 and in doing so, sets the stage for the subsequent in-depth analysis of some of Indonesia's main public resource management issues in the Chapters to come. Covernment Revenue 1.26 As can be seen in Table 1.4, Government revenue has been largely dependent on oil revenues throughout the period of analysis. Oil revenues represented more than half of total government revenues for most of the 10/ For a detailed analysis of these adjustment measures ane their impact on the economy, see Indonesia: Strategy for Economic Recovery, World Bank, Report No. 6694-IND, May 5, 1987. - 14 - Table 1.4: GCENEAL GOVERNMENT ACCOUNTS, 1978-1986 (As percentage of GDP) 1978 1979 1980 1981 1982 1983 1984 1985 1986 Current Receipts 18.7 19.8 21.6 22.1 21.0 21.6 21.9 20.8 17.2 Oil tax revenue 9.^ 11.8 14.1 14.5 12.6 13.2 14.5 12.0 5.6 Non-oil tax revenue 7.7 6.8 6.2 6.0 6.6 6.6 5.8 6.7 8.8 Transfers from private sector 1.0 0.6 0.6 0.6 0.8 0.9 0.7 0.7 0.8 Transfers from rest of the world 0.0 0.1 0.1 0.3 0.1 0.1 0.1 0.1 0.2 Property incomes and operating surplus 0.7 0.6 0.6 0.7 0.8 0.8 0.8 1.2 1.8 Current Expenditures 12.9 12.9 14.6 15.4 15.3 14.4 14.4 14.9 15.0 Consumption 10.7 9.5 10.5 11.0 11.5 11.0 10.5 11.9 11.4 Subsidies 1.2 2.0 2.9 3.2 2.5 1.9 1.7 1.2 0.9 Interest on external debt 0.8 1.1 0.9 0.9 1.0 1.4 1.8 1.8 2.6 Transfer payments to private sector 0.2 0.2 0.3 0.2 0.2 0.2 0.4 0.0 0.0 Government savings 5.8 6.9 7.0 6.7 5.7 7.2 7.6 5.8 2.2 Government Capital Expenditure 5.3 5.6 4.4 6.6 9.7 10.2 6.7 7.3 6.7 Capital transfers to private sector 0.6 0.6 0.9 0.8 0.6 0.7 0.5 0.4 0.3 Investment 4.7 5.0 3.5 5.8 9.1 9.5 6.3 6.9 6.4 Deficit Financing -0.4 -1.3 -2.6 -0.1 4.1 3.0 -0.8 1.4 4.5 Banking system -1.9 -2.6 -4.5 -1.8 0.7 -1.7 -3.8 -0.3 0.3 External borrowing 1.5 1.3 1.8 1.7 3.4 4.7 3.0 1.7 4.2 Memo item: Oil Revenues As share of total tax revenues 54.5 63.5 69.6 70.7 65.7 66.6 71.3 64.0 38.9 As share of total current receipts 49.5 59.5 65.5 65.7 60.3 60.9 66.2 57.6 32.5 Source: Sources and Uses of Funds Framework, Appendix 1. - 15 - period, except in 1978 and 1986. In turn, the availability of oil resources enabled the Government to de-emphasize other sources of revenue, in particu- lar, non-oil tax revenues. As a percentage of GDP, non-oil tax revenues declined from 7.7% in 1978 to 6.6% in 1983 before the tax reform was enacted; these revenues were as low as 6% at the peak of the second oil boom in 1981. For the period 1978-83 the average buoyancy of non-oil taxes with respect to non-oil GDP was only .87. This poor performance of non-oil taxes is related to the weak tax collection effort observed during this period. Tax admin- istration was geared at complying with tax revenue targets rather than uniform enforcement of the tax codes. The overall good performance of the economy during 1978-83 in turn resulted in relatively relaxed tax collection efforts as revenue targets were being reached early in thl fiscal year, and tax agents had little incentive to collect additional taxes. This inverse correlation between the level of economic activity and tax collection effort is evident when comparing the 1978-81 and 1981-83 periods. Between 1978 and 1981, when nominal non-oil GDP growth averaged 32%, non-oil tax revenues increased on average only 24%: an average buoyancy of .75. In contrast, between 1981 and 1983, when nominal non-oil GDP growth averaged cnly 15%, non-oil tax revenues increased 18%: an average buoyancy of 1.2. This feature of the tax collec- tion effort eliminated the automatic stabilization role of the tax system. 1.27 The de-emphasis of non-oil tax revenues during 1978-83 was in itself not a cause for concern. In fact, this is an option that the Government has for channeling the oil windfall gains to the private sector. If the non-oil taxation system operates efficiently, there is ample justification for decreasing the effective tax rates in the face of an exogenous increase in oil rents. Nevertheless, this was not the case in Indonesia; the tax structure was outmoded and rooted in the Dutch colonial administration. Numerous excep- tions, incentives, and loopholes had crept into the system, making it economically inefficient and vulnerable to manipulation and non-compliance. The lower non-oil tax revenues during 1978-83 did not come through lower tax rates, but through a system that largely depended on the discretion of the tax authorities. The recognition of these problems led the Government to conclude, in January of 1981--at the peak of the second oil price boom--that fundamental tax reform was essential. 1.28 In turn, Indonesia implemented one of the most far reaching tax reforms in the Asian region. This consisted of the introduction of a new income tax in 1984; the replacement of the old sales taxes by a value added tax (VAT) and a sales tax on luxury goods in 1985; and the introduction of a new property and stamp duty tax in 1986. Besides establishing a sound tax system, the tax reform has been successful in mobilizing additional resources 11/ This feature of the Indonesian tax administration has been presented in several studies of the Indonesian tax system. See, for example, A. Booth and P. McCawley, "Fiscal Policy," in The Indonesian Economy During the Suharto Era, A. Booth and P. McCawley (eds.), Oxford University Press, New York, 1981, and R.F. Conrad, "Essays on the Indonesian Tax Reform," World Bank, CPD Discussion Paper No. 1986-8, Washington, D.C., February 1986. - 16 - and is responsible foy ;he increase in non-oil tax revenue from 6.6X of GDP in 1983 to 8.8X in 1986.12 During this same time, Indonesia experienced a sharp fall in government oil revenues from 13.2% of GDP in 1983 to 5.61 in 1986. The timing of the tax reform then could not have been more appropriate as non- oil tax revenues have had to partially replace lost oil revenues, and will have to play an increasingly important role in supporting government expenditure programs. Government Expenditure 1.29 With the significant rise in government oil revenues, the government sector was able to increase its relative share in the economy, as measured by total government expenditure, from 15.4Z of GDP in 1978 to 17.91 in 1986 (see Table 1.5). Government investment rose from 4.7% of GDP in 1978 to 6.41 in 1986, while government consumption increased more modestly from 10.7% to 11.41 over the same period. The patterns of growth of total government expenditure showed substantial variation during the period, as the government sector adjusted to the oil cycle. The modest growth of total government expenditure during the oil boom period, 1978-81, is reflected in the modest elasticity of expenditure with respect to GDP of 1.1. This elasticity increased to 1.9 during 1982-83 as the countercyclical response of government expenditure sought to maintain the momentum of aggregate demand in the face of the sharp deterioration in the external environment. Government investment was clearly the main impetus behind the rise in expenditure. Government investment elas- ticity with respect to GDP increased to 3.5 during the 1982-83 period. It is therefore no surprise that the adjustment program, put in place in 1983, had as one of its main components the rephasing of government investment. This policy not only contained the growth of government investment but reversed it, as government investment dropped from 9.5% of GDP in 1983 to 6.4Z in 1986. In all, total government expenditure proved very responsive to the external changes with moderate expenditure during the oil boom period, countercyclical expenditure during the downturn, and curtailed expenditure during the adjust- ment. The main component of adjustment in total government expenditure was investment, which fluctuated significantly during the period as a whole: from 4.7% of GDP in 1978 before the second oil shock to 9.51 before the stabiliza- tion program was put in place, and back to 6.4% by 1986. 1.30 Other government expenditure items also showed substantial varia- tions during this period, and played important roles as the Hyernment sector adjusted to the oil cycle. Between 1978 and 1981 subsidies __ increased, on average, 2.4 times as rapidly as GDP. This was partly because they repre- sented a channel to transfer oil rents to the ezonomy at large. As the oil windfall gains contracted so did the subsidies. From their peak of 3.2% of GDP in 1981 they declined steadily to only 0.9Z of GDP in 1986 as both petro- 12/ A detailed analysis of the revenue performance of the tax reform is presented in Chapter II, para. 2.2. 13/ The main budgetary subsidies included fertilizers, petroleum products and food. Table 1.5 STRUCTURE Of GcovsuWI 6rrDMw, 1978-% (As pere ntage of GOP) 1976 1979 1960 1981 1912 19S3 1964 1985 1iiNt9793-X 1"92/11 1;94-PA 197"1 1J133 16446 197W6 Con4olidated Goverment luxPe- diture 1S.2 11.5 14.0 22.0 25.0 24.4 21.1 22.2 21.7 19.6 24.6 21.7 1.t 1.5 0.4 1.1 Current lxpenditure 12.9 12.9 14.6 15.4 15.3 14.4 14.4 14.9 1S.0 14.3 14.8 14.S 1.2 0.7 1.1 1.1 Con_ptton 10.t 9.- O.S 11.0 11.5 11.0 10.5 11.9 11.4 10.5 T1.2 tl.l ;T i T: T- T.T Subeidies 1.2 2.0 2.9 1.2 2.5 1.9 1.7 1.2 0.9 2.6 2.2 1.1 2.4 -1.1 -1.1 -0.6 Interest an external debt 0.S 1.1 0.9 0.9 1.0 1.4 1.8 1.1 2.6 0.9 1.2 t.1 1.1 1.2 1.6 2.0 Transfers to private sector 0.2 0.2 0.3 0.2 0.2 0.2 0.4 0.0 0.0 0.2 0.2 0.1 1.2 -0.2 -3.5 -0.1 Capttal Expenditure 5.1 5.6 4.4 6.6 9.7 10.2 6.7 7.1 6.7 5.6 10.0 6.9 1.1 3.2 -0.4 1.2 Investmat 4T 5.0 1.5 5.8 9.3 9.5 6. 6.9 6.4 4.6 TI T. t3 1 _T .2 Trensfere to private sector 0.6 0.6 0.9 0.6 O. 0.7 O.S 0.4 0.1 0.l 0.7 0.4 1.5 0.4 -2.0 0.4 _o Itim Total aovernmnt Uxpeudtture 15.4 14.5 14.1 16.6 20.7 20.4 16.6 1A.7 17.9 1S.3 20.5 17.3 1.1 1.9 0.S 1.1 Govermat cm oqtian i7 9.5 10.5 11.0 ti 1.0 10.5 it 1.T 10.5 T 1T1 1. T T1 T1. T1.I Ti Goverment tnvetust 4.7 5.0 t.S 5.8 9.1 9.5 6.1 6.9 6.4 4.3 9.1 6.S 1.1 1.5 -0.2 1.2 As ftraet!e of Total Courm- SotjL e"wernt Wu"piture 300.0 100.0 1mo.0 100.0 100.0 100.0 100.0 100.0 100.q Covermut commotion 69.2 65.6 74. 65.6 SS.9 i3.7 62.6 6'1.4 61.9 Goverment investuent 10.1 14.2 25.1 34.4 44.1 46.1 17.4 16.6 16.I /a Preliinary. Soure: Sorces and Ieee of Funds frommerk. Appetix 1, - 18 - leum and fertilizer prices were raised during this period and the food subsidy eliminated in 1982/83. 1.31 Like many other oil exporting countries, Indonesia did not raise tomestic oil prices to world levels in 1974 and 1979, and chose to) pass on this part of the windfall directly to domestic consumers. As domestic oil consumption grew more rapidly than the economy, the burden on the budget increased. The subsidy for petroleum pd4ucts rose from Rp 197 billion in 1978/79 to Rp 1,333 billion in 1981/82., However, the Government has moved rapidly to remove the subsidies in the past four years. With total domestic price increases of about 225% since December 1981 and the fall in inter- national prices, the weighted average of domestic prices in 1986 was about 10% above the average international level. Thus, by 1986, the oil subsidy had, turned into a tax which generated an estimated revenue of Rp 1.3 trillion.i5/ 1.32 The practice of subsidizing fertilizers and pesticides began in the mid-1970s as a means of promoting agricultural growth in general, and rice production in particular. It played an important role in distributing some of the oil windfall gains to farmers at the same time that it raised productivity in a key non-oil tradable sector. The evidence suggests that, in fact, a substantial part of the increased yield and output in ag -ulture can be explained by the decrease in relative fertilizer prices. Associated with their low prices, there has been a significant increase in the consumption of fertilizers and pesticides during the decade. Consumption of fertilizers per hectare of arable land in Indonesia (75 kg of plant nutriment) is now well above most other Asian countries (e.g., 32 kg in the Philippines and 24 kg in Thailand). The burden on the budget has increased correspondingly. From Rp 83 billion in 1919079 the subsidy is estimated to have reached Rp 600 billion in 1986/87.-! 14/ The petroleum subsidy is designed to compensate Pertamina for losses incurred in refining and distributing petroleum products to the domestic market. The subsidy is calculated on the basis of the difference between domestic sales revenue and the cost of production including an allowance for a margin for Pertamina. In this context, the budget subsidy does not reflect the full economic subsidy of domestic petroleum consumption because the prices used to calculate financial costs are considerably below world market prices. 15/ The recovery in international oil prices during 1987 has already reversed this outcome, and a budget subsidy is expected to emerge for 1987/88. Current projections estimate it at around Rp 435 billion. 16/ See, for example, Peter C. Timmer, "The Role of Price Policy in Rice Production in Indonesia", HIID, Harvard University, Cambridge, May 1985. 17/ As in the case of petroleum products, the fertilizer budget subsidy does not reflect the full economic subsidy, as it does not take into account the implicit production subsidy received by producers in the form of natural gas prices well below world market prices, or credit subsidies. -19- 1.33 As in the case of subsidies, government transfers were used as a channel to pass part of the oil windfall gains to the rest of the economy. The direct recipients were public enterprises and most of these transfers have taken the form of capital participation. Unlike subsidies, the fluctuations in government transfers were rather minor. Government transfers remained at around 1X of GDP for most of the period under analysis and dropped to 0.3X of GDP in 1986. Although the level of transfers may seem rather low, one needs to exercise caution in interpreting these figures as the Government also transfers resources to public enterprises through the banking system by way of preferential credits. In fact, the recent decline in government budget transfers to public enterprises is more an indication of the budget constraint than of the performance of public enterprises and part of the financial burden has now been passed to the banking system, as public enterprises are becoming increasingly dependent upon bank loans for investment financing. Although detailed financial data on Indonesian public enterprises are not readily available to make a comprehensive assessment of the performance of public enterprises, an indicative estimate can be obtained from data compiled by the Ministry of Finance and presented in Table 1.6. The data show that while sales and assets of non-financial public enterprises more than doubled over the past five years, pre-tax profits as a percent of sales and total assets dropped about 30Z. It seems then that if the Government's effort to induce public enterprises to finance a larger share of their investments from internal cash generation and commercial borrowing is to prove successful, improvements in operating efficiency and financial performance of public enterprises are urgently needed. In pursuit of this objective, the President of Indonesia requested his Ministers in December 1986 to review the financial performance of all public enterprises under their jurisdiction, as a first step toward preparing a plan for sector restructuring through rehabilitation, merger or divestiture. This initiative is a welcome development which, if supported by careful analysis and planning, could lead to a significant improvement in public enterprise performance and contribute to overall public resource mobilization. Table 1.6: PERFORMANCE INDICATORS OF NON-FINANCIAL PUBLIC ENTERPRISES (Rp billion) 1981/82 1982/83 1983/84 1984/85 1985/86 Dividends 32.6 45.3 97.1 71.2 67.5 Capital Grants (PMP) 460.8 331.0 474.0 228.7 375.7 Total Assets 19,937.3 26,979.0 34,550.8 39,161.0 44,527.0 Fixed Assets 12,937.0 19,252.2 23,877.4 27,247.0 32,099.3 Profit Before Tax 821.5 528.3 865.0 1,157.0 1,199.3 Total Sales 13,427.0 14,731.0 20,937.0 26,331.0 27,692.0 R*tios Pre-tax profit per total sales 6.12 3.62 4.1X 4.42 4.3X Pre-tax profit per total assets 4.12 2.02 2.52 3.0X 2.72 Source: Ministry of Finance. - 20 - 1.34 Another expenditure item that is absorbing increasing levels ef government resources is interest payments on external debt. Interest payments on external debt grew from 4.41 of consolidated government expenditure in 1978 to 12.2X in 1986. Part of this sharp increase in interest payments resulted from the Government's fiscal policy during 1982-83, as it relied on foreign borrowing to smooth the contraction of aggregate demand. By 1984 interest payments already accounted for 8.31 of total government expenditure. The more recent increase in interest payments, however, is due to factors which are not directly related to fiscal policy, in particular, the depreciation of the US dollar vis-a-vis other currencies and the depreciation of the Rupiah against the US dollar. In all, the significant share of fiscal resources now required to meet interest and principal payments on exterrdl debt represents a major constraint for the ongoing adjustment process. U4ot only does it imply a large drain on scarce government resources, but it also clearly indicates that the Government can no longer rely on foreign borrowing to smooth the adjustment. - 21- CHAPTER II NON-OIL TAX SYSTEM A. The Tax Reform 2.1 In December 1983, a major tax reform was enacted by the Indonesian Parliament. This tax reform comprised a new income tax law which came into effect in January 1984, and a value-added tax law which was implemented in April 1985. In addition, a new property tax law became effective on January 1986 In all, the old tax structure in Indonesia has been replaced by a new one.- The main objectives of the tax reform were to: (a) reduce the heavy dependence of government revenues on oil/LNG taxes; (b) improve the efficiency of the tax system in terms of coverage and collection rates, and streamline the tax administration; (c) improve domestic resource mobilization and raise the buoyancy of tax revenues in relation to income growth over the long term; and (d) enhance the elements of equity and social justice in the tax system. To achieve these objectives several measures were put in place: (i) tax laws were simplified; (ii) tax deductions aiLd exemptions were greatly reduced; (iii) special income tax based incentives were abolished; (iv) official assessment of tax liabilities was replaced by a system of self-assessment; (v) contacts between tax administration and taxpayers were depersonalized; (vi) nominal tax rates were lowered and rate differentiation was reduced; and (vii) the tax base was broadened. 2.2 Three years have now passed since the introduction of the first tax law and in this period the tax reform has proven successful in generating additional government revenues (see Table 2.1). Between 1983/84 and 1986/87 central government non-oil tax revenue increased from 6% of GDP to 8.2%. Most of this increase in revenue can be attributed to the introduction of the VAT. Sales taxes increased from 1% of GDP in 1984/85 to 2.9Z in 1986/87. Of this sharp revenue increase, 70% took place during the first year after VAT was introduced and was mainly due to the inclusion of petroleum and tobacco products in the VAT. These features have led to a one-time increase in the sales-tax-to-GDP ratio which is unlikely to occur in the future. The tax reform has also led to significant improvements in income taxes as well as the property tax. Income tax revenues increased 53% between 1983/84 and 1986/87. For the corporate income tax, most of the increase was due to improvements in tax compliance by state enterprises. Whereas most of the increase in personal income tax revenues was contributed by wage earners--many of whom are civil servants brought into the tax system for the first time with the reform--and captured through the new withholding provisions of the tax reform. The new property tax, in its first year of implementation, proved to perform reasonably well also, with collections 58% higher than IPEDA (the old I/ Detailed information on Indonesia's non-oil tax system, the tax reform and the specific lawe and regulations that were enacted can be found in Appendix 2. Table 2.1: CENTRAL GOVERNMENT NON-OIL TAX REVENUE, 1978/79-1986/87 (As percentage of GDP) 1978/ 1979/ 1980/ 1981/ 1982/ 1983/ 1984/ 1985/ 1986/ Buoysncy /b 79 80 81 82 83 84 85 86 87 Before After (2) - - tax reform tax reform Total Non-Oil Tax Revenue 7.4 6.6 5.9 5.6 6.1 6.0 5.5 6.9 8.2 0.81 1.95 Income Tax 2.4 2.1 2.1 2.2 2.6 2.4 2.4 2.4 2.7 1.01 1.29 Personal income tax 0.5 0.4 0.3 0.4 0.5 0.5 0.5 0.7 T.7 T 'T8 =7 Corporate income tax 0.9 0.9 0.9 1.0 1.1 1.0 1.9 1.7 2.0 1.10 1.22 Withholding /a 1.0 0.8 0.9 0.9 1.0 0.9 Value added tax/sales tax 1.4 1.0 0.9 0.9 1.1 1.1 1.0 2.4 2.9 0.70 10.06 Property tax 0.3 0.2 0.2 0.2 0.2 0.2 0.2 0.2 0.2 0.67 10.77 Others 3.2 3.2 2.7 2.3 2.2 2.2 1.9 1.9 2.3 /a Refers to withholding tax unallocable between corporate and personal income tax. /b Since the breakdown of withholding taxes is not available before 1983/84. after-tax reforo buoyancy for both personal and corporate income taxes is only calculated between 1984/85 and 1986/87. Source: Ministry of Finance, Directorate General of Taxation. World Bank staff estimates. - 23 - property tax) revenues during 1985/86. There is, however, significant evidence that tax compliance in Indonesia is still low and, although the tax reform effort has made some progress in addressing it, this remains a principal source of concern. The tax collection effort is still determined by tax targets and only limited progress has been made in improving tax admin- istration and ensuring that the tax burden is distributed more equitably (e.g., taxing self-employed). Compared with other Asian CGuntries whose tax to GDP ratio on average exceeds 102, Indonesia's 8.2% non-oil tax ratio is still quite low (see Table 2.2). &.3 While no additional taxes were announced in the 1987/88 central government budget, non-oil tax revenr2s are expected to increase 11.2% as a result of ongoing efforts to improve tax administration and compliance. As Table 2.3 indicates, the additional revenue is expected to come mainly from three different taxes: the income tax, the value added tax, and the property tax. The main question raised in this Chapter is the extent to which the tax system that has been put in place by the tax reform, is capable of generating additional central government revenue without changing its tax rates or basic structure. The purpose is to assess the revenue potential of the existing tax system and, in this context, determine the room that the Government has in pursuing its current policy of increasing revenue through increased tax enforcement without raising tax rates or introducing new taxes. The analysis seems to indicate that, although the 1987/88 budget revenue estimates may be somewhat optimistic for some of the main taxes, tax enforcement can be strengthened in the medium term and there is scope for raising non-oil tax revenues to 10% of GDP by 1990/91 without changes in the existing tax structure. Remaining within the framework of the tax reform, this Chapter then explores other tax policy options to further increase tax revenue and improve the present tax system. The outline is as follows: Section B focuses on tax enforcement. An attempt is made to determine how much revenue each individual tax could potentially have generated in 1985/86, had the tax laws been fully applied and enforced. The results are used to make revenue projections to 1990/91 which outline the revenue implications of a policy with and without increased enforcement. They also provide a basis to assess the improvement in tax administration and enforcement in 1986/87 and the implicit assumptions on further improvements contained in the 1987/88 Budget. Section C then reviews a number of selected tax policy issues: (a) indexation of deductions and thresholds for marginal tax rates; (b) extension of VAT; (c) tax treatment of interest; (d) suspension of VAT on capital goods; (e) VAT borne by the Government; and (f) treatment of income derived from foreign-aid projects. Some of these issues have clear revenue implications which will be presented for both levels of enforcement as defined earlier. Other issues refer to tax administration and the allocative effects of the existing tax treatment. To the extent possible, specific reconmendations are made with respect to each of these issues. - 24 - Table 2.2: TAX EFFORTS IN SELECTED ASIAN COUNTRIES, 1986 (As percentage of GDP) Consumption Incose taxes taxes External Total Non-oil Per- Corpo- VAT/ trade taxes Other taxes taxes Total sonal rate sales Excise Import Export taxes Low Income India 19.4 19.4 2.3 1.1 1.3 3.9 6.7 4.2 0.0 2.2 Pakistan 13.2 10.7 1.9 - - 1.0 2.8 4.9 0.1 0.0 Lower-Middle Income Indonesia 14.6 8.2 2.7 0.7 2.0 2.9 1.1 1.0 0.1 0.4 Philippines 10.5 10.5 3.1 - - 1.7 2.6 2.7 0.1 0.3 Thailand 13.5 13.3 3.2 1.8 1.4 2.6 3.7 2.7 0.1 0.9 Upper-Middle Income Malaysia 22.0 15.8 7.6 2.4 5.2 1.4 2.0 2.8 0.0 2.0 Korea 15.8 15.8 4.6 2.1 2.5 3.8 1.9 2.2 0.0 3.3/a /a Includes a defense surtax and an education surtax. Source: World Bank staff estimates. - 25 - Table 2.3: THE 1987/88 BUDGET (Rp billion) As X As X Growth rate 1986/87 /a GDP 1987/88 /b GDP (2) Non-oil tax revenues 8,211.0 8.2Z 9,133.9 8.3% 11.2% Income tax 2,735.2 2.7% 3,315.9 3.0X 21.2% Valued added tax and luxury sales tax 2,942.3 2.9X 3,546.0 3.2Z 20.5% Import duty 960.1 1.0% 661.7 0.6% -31.1% Excise tax 1,055.8 1.1 1,075.9 1.0% 1.9% Export tax 78.8 0.1% 70.9 0.12 -10.0% Property tax 243.7 0.2Z 274.0 0.2% 12.4% Other taxes 195.1 0.2% 189.5 0.2% -2.9% /a Preliminary. 7r Budget. Source: Ministry of Finance. B. Enforcement of the Tax System The Case for Enforcement 2.4 The laws of the tax reform present the Minister of Finance with ample flexibility to increase ta* rates considerably without resorting to com- plicated legislative procedures.t' Although this possibility should not be ruled out a priori in light of the sharp revenue shortfall resulting from the drop in oil prices, this Section explores the policy option that the Government has so far adopted: concentration on tax enforcement and consoli- dation of the existing tax system. This policy option has important merits. As will be pointed out subsequently, there are reasons to believe that tax enforcement in Indonesia is relatively weak. Under such circumstances, an increase in tax rates per se would lead to greater tax avoidance and would thus undermine the very principle of a low-rated and broadly-based tax system as conceived by the tax reform. A lack of compliance with tax laws is not only an issue of foregone government revenues. The objective of, and Government's commitment to, equitable and less distortionary taxes are of equal concern. If tax laws are only partially applied, distcrtions will arise from the fact that similar goods and services are taxed de facto at different rates. Noncompliance and a lack of punitive actions will be perceived by the existing taxpayers as unfair and will provide an incentive for further tax 2/ See Appendix 2, para. 4. - 26 - avoidance. Greater emphasis on tax administration and enforcement will be important to maintain the credibility of the reform process, particularly at its present stage of implementation. Finally, increased compliance will by itself make any future actions with respect to tax rates more effective. Indicators of Low Compliance 2.5 The available information on the number of registered taxpayers is shown in Tables 2.4 and 2.5. Although the umber of registered taxpayers has increased significantly in the recent past,_ with only around 2.4 million individuals and 150 thousand corporations paying income taxes, it is clear that the number of taxpayers that are part of the tax system in Indonesia is very small for the size of the country. The picture is even more worrisome as one analyzes the information on the actual filing of tax returns. As illus- trated in Table 2.5, in June 1986 only 32.9% of the registered VAT taxpayers actually f ed a tax return; of these less than half (48Z) declared a positive liability.- Interviews with the Indonesian authorities suggest that the ratio of filing to registered taxpayers is 55% for corporate income tax. 2.6 A less visible element of noncompliance is the underreporting of tax liabilities. A system of self-assessment can only be effective when well- aimed and selective audits are operational. Official audits were suspended during the tax reform and, so far, only limited internal checking has taken place for both the income tax and the VAT. These preliminary investigations have apparently indicated substantial deviations between actual and reported income tax or VAT due. There is also evidence that assessed property values used for the purpose of the property tax are far below the actual market value. The existing valuation system is still based on the old procedures of mass valuation of property as applied under the old IPEDA system. Under that 3/ Part of this increase was due to the tax amnesty which was in effect between January 1984 and June 1985. The amnesty introduced a pardon for taxes evaded between 1979 and 1983. It covered individual and corporate income tax, wealth tax, withholding tax, sales tax, tax on interest, dividends and royalties and employee income tax. For those who had properly filed for income tax in 1983 and property tax in 1984, a penalty of 1% was applied on taxes not paid for. In other cases, a penalty of 10X was applied under the amnesty. Excluding individuals on whose behalf tax is withheld, 195 thousand individuals and 26 thousand corporations took advantage of this amnesty. 4/ The low filing ratio for VAT may partly be explained by the fact that some of the firms who were liable under the old sales tax are not liable under the VAT and are still registered as taxpayers. Other explanations include one-time contractors who do not incur VAT liabilities on a regu- lar basis and those who have gone bankrupt since registering for VAT. This suggests a need for continuous updating of the registration list. The filing ratio also appears to vary widely between tax districts: 581 on average for all the Jakarta districts as opposed to less than 10X for Jayapura. - 27 - Table 2.4: INDONESIA: NUMBER OF TAXPAYERS REGISTERED, PERSONAL AND CORPORATE INCONE TAX, 1984 - 1986 /a -- ~Taxpag ers am at 12/31/84 12/31185 06/01/86 Personal income taxpayers (PPh)/b 330,287 536,769 614,194 Individuals withholding income tax on employees (PPh, Article 21) 12,426 15,996 16,643 Individuals withholding income tax on payment of interest, diwidends, etc. (PPh, Article 23) 480 522 507 Corporate income taxpayers (PPh) 101,370 130,016 148,467 Corporations withholding income tax for employees (PPh, Article 21) 102,376 140,507 165,532 Corporations withholding income tax on imports (PPh, Article 22) 40,396 36,951 40,062 Corporations withholding income tax on payment of interest, dividends, etc. (PPh, Article 23) 81,310 105,244 127,505 Corporations paying stamp duties - - 12,620 PPh: Income Tax. Articles refer to Law of the Republic of Indonesia, number 7 year 1983 concerning Income Tax. /a In addition, there were approximately 1.8 million individuals as at June 1986 on whose behalf income tax was being withheld, and the withholding tax represented the final tax liability. For 1984 and 85 there were around 900,000 such individuals. /b Excludes personal income taxpayers on whose behalf personal income tax is withWeld and the withholding tax represents the final tax liability. Source: Ministry of Finance, Directorate General of Taxation. - 28 - Table 2.5: INDONESIA: NUMBER OF TAXPAYERS REGISTERED AND TYPES OF RETURNS FILED FOR THE VALUE-ADDED TAX, APRIL 1985 - JUNE 1986 /a *Restl- No. of No. of Returns 'Pay"Ib 'Coupen- tution" /d 'Nil" /e registered returns filed as returns cation" /c returns returns tax payers filed x of as x of as% of as 2 of as Z of beginning for the regis- total total total total Month of the month period tered filed filed filed filed April 25,065 7,233 28.9 62.4 18.1 0.4 19.1 May 31,840 9,188 28.9 61.2 18.8 0.7 19.3 June 36,734 11,742 32.0 60.9 20.2 0.7 18.2 July 39,665 14,640 36.9 56.6 18.0 1.0 24.4 August 43,884 15,412 35.1 55.6 18.4 1.2 24.8 September 47,331 18,331 38.7 53.5 15.9 1.1 29.4 October 51,065 20,792 40.7 52.4 15.3 1.1 31.2 November 53,954 22,118 41.0 52.7 14.4 1.0 31.9 December 56,660 23,220 41.0 54.1 12.9 1.0 32.0 January 59,156 24,590 41.6 52.2 13.4 0.9 32.9 February 61,319 24,254 39.6 59.0 13.6 1.0 30.8 March 63,143 24,886 39.4 59.0 13.6 1.0 26.5 April 65,872 23,031 35.0 53.1 14.9 1.1 30.9 May 66,864 21,467 32.1 50.3 17.1 0.0 32.4 June 67,839 22,277 32.9 47.9 18.8 0.0 35.2 /a Figures for April to July 1985 are somewhat less reliable than the figures for subsequent months. /b "Pay" returns are those where the VAT liability is positive, i.e. output tax is greater than the input tax. /c "Compensatory" returns consist of those returns where the output tax is less than the input tax, but the tax credit due to the taxpayer is carried forward. /d "Restitution" returns consist of those returns where the tax credit due is to be refunded to the taxpayer rather than being carried forward. /e "Nil" returns are those where no input or output tax is being incurred or these two taxes are exactly equal. Source: Ministry of Finance, Directorate General of Taxation. - 29 - system valuation was to be carried out once every tgn years, except in cases of fluctuations in values exceeding 10%. Studies _ have suggested that assessed values could well be less than 25% of true market values and that there is a wide dispersion gf effective property tax rates and valuation procedures between sectors.- 2.7 Besides the direct evidence of noncompliance described before, there are some other indicators of low tax compliance in Indonesia. For the corpor- ate income tax, for example, the fact that at least 4§; of the total tax revenue in 1986/87 is generated by state enterprises r may well indicate that a significant part of the corporate sector remains outside the tax system. For the personal income tax, on the other hand, only 12% of the tax revenue is paid by the self-employed. As most individuals with the highest income would fall into this category of taxpayers, their income tax share is very small. In Malaysia, fgy example, 35% of personal income tax revenue is paid by the self-employed.- Potential Tax Revenues 2.8 For each of the taxes covered by the tax reform, the potential tax revenue is estimated for 1985/86 and presented in Table 2.6. The theoretical tax potential is obtaine1 by estimating the tax base of eyh particular tax, and applying to it the corresponding statutory tax rates.- As indicated by the ratios of actual to potential tax revenues, referred to as administrative efficiency factors (AEF) in Table 2.6, there is substantial scope for raising non-oil tax revenues within the existing tax structure. For any individual tax, at most 55% of its potential tax revenue was being captured by the tax authorities during 1985/86. 2.9 Sources of Potential Tax Revenue. The revenue effects of incomplete registration and filing, and underreporting, with respect to the personal income tax, are summarized in Table 2.7. The potential revenue that could be obtained from the existing set of registered taxpayers alone is 60% higher 5/ See R. Kelly, "Property Tax Reform in Indonesia", Harvard Institute for International Development, paper presented at the Urban Land Seminar held in Sanur, Bali, July 21-24, 1986, p. 28. 6/ Appendix 3, Section D provides some further evidence on this subject. More detailed analysis is provided in Chapter 3, Section C (see para. 3.36). 7/ In 1986/87 state enterprises paid a total of Rp 927 billion in corporate taxes. The actual amount paid is larger if one takes into account the unallocable corporate income tax withheld at source. 8/ Source: Department of Revenues, Annual Report, 1982. 9/ The methodology as well as assumptions underlying these calculations are set out in Appendix 3. - 30 - Table 2.6: 1985/86 /a NON-OIL TAX REVENUE, ACTUAL AND THEORETICAL POTENTIAL REVENUR (Rp billion) Theoretical Actual potential Tax revenue revenue A.E.F. /b Personal income tax 674.7 1,589.2 0.42 Corporate income tax 1,638.3 3,415.6 0.48 Value-added tax /c 2,117.3 3,903.9 0.54 Property tax /a 243.7 443.6 0.55 /a For property tax, data refer to 1986/87 actual revenue and 1986/87 poten- tial revenue. Property tax was not in effect in 1985/86. /b A.E.F.: Administration efficiency factor. It is defined as the ratio of actual to theoretical potential revenue. /c Excludes luxury sales tax. - 31 - Table 2.7: PERSONAL INCOME TAX 1985/86: DISCREPANCIES BETWEEN ACTUAL AND THEORETICAL POTENTIAL REVENUE AND TAXPAYERS Revenue (Rp billion) Actual revenue 674.7 Estisated additional revenue if: Registered taxpayers file 119.5 Registered taxpayers report correctly 276.3 Total Potential Revenue from Registered Taxpayers 1,070.5 Estimated additional revenue if: Nonregistered taxpayers register /a 326.9 Nonregistered taxpayers file and report correctly 19 .8 Total Theoretical Potential Revenue 1,589.2 Taxpayers ('000) Estimated registered taxpayers. 2,434 Estimated filing taxpayers 2,068 Potential taxpayers 3,614 /a Assuming existing levels of compliance. - 32 - than actual revenue, due to incomplete filing and underreporting. Moreover the total number of taxpayers could be raised by 48% with a potential of addi- tional revenues amounting to 77% of current levels. The detailed lalculations of potential tax revenues from each per capita expenditure group - also suggest that noncompliance with the tax laws must, to a large extent, take place in the group of self-employed with high incomes. The theoretical ll personal income tax potential of the highest per capita -xpenditure group,- consisting mainly of families whose head is either self-employed or receives income other than from wages alone, is estimated at Rp 448 billion. Actual revenue from all self-employed or persons with income other than wages alone, including those with lower per capita expenditures, amounted to only Rp 83 billion in 1985/86. Table 2.8 gives some indication with respect to the source of potential tax revenue from the other taxes. For the corporate income tax, the potential of the easily identifiable sectors (large industrial firms and banks) appears not to be large, and enforcement geared to other sectors, mainly services, is likely to have greater revenue potential. For the VAT, the actual revenue on petroleum products is already close to poten- tial revenue, but a large VAT potential exists on nonfood related manufactured products. For the property tax, although the AEF is high because of the large share of the government-controlled estates, forestry and mining sector, there is potential for increasing revenues through more accurate property valuation. 2.10 The 1986/87 Budget Outturn. Tax collections during 1986/87 show a significant improvement in some areas of tax administration, with the AEF for both the value added tax and the corporate income tax, reaching 0.64 and 0.57 respectively. For personal income taxes, however, the AEF remained basically constant, at 0.42. Despite these improvements, as discussed below, there is still substantial scope to raise tax revenues through further improvements in tax administration. Revenue Projections With and Without Enforcement 2.11 Basic Methodology and Assumptions. Revenue projections can be made by using the various tax bases as calculated in the previous Section and applying the statutory tax rates, taking into account projected trends in main macroeconomic variables and population growth. For this purpose it is assumed that: (a) total personal income (before taxes) grows at the same rate 1a/ GNP; (b) the total taxable base for corporate income tax and the gross VAT - paid by the taxable sectors grow at the same rate as GDP; (c) VAT levied on imports and VAT drawback granted on exports grow at the same rate as imports and exports, respectively; (d) the value of taxable property increases by 10% p.a. for urban properties and 5% for rural properties; (e) the proportion of import and export duties to total c.i.f. imports and f.o.b. exports remains constant; and (f) revenue from excise taxes grow at the same rate as private consump- 10/ See Appendix 3, Table A3.1. 11/ 1984 per capita expenditure of Rp 80,000 or more. 12/ Excluding VAT levied on imports and VAT drawback granted on exports. Table 2.8: ESTIMATED 1985/86 /a THEORETICAL POTENTIAL iZVENUES FRO14 VARIOUS SECTORS (Rp billion) Corporate incoue tax VAT Property Tax (PBB)/a Potential Potential Potential Sector revenue Sector /b revenue Sector revenue Industry 815.3 Food, beverage, tobacco 1,103.7 Urban 155.0 State and private 163.0 Other industries 1,270.8 Rural 156.1 banks Oil refinery 560.9 Estates, forestry & mining 132.6 Others 2,437.3 Construction 968.5 Total 443.6 Total 3,415.6 Total 3,903.9 Mbsorandum Item: Memorandum Item: Memorandum Item: Actual total revemue 243.7 Actual total 1,638.3 Actual total revenue /c 2,117.3 revenue Potential VAT on imports 785.5 of taxable goods Potential VAT drawback on 247.6 exports /a Property tax figures refer to 1986/87 as new tax was not yet in effect in 1985/86. /b Sectors refer to those of Input-Output Table. Sectoral revenue include VAT paid by domestic sectors and VAT levied on imports of goods or services classified in those sectors. /c Excludes luxury sales tax. 34 - tion. More details on the projections and the data used can be found in Appendix 3. It is furthermore assumed that all exemptions, deductions and marginal tax rate thresholds are not indexed to increases in the price level. This assumption will be relaxed in Section C, reviewing other tax policy options. 2.12 Results: Revenue With ind Without Enforcement. The results of the projections are shown in Table 2.9. Two scenarios are illustrated. In the first scenario, the AEF remains at its present level. In the second scenario, a gradual increase to an AEF of 0.75 by 1990/91 takes place. Given the present low levels of enforcement, such increase is considered feasible.2-2 2.13 The results of the tax revenue projections are used to evaluate the tax revenue figures presented to Parliament in the 1987/88 Budget. Comparing the 1987/88 budget figures (see Table 2.3) with those in the projections for Scenario II one can see that while property tax revenues come very close to one another, together VAT and income taxes in the Budget seem to overestimate revenues by approximately Rp 250 billion. Even then, the overall non-oil tax budget revenue estimate is below that in Scenario II. The reason for this is that the budget figures seem to underestimate import duties as they do not consider the substantial improvement in import 4uty collections achieved during 1986/87 through trade reform measures - whose primary objectives was to move the majority of products away from binding license restrictions (QRs) toward tariff-only protection. Import duties, as a percent t of total imports, increased from 3.8Z in 1985/86 to 5.4Z in 1986/87. - In fact, total non-oil tax revenue projected in the 1987/88 Budget is close to Scenario I estimate (which assumes no improvement in tax administration), and may there- fore be on the conservative side. 2.14 The projections presented in Table 2.9 can also be used to test the feasibility of the current government strategy of increasing revenue through increased tax enforcem-nt without raising tax rates or introducing new taxes. Table 2.10 presents a consolidated set of budget projections which incorporates the non-oil tax revenue figures of Scenario II as well as projections of other sources of government revenue (i.e., oil revenue, non-tax revenue and grants). It clearly shows that the tax enforcement effort would allow the Government to substantially reduce the fiscal deficit from its 13/ It should be clear that the target cannot be to increase the AEF to 1. Even in countries with the most sophisticated enforcement mechanisms, actual revenues do not equal theoretical potential revenues. Moreover, an attempt at full enforcement is likely to affect economic activity negatively and to enlarge the underground economy. The assumption of a constant tax base (used in the calculations) would no longer be valid. 14/ A detailed analysis of these measures is presented in World Bank (1987), op. cit. 15/ Using the 3.81 figure to estimate 1987/88 import duties, the resulting revenue is Rp 676.3 billion which is quite close to the budget figure. Table 2.9: ESTIMATED NON-OIL TAX REVENUE 1986/87-1990/91 WITHOUT AND WITH ENFORCEMENT (Rp billion) 1986/87 1987/88 1988/89 1989/90 1990/91 % of Z of % of x of Z of Revenue GDP Revenue GDP Revenue GDP Revenue CDP Revenue GDP Scenario I (Without enforcement: No increase in A.E.F.)/a Personal income tax 712.3 0.71 819.1 0.75 943.2 0.79 1,050.5 0.82 1,138.6 0.84 Corporate income tax 2,022.9 2.03 2,247.9 2.05 2,441.1 2.04 2,620.6 2.04 2,793.3 2.06 VAT and luxury sales tax 2,942.3 2.95 3,213.7 2.93 3,536.3 2.95 3,792.8 2.95 3,994.7 2.94 Property tax 243.7 0.24 261.1 0.24 279.8 0.23 299.8 0.23 32).Z 0.24 Import duttes 960.1 0.96 1,080.5 0.98 1,261.2 1.05 1,378.4 1.07 1,438.2 1.10 Export duties 78.8 0.08 105.1 0.10 127.7 0.11 143.5 0.11 152.3 0.11 Excises 1,055.8 1.06 1,123.7 1.02 1,208.7 1.01 1,283.0 1.00 1,345.8 0.99 Other taxes 195.1 0.20 214.5 0.20 234.3 0.20 251.0 0.20 265.2 0.20 Total 8,211.0 8.20 9,065.6 8.30 10,032.3 8.40 10,819.6 8.40 11,449.3 8.40 Total as Z of Non-Oil GDP 10.32 10.31 10.55 10.64 10.59 Scenario II (With enforcement: Increase in A.E.F.)/a Personal income tax 712.3 0.71 916.1 0.83 1,241.2 1.04 1,672.8 1.30 2,037.8 1.50 Corporate income tax 2,022.9 2.03 2,355.5 2.15 2,752.5 2.30 3,247.5 2.53 3,684.3 2.71 VAT and luxury sales tax 2,942.3 2.95 3,282.3 2.99 3,737.5 3.12 4,197.6 3.27 4,563.2 3.36 Property tax 243.7 0.24 275.6 0.25 321.7 0.27 385.2 0.30 444.9 0.33 Import duties 960.1 0.96 1,080.5 0.98 1,261.2 1.05 1,378.4 1.07 1,438.2 1.10 Export duties 78.8 0.08 iO5.1 0.10 127.7 0.11 143.5 0.11 152.3 0.11 Excises 1,055.8 1.06 1,123.7 1.02 1,208.7 1.01 1,283.0 1.00 1,345.8 0.99 Other taxes 195.1 0.20 214.5 0.20 234.3 0.20 251.0 0.20 265.2 0.20 Total 8,211.0 8.20 9,353.3 8.50 10,884.8 9.10 12,559.0 9.80 13,931.7 10.30 Total as 2 of Non-Oil GDP 10.32 10.64 11.45 12.34 12.88 /a A.E.P. - Administrative Efficiency Factor. In Scenario I, it remains at its present level for each tax. In Sce- nario II, it increases to 0.75 by 1990/91. Of the total increase, 152 will take place in 1987/88, and 252, 352 and 252 in 1988/89, 1989/90 and 1990/91, respectively. - 36 - current level of 4.5Z of CDP to less than 12 of CDP by 1990/91, while main- taining both capital and current expenditures (excluding ifl,rest payments on external debt), as a proportion of GDP, at present levels. Specific recoimendations and steps to be taken to achieve the level of administrat;ve efficiency implied in the projections are presented below. Table 2.10: CENTRAL GOVERNMENT BUDGET PROJECTIONS, 1987/88-1990/91 (As percentage of GDP) ___------- Projections ------…----- 1986/87/a 1987/88 1988/89 1989/90 1990/91 Total revenues and grants 16.1X 17.7Z 19.1X 19.62 19.9Z Oil and LNG 5.62 7.7Z 8.4Z 8.2Z 7.9Z Non-oil ta- revenue 8.22 8.5Z 9.1Z 9.8Z 10.3Z Non-tax revenue 2.32 1.52 1.6Z 1.7X 1.7Z Current expenditures 13.1Z 13.5Z 13.5Z 13.5Z 13.32 Interest payments on external debt 2.8Z 3.22 3.2Z 3.1Z 3.0Z Other 10.32 10.3Z 10.32 10.3Z 10.3Z Government savings 3.0Z 4.2Z 5.6Z 6.2Z 6.6Z Capital expenditure 7.52 7.5Z 7.52 7.5Z 7.52 Overall balance -4.5Z -3.3Z -2.02 -1.3Z -0.92 /a Preliminary. Source: Staff projections. 16/ Of course, Government might consider current levels of expenditure as being too low. Although the projections do present some room for increasing expenditures after 1988/89, the Government might well prefer to further increase tax revenue and gain some extra room for maneuver. Section C analyses some of the policy options the Government might consider in such a case. - 37 - Recommendations 2.15 In order to achieve higher non-oil tax revenue through increased enforcement, various steps need to be undertaken, focusing primarily on tax administration. With a sound tax system in place, improvements in administra- tion and management of the system are the main challenges that lie ahead. Indeed, the continued success of the tax reform hinges on improved compliance with the tax laws. Management should move away from emphasizing tax revenue targets alone. Specific targets must be set at a national level on other quantifiable indicators of tax performance. These would include the number of active taxpayers, filing to registration ratios, and number of audits to be undertaken. As a first step, crucial data related to tax administration should be collected and be readily available to tax administrators. These data should include the overall number of registered taxpayers, as well as information on the filing taxpayers for the income tax and the property tax, and updated lists of noncomplying taxpayers. Information on the amount of revenue obtained from the application of penalties for late and nonpayment of taxes broken down by interest receipts, administrative surcharges and administrative fees, and the number of audits undertaken would give a good indication of the enforcement effort. This information should be broken down by district office. 2.16 All information should, to the extent possible, be standardized and shared between the different Directorates, each of which is, at the moment, responsible for a specific tax. The overall responsibiliy of coordinating data-base management Lies with the computer center, PAIK,_ which reports to the Secretary General of the Ministry of Finance. Efforts should be made to ensure that the New Payment Control System (NPCS), which is being put into operation by the Directorate General of Taxation, is fully compatible with the master file of PAIK. At present, there seems to be no formal organizational link between PAIK and the Department of Data Services of the Directorate General of Taxation. 2.17 Data availability and exchangeability are prereauisites to address the various elements of noncompliance: incomplete registration and filing, and underreporting. The cross-checking of information on taxpayers can be extremely useful in identifying noncompliance. The level of refunds requested by a VAT payer for taxes paid on inputs or for exported output can, for ?xample, indicate the overall level of output and the likely level of corpo- rate income taxes due. Similar cross-checking, between data on recipients of Government payments, with those on registered taxpayers, will also assist in identifying the nonregistered taxpayers. Although the number of registered taxpayers has already increased considerably as a result of, inter alia, the tax amnesty, it is important to expand registration further. As shown in Table 2.7, registration for personal income tax, for example, is far from complete. If Government is perceived as only following up on the existing taxpayers, there will be an incentive to avoid registration altogether. 17/ Pusat Anlisa Infomasi Keungan. - 38 - Besides cross-checking of information, penalties for nonregistration must be applied and their imposition well publicized to increase the number of taxpay- ers. 2.18 Underreporting can only be minimized by effective audits. These should be resumed as soon as possible. A system of self-assessment can only be effective when a well functioning audit system is in place, including follow-up to enforce the penalty clauses of the tax laws in cases of under- reporting. There is a clear need for specialized auditors for the new VAT, large corporations and multinational enterprises. At present 800 auditors (600 for the income tax and 200 for the VAT) are being trained. This should be regarded as a first step, and adequate budgetary support should be given for longer-term upgrading of specialized technical skills. In this context, it is essential that the mandatory three-to-four-year rotation of tax officials be limited to similar functional duties. The reorganization of the Directorate General of Taxation, which is presently being considered, should focus on clearly defined functional lines. 2.19 As opposed to nonregistration and underreporting, nonfiling is rela- tively easy ig identify. If the various penalty clauses of the new tax laws are applied,_ filing ratios and revenues should incrjarOe within a short period. When taxes are not paid, a "collection path,"-' ranging from the sending of tax collection notices and distress warrants to the actual prosecu- tion and the auctioning of the delinquent taxpayer's property should be followed as a regular procedure. These various steps should not be undertaken by the same tax collectors or the same tax departments. If exceptions are made to the regular collection path, for example by allowing for payment in installments, such decisions should always be properly documented. Further- more, tax rulings should always be in writing, and decrees and implementing regulations should be available from a convenient single source. C. Selected Tax Issues 2.20 There are a number of selected tax issues that the Government needs to consider as it examines the policy options available to further increase non-oil tax revenues or to improve the existing tax system. Two important options that the Government may wish to consider if a further increase in non- oil tax revenue is required, are the nonindexation of deductions and thresholds for marginal tax rates (to avoid the related loss in revenue) and 18/ These consist of Rp 10,000 for each return not filed or filed late, 2Z interest per month on tax underpaid or not paid, and administrative sur- charges of: (a) 50X for income tax underpaid; and (b) 100% of underwith- holding of VAT. See Laws of the Republic of Indonesia, Number 6, 1983, Articles 7, 8, 13 and 21. 19/ The NPCS, which is now being pi' :-to place in the district offices after the successful pilot project in the u.itrict 122, region 10 office in Jakarta, will automatically identify the nonfilers and notify them of the penalties involved. - 39 - the extension of VAT. This Section reviews these options and estimates their revenue implications. As in the previous Section, two alternative scenarios for the revenue projections are presented: one wich unchanged levels of enforcement and one with increased enforcement. The Section concludes with an analysis of other tax issues which the Government should consider, not only because of their revenue implications, but because of their effect on resource allocation and their simplicity in tax administration. These include: (a) tax treatment of interest; (b) suspension of VAT on capital goods; (c) VAT borne by the Government; and (d) treatment of income derived from foreign-aid projects. Specific recommendations on all of these taxation issues are advanced for consideration. Issues specifically related to property taxation are discussed in the next Chapter on Local Government Finances, Section C. Indexation of Deductions and Thresholds for Marginal Tax Rates 2.21 The various tax laws explicitly provide the Minister of Finance with the authority to adjust, by Decree, both the levels of the deductions and the tax bracketw 0or which the three different marginal tax rates (152, 252 and 35Z) apply. This adjustment can be effected automatically by indexing all .evels of deductions and tax brackets to the domestic price index, or periodically on a more discretionary basis. So far, since the tax reform was e.acted, the Government has opted not to adjust the tax structure for inztlation. The revenue implications of maintaining a policy of non-indexation are i'lustrated in Table 2.11. Scenarios I and II correspond to the scenarios in Table 2.9, i.e. with existing and improved tax enforcement but with no adjustments for inflation. Scenarios III and IV, also make corresponding assumptions about tax enforcement, but adjust for inflation both deductions and tax brackets. In particular, the following components are indexed, on an annual basis, to projected increases in domestic prices: (a) taxable incom8 levels of Rp 10 million and Rp 50 million, which determine the marginal tax rate of 152, 25Z and 352; (b) family size-related aeductions Li/ amounting on average to Rp 2.4 million per taxable family in 1985/86; (c) the maximum deductions for pension fund contributions and functional expenses of respectively Rp 120,000 and Rp 360,000; and 20/ See, for example, laws and regulations of the Republic of Indonesia, number 7, Article 7 (3), Article 17 (2), Year 1983, concerning income tax, and law number 12, Article 3 (4), Year 1985, concerning tax on land and buildings. 21/ These consist of: (a) Rp 960,000 for an individual taxpayer; (b) an additional Rp 480,000 for a married taxpayer; (c) 4n additional Rp 960,000 for a working wife earning income not 'elated to her husband's business; and (d) an additional Rp 480,000 for each dependent up to a maximum of three per family. - 40 - TSblo 2.11: IST TO O01*-OL TAX RVV11U 1996/87-199/91 VITUOUT APo W1TH INATION Op DDCUSAN HNAM!AL, TAX RATE TDZUULDU /a (Hp billion) IgUt$7 1967/88 1988/8 1909/90. x o90x bAeMa OFP HeVeMe GCD HeVeWAn CD7 Hwnemi CP Heenu GMD D9DVCTS11S 1114AMINAL TAX NATe tUNEItO Witol Enocmet/ Persio r, Vitbont .*dorent /b 712.3 0.71 619.1 0.75 943.2 0.79 1,050.5 0.62 1,138.6 0.A4 Corporate icome tax 2,022.9 2.03 2,247.9 2.05 2,441.1 2.04 2,620.6 2.04 2,793.3 2.06 Pro"ety tax 243.7 0.24 261.1 0.24 279.6 0.23 299.8 0.23 321.2 0.14 Total of Tamas Affected b TLajxot Loe 2,978.9 2.98 3.328.1 3.04 3.664.1 3.06 3,970.9 3.09 4.253.1 3.14 VAT end luxury "Ilts tax 2,942.3 2.95 3,213.7 2.93 3,536.3 2.95 3,792.8 2.95 3,994.7 2.94 Import duties 960.1 0.96 1,080.5 0.96 1,261.2 1.05 1,376.4 1.07 1,436.2 1.10 Export duties 78.8 0.08 105.1 0.10 127.7 0.11 141.5 0.11 152.3 0.11 Exciodt 1,055.6 1.06 1,123.7 1.02 1,208.7 1.01 1,263 0 1 00 1,345.8 0.99 Other taxas 195.1 0.20 214.5 0.20 234.3 0.20 251.0 0.20 265.2 n.20 Total Other Taxe3 5.232.1 5.25 5.737.5 5.23 6,368.2 5.32 6.848.7 5.33 7,196.2 5.30 Total Non-Ol STaxea 1.211.0 8.23 9,065.6 8.27 10.032.3 8.38 10,819.6 8.42 11.449.3 8.44 Total as S of Non-Otl CD? 10.32 10.31 10.55 10.64 10.59 Seonario Ili With Cnforce_nt Lb SceF o *ni itcot th 712.3 0.71 916.1 0.83 1,241.2 1.04 1,672.8 1.30 2,037.8 1.50 Coreorate income tax 2,022.9 2.03 2,355.5 2.15 2,752.5 2.30 3,247.5 2.53 3,684.3 2.71 Property tax 243.7 0.24 275.6 0.25 321.7 0.27 385.2 0.30 444.9 0.33 Total of Teals Affected by ncexat"on 2,978.9 2.98 3.541.2 3.23 4.315.4 3.61 5,305.5 4.13 6.167.0 4.54 Vaf and luxry saleu tax 2,942.3 2.95 3,282.3 2.99 3,737.5 3.12 4,197.6 3.27 4,563.2 3.36 tmport duties 960.1 0.96 1,060.5 0.96 1,261.2 1.05 1,378.4 1.07 1,438.2 1.10 Export duties 78.8 0.08 105.1 0.10 127.7 0.11 143.5 0.11 152.3 0.11 Excises 1.055,6 1.06 1,123.7 1.02 1,206.7 1.01 1,260 1.0 1,345.0 0.99 Other tauxs 195.1 0.20 214.5 0.20 234.3 0.20 N251.0 020 265.2 0.20 Total Other Txa 5232.1 5.25 5.806.1 5.29 6.569.4 5.49 7.253.5 5.65 7.764.7 5.72 Total Won-Otl Taxes 8,211.0 8.23 9,353.3 8.52 10.864.8 9.10 12.559.0 9.78 13.931.7 10.26 Total as 2 of son-Oil GDP 10.32 10.64 11.45 12.34 12.88 DEDUCTIONS AND tU9CI1AL TAX NATZ TRhcEfNULff' LUDMFl Scenario IUts Without Enforcement /b Personal Income tax - 712.3 0.71 765.0 0.70 848.2 0.71 926.4 0.72 995.2 0.73 Corporato income tax 2,022.9 2.03 2.235.5 2.04 2,421.2 2.02 2.595.6 2.02 2,765.3 2.04 Property tax 243.7 0.24 258.7 0.24 275.6 0.23 294.5 0.23 315.2 0.23 Total of Taxes Affected by In#exation 2.978.9 2.98 3.259.2 2.98 3.545.0 2.96 3.816.5 2.97 4,075.7 3.00 VAT and luxury sales tax 2,942.3 2.95 3,213.7 2.93 3,536.3 2.95 3.792.8 2.95 3,994.7 2.94 Import duties 960.1 0.96 1,080.5 0.96 1,261.2 1.05 1,378.:4 1.07 1,438.2 1.10 Export duties 7A.8 0.08 105.1 0.10 127.7 0.11 14 3 0.11 152.3 0.11 Excises 1.055.8 1.06 1,123.7 1.02 1,208.7 1.01 1,283.0 1.00 1.145.6 0.99 Other taxes 195.1 0.20 214.5 0.20 234.3 0.20 251.0 0.20 265.2 0.20 Total Other Taxes 5.232.1 5.25 5.737.5 5.23 6.368.2 5.32 6.848.7 5.33 7.196.2 5.30 Total Non-Oil TazSo 8.211.0 6.23 8.99b.7 6.21 9,913.2 8.28 10.665.2 6.30 11.271.9 8.30 Total as * of Won-Oil GOP 10.32 10.24 10.43 10.48 10.42 Scenarto IV: With Enforcement /b rersonal Income tax - 712.3 0.71 848.6 0.77 1 095.2 0.91 1,432.1 1.11 1,719.7 1.27 Corporate incom tax 2,022.9 2.03 2,342.5 2.13 2,730.1 2.26 3,216.6 2.50 3,647.4 2.69 Property tax 243.7 0.24 273.0 0.25 316.6 0.26 377.5 0.29 435.2 0.32 Total of Taxes Affected by LndezAtlon 2.978.9 2.98 3.464.1 3.15 4.141.9 3.45 5.026.2 3.90 5,802.3 4.28 VAT and luxury sales tax 2,942.3 2.95 3,282.3 2.99 3,737.5 3.12 4,197.6 3.27 4,563.2 3.36 Import duties 960.1 0.96 1,080.5 0.98 1,261.2 1.05 1,378.4 1.07 1,438.2 1.10 Export duties 78.8 0.08 105.1 0.10 127.7 0.11 143.5 0.11 152.3 0.11 Excises 1,055.8 1.06 1,123.7 1.02 1,208.7 1.01 1,283.0 1.00 1,345.8 0.99 other taxes 195.1 0.20 214.5 0.20 234.3 0.20 251.0 0.20 265.2 0.20 Total Other Taxes 5,232.1 5.25 5.806.1 5.29 6,569.4 5.49 7,253.5 5.65 7,764.7 5.72 Total Non-Oil Taxes 8,211.0 8.23 9,270.2 8.44 10,71t.3 6.94 12.279.7 9.55 13.567.0 10.00 Total ae S of Non-Oil CDP 10.32 10.55 11.27 12.07 12.54 - 41 - (d) the tax exempt level of Rp 2 million for each building subject to property tax. 2.22 By comparing Scenario II and IV, the revenue gain achieved by not indexing the tax system is estimated to amount to Rp 365 billion or 0.26% of GDP by 1990/91 when enforcement is improved. Related to this revenue gain is the automatic stabilization function of the tax system. In a system without indexation, inflation will move taxpayers into higher marginal tax brackets, increase the effective tax rate and thus contract the economy and reduce inflationary pressures. However, these gains in revenue and related automatic stabilization are achieved while imposing a disproportionate tax burden on the lower income groups. Whereas 91% of all Indonesian families are currently exempt from income taxes, only 74Z of all families will be exempt by 1990/91 without indexation. Therefore, for both equity purposes and to avoid increasing the number of taxpayers unnecessarily, adjustment to price increases should be made at discretionary intervals, depending on the overall revenue situation and inflationary conditions. In the present low inflation- ary environment in Indonesia, it seems justified that no adjustments be made for the time being. Extension of VAT 2.23 The revenue effects of two types of extensions of the VAT are illustrated in Table 2.12. Here, scenarios III and IV indicate by how much revenue will increase when the gas, electricity and water sector is, as a whole, taxable. Scenarios V and VI illustrate the revenue impact of an extension of the VAT to the retail level. As can be seen, by comparing Scenarios II and IV, total VAT revenue will only increase by Rp 39 billion or 1.2% in 1987/88 in the case with enforcement when VAT is extended to include the gas, electricity and water sector. The reason for this low contribution is that the old taxable sectors will be able to deduct more input tax from their final output tax due. The AEF on the collection of VAT on electricity, gas and water can, however, be expected to be high as only a limited number of firms, mainly state enterprises, would be involved. 2.24 Extension of the VAT to the retail level would be more revenue- effective. Scenario VI, for example, shows that, with an increase in AEF, VAT revenue could amount to 3.9% of GDP by 1990/91. This figure is comparable to VAT revenue in Korea (see Table 2.2), where the VAT is extended to the retail level. However, given the existing problems with enforcement, such extension does not seem feasible in the near future in the case of Indonesias improve- ments in administrative efficiency should first materialize on the existing tax base. As can be seen by comparing Scenarios II and V, enforcement is, by itself, almost as revenue effective as an extension to the retail level without enforcement. Tax Treatment of Interest 2.25 The tax reform legislation approved by Parliament included full taxation of interest income. However, the beneficial effects of this provi- sion were removed by a subsequent decree providing for temporary exemption of interest on time and savings deposits. The impact of this exemption is - 42 - Table 2.12: EXTENSION OF VAT: ESTIMATED REVENUE UNDER ALTERNATIVE SCENARIOS (Rp billion) 1986/87 1987/88 1988/89 1989/90 1990/91 % ofTOf T o Z of %o%f o Scenarios /a Revenue GDP Revenue GDP Revenue GDP Revenue GDP Revenue GDP Scenario I 2,942.3 2.95 3,213.7 2.93 3,536.3 2.95 3,792.8 2.95 3,994.7 2.94 Scenario II 2,942.3 2.95 3,282.3 2.99 3,737.5 3.12 4,197.6 3.27 4,563.2 3.36 Scenario III 2,942.3 2.95 3,251.9 2.96 3,577.9 2.98 3,837.4 2.99 4,041.9 2.98 Scenario IV 2,942.3 2.95 3,321.3 3.03 3,781.6 3.15 4,247.0 3.31 4,617.1 3.40 Scenario V 2,942.3 2.95 3,776.3 3.44 4,141.3 3.45 4,436.2 3.45 4,674.1 3.44 Scenario VI 2,942.3 2.95 3,856.9 3.51 4,377.0 3.65 4,909.7 3.82 5,339.3 3.93 /a (1) Scenario I: Without enforcement, no extension of base. (2) Scenario II: With enforcement, no extension of base. (3) Scenario III: Without enforcement, extension of base to include electricity, gas and water in 1987/88. (4) Scenario IV: With enforcement, extension of base to include electricity, gas and water in 1987/88. (5) Scenario V: Without enforcement, extension of VAT to retail level in 1987/88. (6) Scenario VI: With enforcement, extension of VAT to retail level in 1987/88. (7) "Without enforcement" implies a constant administrative efficiency factor. (8) "With enforcement" implies a gradual increase of the administrative effi- ciency factor to 0.75 by 1990/91. See Table 2.7 for details. - 43 - considered to be negative with regards to revenue, efficiency and equity. It is estimated that withholding income tax at source on interest payments on time and savings deposits, could yield additional revenues of approximately Rp 200 billion. The exemption creates a bias in favor of bank deposits at the expense of other financial and investment instruments. Furthermore, since interest payments of corporations can be deducted as a business cost only to the extent that they exceed interest received on time and savings deposits, the current exemption provides an incentive to split firms artificially. A firm could, for example, maximize its own borrowings while channeling part of its earnings or surplus funds to a related firm, which, when taxed separately, could take full advantage of the nontaxability of interest receipts. And finally, with regard to equity, the exemption benefits mainly high income groups. About three-quarters of time deposits are held in large accounts of Rp 100 million or more. 2.26 The argument that has been given against removing this tax exemption is that it will have a direct impact on domestic interest rates and will provide incentives for capital flight. Although the argument is correct in principle, it is important to underline that taxing policy is not the most appropriate instrument to achieve a particular level of domestic interest rates. Appropriate coordination with monetary policy may well avoid the related capital flight. Furthermore, the risk of capital flight is lessened by the fact that many of the deposits are those of "captive" institutions, such as st ny-owned enterprises, which are not allowed to put their money elsewhere.- It is therefore recommended to remove the tax exemption of interest income on time and savings deposits, and to withhold this tax at source. To contain the risk of capital flight, it is important to allow interest rates to adjust, to minimize the bureaucracy related to the tax and to introduce the tax when speculative pressures against the Rupiah are low. Suspension of VAT on Capital Goods 2.27 Because of cash flow considerations,23/ collection of V f on capital goods purchased by taxable firms has been suspended indefinitely._ Obviously, VAT which is not paid for on inputs cannot be cred.ted from VAT due on output. Consequently, the revenue impact of this measure is not signifi- cant, as long as the products concerned are inputs and the producer or importer of the concerned goods is taxable. However, the postponement, to a maximum of five years, of VAT payments on imports of capital goods of selected 22/ Available information on the composition of Rupiah deposits by ownership shows that in 1985, 15% of total time and savings deposits were held by Government and state enterprises. 23/ For example, it is clear that payment of VAT on capital goods used in the manufacturing of exports only affects the cash flow of the exporter as exports are zero-rated and all VAT paid on inputs is in principle refunded. 24/I Decree of the Ministry of Finance 827/84. - 44 - services approved by BKPM including hotels and shopping centers has serigys revenue implications as these services do not levy VAT on their output. In either case, the suspension of VAT on capital imports leaves a significant loophole for tax evasion through the classification of imported items. 2.28 The big disadvantage of any exception made to the actual payment of VAT on inputs, is that the audit trail is interrupted: when the VAT does not have to be paid, no incentive exists to settle final taxes due. Exemptions to VAT should therefore be minimized and adequate and efficient mechanisms should be set up to refund excess taxes paid. Reciprocity would then require that an 25/ See Presidential Decree No. 37/1986, August 13, 1986. According to the law, the only taxable services are construction services. The decree effectively allows for the postponement of VAT on inputs of firms that do not levy VAT on their output, implying a direct loss in revenue to Gov- ernment. An example may clarify the effect of allowing for a suspension or postponement of VAT, in the case of taxable and nontaxable services. Suppose the output of both taxable and nontaxable services is the same and is valued at ten (excluding tax). Input is also assumed to be the same and is valued at six (excluding tax). The input is a taxable good. Normally, both the taxable and the nontaxable services would pay VAT: - Taxable Services (1) 0.1*6 = 0.6 at the time of the purchase of the input; (2) 0.1*10-0.6 = 0.4 after sale of the output, settling final VAT due. - Nontaxable Services 0.1*6 = 0.6 at the time of the purchase of the input. Assuming that the supplier of the input pays the full amount of VAT collected from the taxable and the nontaxable services to the Government, total government revenue will, ceteris paribus, be: 0.6+0.4+0.6 = 1.6. When payment of VAT on input is suspended or postponed, the taxable ser- vices will still pay the same VAT: (1) zero at the time of the purchase of the input; (2) 0.1*10-0 = 1 after sale of the output, settling final VAT due. The nontaxable services do not pay VAT at all and government revenue decreases, or is postponed, by 0.6, the full amount of VAT levied when no suspension or postponement of VAT had been granted. For the taxable services, suspension or postponement of VAT merely affects the cash flow: payment is postponed to the time final taxes are due. - 45 - interest fee of 2% per month 26/ is due by Government when refunds are not made on time. VAT Borne by the Government 2.29 Government as a purchaser of taxable guids must pay VAT. Until now, this aspect of the VAT has effectively been suspended, as VAT due by the Government has not actually been paid. This has a negative impact on alloca- tive efficiency as the Government is facing different relative prices than the private sector. Furthermore, tax administration is complicated as there is the need to distinguish between sales to the Government and to the private sector. It is therefore recommended to implement the referred provision fully and to collect VAT on government purchases. In principle, as long as the VAT which is paid for by the Government is returned in the form of tax payment, this provision will just increase both revenue and expenditure of the Government without affecting the overall budget deficit. Nevertheless, because the AEF is not one, the Government may lose revenue by directly paying VAT as a purchaser of goods. To avoid this loss of revenue, the Government should require sellers to provide tax registration numbers as well as receipts, with VAT clearly specified on it. In all, this will force govern- ment suppliers to file their VAT returns and will allow the Government to check this on a systematic basis. Furthermore, this may also enable the Government to bring new taxpayers into the system and cross-check the obtained information with corporate and personal income tax records. Treatment of Income Derived from Foreign-aid Projects 2.30 The ir/atment of income derived from foreign-aid projects at present is as follows._ Personal income derived from projects is fully taxable and must be withheld by the employer at the normal statutory tax rates. Corporate income is not taxable. Under the new income tax law, this treatment encou- rages employers and employees to settle for remuneration in fringe benefits when the primary source of income is a project financed through foreign aid. For corporations also obtaining income from other sources, a distinction is to be made on the source of income, iae., whether or not it is derived from a foreign-aid project. Besides being cumbersome to administer, an incentive is thus created to artifically shift business costs to the taxable component of income. It is therefore recommended that corporate income tax treatment be applied uniformly to all income, irrespective of its source. The additional cost of foreign-aid projects would simply be financed through the related increase in tax revenue. Again, as in the case of VAT on government purchases, the Government should use the opportunity provided by foreign-aid projects to force taxpayers into the system. Taxpayer identification numbers and receipts of income derived from these projects should be required as part of project implementation procedures. 26/ See footnote 18. 27/ See Presidential Decree 29/1986, July 12, 1986. - 46 - Recommendations 2.31 In suwary, the foregoing analysis suggests several specific recom- mendations: (a) deductions and marginal tax rate thresholds should not be adjusted for inflation for the time being, although for equity and tax administration considerations this option should be reviewed periodically in light of the overall revenue situation and inflationary conditions; (b) interest received on time and saving deposits should be taxed in the same way as dividends and capital gains; (c) the suspension of VAT payments on capital goods should be removed, to avoid interrupting the audit trail as well as revenue losses, and an adequate and efficient mechanism should be set up to refund excess taxes paid; (d) VAT on government purchases should be collected and, to avoid any associated revenue loss, the Government should require sellers to provide tax registration numbers as well as receipts with VAT clearly specified; (e) no exemptions for corporate income tax should be given to suppliers of goods and services for foreign-aid-financed projects, and taxpayer identification numbers and receipts of income derived from these projects should be required as part of project implementation procedures; and (f) the extension of the VAT to cover electricity, gas and water would have limited revenue impact. Ultimately, an extension to the retail level can be revenue-effective when administered efficiently. In the short run, such an extension should not be considered. - 47 - CHAPTER III LOCAL GOVERNMENT FINANCES A. Introduction Structure and Role of Local Governments 1/ 3.1 Indonesia has a four-tier hierarchy of local governments, which are generally referred to as "regional governments". There are 27 provinces, which comprise "level I" and which, in turn, are subdivided into 292 "level II" governments. The latter are of two types, the "Kotamadya" (municipali- ties), of which there are 54, and the "Kabupaten" (regencies or districts), which account for the remainder. Level II regions are subdivided into 3,500 third level administrative units known as "Kecamatan" (sub-districts) which are in turn sub-divided into 64,000 fourth level "Desa" et "Kelurahan" (rural or urban villages). 3.2 The functions of central and regional governments are defined in Law No. 5 of 1974, which distinguishes between those services provided directly by central government sector departments ("deconcentrated" services) and those which are assigned to regional governments ("decentralized" services). The law also refers to the provision of services by "coadministration", whereby services are executed by regional governments under the direction of central government. Under the law, a wide range of functions are "decentralized" to the local level. At the level of the provinces, these include the operation and maintenance of major road and irrigation networks. Similarly, level II governments are responsible for "local" services ranging from local roads and drainage to water supply and solid waste collection. The areas where central government sector departments or public enterprises retain major responsibility include certain services, such as health, education and electricity supply, as well as the development of major infrastructure in all sectors. 3.3 In addition to the di. ct control exercised by central government over "deconcentrated" services,- regional administrations are subject to the technical guidance of central sectoral ministries (such as the Ministry of Public Works) and are under the general supervision of the Ministry of Home Affairs, which provides oversight through various Directorate Generals (DGs). 1/ Local governments are generally referred to as "regional" governments in Indonesia. The terms are used interchangeably throughout this Report. 2/ To provide these "deconcentrated" services, most central government ministries have regional branch offices throughout the country, generally known as "Kanwils". Their local counterparts are service departments, known as "Dinas", which form part of the regional governments. In some cases, the head of both the central and local government office is the same person. - 48 - The DC for General Administration of Autonomous Regions (PUOD) controls nominations of governors and mayors as well as staffing and remuneration of regional staff, for which it allocates funds through the Subsidi Daerah Otonom (SDO). The DG for Regional Development (Bangda) guides and supe-vises regional capital investment programs through the allocation of the key development grants (the "INPRES" grants). 3.4 Although the Ministry of Home Affairs has primary responsibility for supervision of regional governments, the National Development Planning Board (BA2PENAS) and the Ministry of Finance also have significant influence in regional affairs. BAPPENAS reviews and approves specific projects proposed each year by provincial and second-level governments as well as by the national sectoral ministries. The Ministry of Finance has several DCs with some involvement in local government finances. The DG for Monetary Affairs exercises general financial oversight and monitoring of local governments and administers some loan schemes. The DC for Budget has authority for all central government payments (including grants to local governments) and supervises central and local treasury functions, while the DC for Taxation is responsible for the collection of certain revenues which are assigned to local governments, such as property tax revenues, including the supervision of regional property tax offices (IPEDA/PBB Inspectorates). Finally, the DG for State Financial Audit has external audit responsibility for all government entities, including local governments. 3.5 In all, although the legally defined division of responsibilities provides local government autonomy in principle, in practice the central government plays a dominant role in nearly all local government activities, reflecting the predominance of central government financing as well as technical and administrative weakness at the regional level. Local Governments: Consolidated Expenditures and Sources of Financing 3.6 Table 3.1 presents consolidated local government accounts for the 1978-86 period. During this period, local government expenditure averaged 5Z of GDP, or approximately 30% of total general government expenditure. Between 1978 and 1986, there was a large increase in the share of government consump- tion in total local government expenditures (from 64.1% in 1978 to 86.1% in 1986), and a concommitant decline in the share of government investment (from 35.9Z to 13.9%); exactly opposite to the trend followed by central government expenditures (see Table 1.5). In part, this trend reflects the role local governments play in operating and maintaining government services. As projects financed by the central government are completed, the responsibility of operating and maintaining a large number of them passes over to the local governments. Because there is no commensurate increase in the level of central government transfers, local governments are forced to devote a larger share of their resources to government consumption and away from investment. Besides being a clear indication that recurrent expenditure, its financing and executing responsibility are not adequately taken into account at the time of investment (see Chapter IV, Section D), the observed trend of local government expenditure may also indicate that local revenue authority and performance are not commensurate with local expenditure responsibilities. In such a case, to understand the structure of local government expenditures it is necessary to analyze Lhe sources of iLs financing. - 49 - Table 3.Is MMIUCIAL AM LOCAL GWEDIJEIT ACCOUNTS, 1976-86 (As percentage of GDP) 1978 1979 1980 1981 1962 1963 1964 1965 1986 Current Receipts 3.8 3.1 3.1 3.3 3.7 3.9 3.2 3.6 3.8 Direct taxes 0.4 0.3 0.3 0.4 0.3 0.3 0.3 0.3 0.3 Indirect taese 0.3 0.3 0.2 0.2 0.3 0.3 0.2 0.2 0.2 Tranafers from private sector 0.7 0.4 0.4 0.5 0.7 0.8 0.5 0.4 0.4 Transfer* from central govt. 2.1 1.8 1.8 2.0 2.1 2.0 2.1 2.4 2.6 Property Income an d operating 0 surplus 0.3 0.2 0.2 0.2 0.3 0.3 0.2 0.2 0.2 Current Expenditures 3.2 2.7 2.7 2.9 3.6 4.0 3.9 4.2 4.7 Consumption 3.1 2.7 2.6 2.9 3.5 3.9 3.8 4.2 4.6 Subsidies 0.1 0.0 0.0 0.0 0.0 0.0 0.1 " 0. 0.0 Transfer payments to private sector 0.0 0.0 0.0 0.0 0.0 0.0 0.0 u.0 0.0 Gover ment Savings 0.5 0.3 0.4 0.4 0.2 -0.1 -0.6 -0.6 -0.6 Gove rnent Invetment 1.7 1.4 1.4 1.5 1.8 1.9 1.1 1.2 0.7 Deficit Financing 1.2 1.0 1.0 1.1 1.6 2.0 1.8 1.8 1.6 Capital Transfer from Central Govt. 1.7 1.5 1.3 1.8 1.8 1.8 1.7 1.6 1.6 Banking System -0.5 -0.5 -0.5 -0.7 -0.2 0.2 0.1 0.2 0.0 Memo item : Total Local Government Expenditure 4.8 4.0 4.0 4.3 5.3 3.8 4.9 5.3 3.4 Local government consumption 3.1 2.7 2.6 2.9 3.5 3.9 3.8 4.2 4.6 Local government lnvestent 1.7 1.4 1.4 1.5 1.6 1.9 1.1 1.2 0.7 As Percentage of Total Local Government Expenditure Total Local Government Expenditure 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 Locol government consumption 64.1 66.4 66.0 66.2 66.6 67.3 76.8 77.8 86.1 Local governnent investment 35.9 33.6 34.0 33.8 33.2 32.7 23.2 22.2 13.9 As Percentage of Total General Gover ment Expenditure Total Local Government Expenditure 31.2 27.8 28.5 25.6 25.5 28.6 29.2 28.5 30.0 Local government consumption 28.9 28.0 25.1 26.0 30.3 33.9 35.8 34.9 40.4 Local governe nt investment 36.4 27.3 38.6 25.3 19.2 20.2 18.2 17.3 11.5 Source: Sources and Uses of Funds Frmework, Appendix 1. - 50 - 3.7 Local Government Finances. The sources of finance for services provided by regional governments are: (a) central government grants (INPRES and SDO grants channeled for development and routine expenditures respec- tively); (b) assigned revenues, levied by the central governrment but assigned wholly or partly to regional government (e.g., property tax revenues); (c) revenue from local tales and service chArges; and (d) fuLds channeled through the banking system (e.g., loans to regional governments). 3.8 The most imrportant grants to local governments are the Subsidi Daerah Otonomi (SW) for routine expenditure, and the Instruksi Presiden (INPRES) programs for development expenditure. The SDO covers mostly wages and salaries for regional government staff whose appointment are centrally approved. A small proportion of the SDO (about 10%) finances non-staff operational expenditures, including small allowances for maintenance of primary schools and hospitals. The INPRES comprises two sets of programs.3 The general grant program, which comprises grants for three different levels of local government: INPRES Dati I (level I), INPRES Dati II (level II), and INPRES Desa (level IV). And the specific grant program, which comprises grants specifically directed to four different sectors: INPRES Sekolah Dasar (education), INPRES Kesehatan (health), INPRES Reboisasi (re-afforestation and re-greening), and INPRES Jalan (roads). 3.9 There are a number of revenue sources levied by the central govern- ment but assigned to regional governments including: royalties on gasoline sales (payable to provinces), royalties on forestry and mining (also payable to provinces), and the property tax (allocated mainly to second level authorities). Overall, the most important of these "assigned" revenue sources is the property tax, which was known as IPEDA (Iurai. Pembangunan Daerah or Regional Development Contribution) until January 1986, when it (along with some other smaller taxes) was replaced by a new tax on land and buildings called the Pajak Bumi dan Bangunan or PBB. The central government is responsible for assessment of tax liabilities and collects the tax directly (through its regional tax inspectorates) for estates, forestry and mining, while local governments collect the urban and rural property tax. The new PBB law allocates 10Z of property tax revenues to the central government, with the remaining 90% distributed as follows: 9X to cover valuation, assessment and collection costs, 16Z to provincial governments and 65Z to level II govern- ments. While IPEDA revenues were supposed to be used by local governments for development expenditures, there are no formal restrictions on the use of PBB revenues. 3.10 In addition to the taxes which are collected by the central government and assigned to local governments, there are a large number of local taxes. The major provincial taxes are those on ownership and transfer of motor vehicles; the major second level taxes are the hotel, restaurant and entertainment taxes. There are, however, .nany other local taxes of varying 3/ There is a third program, INPRES Pasar, which is a loan subsidy scheme available to local governments to reduce their costs of borrowing for market development (see para. 3.11). - 51 - significance. Service charges are also numerous, especially in second level regions where they are generally a larger aggregate source of income than local taxes. Local tax legislation, for both provinces and second level regions, is subject to approval by the Ministry of Home Affairs, in consultation with the Ministry of Finance in cases where a tax is being intro- duced for the first time. The same approval procedure applies to provincial service charges. For second level regional services, charges need to be approved only by the provincial governors. In practice, the most important tax and charge rates are standardized nationally, and local fiscal autonomy is very limited. 3.11 Most borrowing by regional governments has been confined to small loan schemes sponsored by the central government for certain types of revenue- earning projects, and administered by the Ministry of Finance. These include the INPRES Pasar program, which provides interest-free loans to second level regions to develop market centers. The terms of these loan schemes differ but interest rates are generally well below domestic market rates. In addition, there are a number of specific projects for which foreign loan funds have been on-lent to local governments (generally the large Kotkmadyas). Regional governments tend to regard loans aF au except,ional source of finance for special projects only, rather ther a normal means of financing a part of their development spending requi.ements. 3.12 Tabloe 3.2 presents the relative contributions made by the different sou:ees Cf regionat revenues o-ver the 1978-86 period. Clearly, central governm-rt -r*±nts vre the most dominant, averagiag 72X of total local governmetnt revenues. The remaining 28% is composed of local taxes and fees, su'rv:cea charges, central government revenue assigned .9 the regions (property taK*,I ard. funds channeled througi the banking system.' Very disturbing, is the fact that thz contzibution of locel tae.s, fees and ciarges to local governmet 7evenues has fallen almouL steadily between 19T? and 1986 (from 32r to 21.8%). In fact, total tegionally, gferated revenues, including pruparty ta-ea, represented onty 1.4% of CDt in w ,hereas total :ocal ex3aditures accounted for 5.3% of CDP. Th2re is, clearly1, t%; neel to mobi Lize additional local government revenues; not only P a kakud Local got/; _ments' expenditure capacity, but to diminiFh the. "rWa-.Zd Ae-se d%nce on cenitral government transfers which are current3y "n impoeraat eeterrinant of the allocation of local government exp ' (sef: S'ctiorn ). t ae recent 41 Caution needs to be exercised w:IL- irmerptw.ing the figu7.rs r&ated to the financing role of the banking *ohzl lytl, t4ea- figr:s portray the fact that local governments did not na-v. tc, cp 4d1 uael r :entral government budget a.locations in any ovte yeer, This was 'ade possible by the existence of the SlAPs (spendinri aurhority crx ov_-. £rom one fiscal year to the next) which allowed l]ca goverrLeuts to: examr-le, to accumulate asseto wiith the banking syr.icm vetweeCv 191w. n (\a Part of these balances wit' the banking system we:e " t' n be;rp 'a"'- between 1983 and 1985 before the SIAPs were abolished in i3t I. gel.eral, loans havL never been an. important source of regionoa revew;e, fluituating only around 1% of total ravenues. - 52 - decline in oil prices and consequent fall in central government revenues have made this need more urgent. The following sections will examine in more detail the performance and prospects of the main sources of local government revenue and the related need for policy action. In particular, Section B analyzes the role of central government transfers, Section C reviews the issues related to property taxation, Section D examines the need to reform the system of local government taxes and Section E analyzes other sources of financing such as user charges and loan finance. Table 3.2: MAIN SOURCES OF LOCAL GOVERNMENT FINANCES, 1978-86 (As percentage of total sources of financir3) 1978 1979 1980 1981 1982 1983 1984 1985 1986 Central Governmient Grants 72.5 76.5 78.7 82.3 68.5 62.5 71.4 71.1 73.8 Routine grants (SDO) 42.9 45.1 45.6 45.0 38.7 34.3 41.0 45.3 49.0 Development g.rants (INPRES) 29.6 31.4 33.1 37.3 29.8 28.2 30.4 25.8 24.8 Property Tax 5.1 4.9 4.2 3.6 3.1 2.9 3.4 3.2 4.4 Local taxes, fees and charges 32.7 30.2 30.3 30.5 31.2 32.0 23.7 21.6 21.8 Banking system -10.2 -11.6 -13.2 -16.4 -2.8 2.6 1.5 4.1 0.0 Source: Sources and Uses of Funds Framework, Appendix 1. B. The Role of Central Transfers Structure and Evolution of the Grant System 3.13 The central-local grant system 5/ in Indonesia is composed of two types of grants: 5/ Full details of each grant program are given in Appendix 4, Table A4.1. They include the specific objectives of each program; the criteria for allocating each grant as between village, local or provincial governments; categories and components of grant expenditure within each program; planning and execution guidelines and instructions, including channels for the release of approved project funds and project implementation reporting channels; and changes which have been made periodically to the components or balance of expenditures under each program. The information is extracted from Douglas Lamb, "The INPRES Grant Programmes--Overview, Problems and Issues," Institute of Local Government Studies, University of Birmingham, November 1986, pp. 13-15. - 53 - (a) "Specific" grants. These are grants for expenditure on specified services, and are subject to detailed central government control as to their use. These grants comprise: (i) the SDO, (ii) the "directed" (ditetapkan) part of the INPRES Dati I earmarked for roads, bridges and irrigation; (iii) the INPRES Reboisasi (part of which is spent by provinces and part by second level governments); and (iv) the second level region grants INPRES Sekolah Dasar, INPRES Kesehatan and INPRES Jalan. (b) "Block" grants. These are grants on which there is an element of local choice, although they are also subject to certain government guidelines. These grants comprise: (i) the "guided" (Diarakhan) part of the INPRES Dati I; (ii) the INPRES Dati II; and (iii) the INPRES Desa. 3.14 Table 3.3 shows the structure and evolution of the grant system from 1979/80 to 1987/88. These figures underline the considerable importance of transfers for the central government budget; their share in total consolidated central government expenditure (excluding external debt service payments) rose from 15.2% in 1979/80 to 22.3% in 1987/88. The expansion of the grant system during this period, reflected central government views that the content and physical implementation of the grant system should be specified in great detail with central control exercised through rigorously defined procedures. The "specific" component of the grant system correspondingly expanded faster than the "block" component, whose relative share contracted from 16.9% in 1979/80 to 14.7% in 1987/88, albeit some strengthening during the last two years. 3.15 There is little disagreement about the generally positive contribution of the grant system to both social and economic development of the regions by expanding regional and local road and irrigation systems and rehabilitating agricultural land and forest, as well as expanding primary school opportunities and providing the regions with central primary health facilities and services. Nevertheless, the heavy dependence of regional governments on central grants and the structure and evolution of the grant system have created a number of distortions and disincentives, some of which are more widely recognized than others. The following discussion summarizes the major problems and issues related to the current system of central-local transfers, most of which have been identified in previous analyses and studies undertaken for the Government of Indonesia.° 6/ Kenneth Davey, "Central-Local Financial Relations", Institute of Local Government Studies, University of Birmingham, 1979; Brian Binder, "Financial Management in Local Government", Institute of Local Government Studies, University of Birmingham, 1982; Nick Devas, "Local Taxation and Related Issues of Central Local Financial Relations", Institute of Local Government Studies, University of Birmingham, 1986. See also the recent Inception Report for the ongoing study of the INPRES program by D. Lamb (1986), op. cit. Table 3.3: GRANT SYSTEM, 1979/80-1987/88 (Rp billion) 1979/80 1980/81 1981/82 1982/83 1983/84 1984/85 1985/86 1986/87 1987/88 "Block Grants Datl I iilarakhan 72.9 113.0 145.1 170.5 170.8 171.8 194.5 201.5 201.5 Datl II 87.1 119.4 162.6 193.9 194.1 194.6 188.6 220.8 226.0 Desa 31.0 50.7 70.5 88.4 91.6 92.8 98.6 98.9 98.9 Subtotal 191.0 283.1 378.2 452.8 456.5 459.2 481.7 521.2 526.4 Specific" Grants /a Dat I Ditetapian 29.3 53.6 69.9 82.5 82.2 81.2 95.2 78.5 78.5 Sekolah Dasar 155.8 249.8 374.5 589.2 549.3 572.0 526.1 417.2 100.8 Kesehatan 30.0 50.4 78.8 80.3 87.3 64.6 110.6 114.6 76.3 Reboisasi & Penghijanan 40.8 48.6 70.4 49.6 59.4 61.2 42.5 42.3 16.2 Jalan & Jembatan 13.0 25.9 54.8 42.4 64.6 101.1 70.1 130.0 130.0 Subsidi Daerah Otonomi 669.9 976.1 1,209.4 1,315.4 1,546.9 1,883.3 2,489.0 2,639.7 2,649.1 Subtotal 938.8 1,404.4 1,857.8 2,159.4 2,389.7 2,763.4 3,333.5 3,422.3 3,050.9 Total - All Grants 1,129.8 1,687.5 2,236.0 2,612.2 2,846.2 3,222.6 3,815.2. 3,943.5 3,577.3 Memo Items x of total grants to consolidated central gov. expenditure /c 15.2 15.4 17.2 19.9 17.5 19.4 19.5 22.9 22.3 2 of "block" grants7to consolidated central gov, expenditure /c 2.6 2.5 2.9 3. 2.8 2.Q 2.5 3.0 3.3 2 of "block" to totiaT grants 16.9 16.8 16.9 17.3 16.0 14.3 12.6 13.2 14.7 2 of "block" to INPRES grants 41.5 39.8 36.8 34.9 35.1 34.3 36.3 40.0 56.7 2 of SDO to total grants 59.3 57.8 54.1 50.4 54.3 58.4 65.2 66.9 74.1 /a Excludes INPRES 'asar loan fund. 7W Budget. 7Ec Excluding external debt service payments. Sources: Ministry of Finance Ministry of Home Affairs. - 55 - The Grant System: Problems and Issues 3.16 The grant system has attracted adverse criticism for, on the one hand, having overly detailed and inflexible central guidelines for its implementation and, on the other, using rather simple criteria to allocate grants between regions *9d consequently not taking into account differences in regional circumstances.- In particular, no consideration is given to differentials between regions with respect to: (i) expenditure needs; (ii) costs of providing services; (iii) local resource potential; and (iv) local revenue raising effort. 3.17 Fragmentation and Central Control. As explained in para. 3.14, the grant system is overly biased in the direction of specific grants, and thus control by central government over specific expenditure allocation decisions. However strong the justification for delivering services to the regions through vertically fragmented, centrally specified and overly controlled grants when each of the components of the grant system was originally introduced, there may be significant costs in persisting with that system at a time when there is a need to develop administrative and technical capabilities at the local level as well as to respond to pressing demands for the expansion of services more in line with local priorities and needs. 3.18 Differential Expenditure Needs. The distribution formulae currently being employed to allocate existing grants between regions do not adequately take into account differential expenditure needs (e.g., differences that arise from the proportion of total regional population accounted for by the service target group or the area within which services should be available). Within the "block" grants only INPRES Dati II incorporates certain differentiation by using regional population as the allocation criteria (in 1986/87 Rp 1,250 per capita). Neither INPRES Dati I nor INPRES Desa allocation criteria provide for regional differentiation. While allocation criteria for "specific" grants do take more into account relative expenditure needs, some further refinements are required. For example, the SDO has no objective system of determining local manpower needs for each region, without which it is difficult to judge regional proposals for extra staff. Furthermore, regions are not encouraged by the system to economize in their use of staff, and in proposals for extra recruitment; as the SDO automatically covers the salaries once appointments are approved, the grant could be seen as encouraging expenditure on staff rather than on services. As shown in Table 3.3 the share of SDO in total grants increased from 59.3% in 1979/80 to 74.1% in 1987/88. In summary, the grant system should be more responsive to regional expenditure need differentials. i 3.19 .Differential Costs of Providing Services. There is no provision within the grant allocation criteria for possible differences among regions in the costs involved in providing a particular service. These cost 7/ Detailed information on the referred central guidelines as well as the criterit to allocate existing grants is presented in Appendix 4, Table A4.1. - 56 - differentials arise, for example, from providing services to either remote or topographically difficult areas or dispersed population within relative large areas. They can also relate to differences in the natural environment or climatic factors like volcanic activity, flooding or landslip which have an effect on the cost of maintaining infrastructure. For a more equitable grant system these cost differentials need to be accounted for. 3.20 Differential Local Resource Potential. One of the goals of central- locrl grants is to reduce the inequality of local revenues across jurisdictions. Indonesia's current grant system lacks the elements to pursue this objective. Furthermore, given the allocation criteria being used, the system actually introduces unwarranted variations of revenues across jurisdictions which may augment interregional inequality in revenues (e.g., providing same grant allocation to provinces with different income per capita). The relative revenue raising capacities of the regions need to be monitored and the grant allocation criteria need to compensate for differential local resource availability. 3.21 Differential Local Revenue Raising Effort. Current grant distribution formulae provide no incentives to regions for improving their own revenue generation. If the grant system is to be replaced by local resource mobilization there is the need to include, as part of the grant allocation criteria, an element which would reward local governments as they improve their own revenue generation: an "incentive" element. Reform of the Grant System 3.22 During the last two years (see Table 3.3), the Government has increased the share of grants provided in the form of block grants, and relied more on broad functional guidelines, rather than physical targets, in determining the use of specific grants. This trend should continue. In addition, there is the need to change the distribution formulae of grants to recognize differences in local government needs, costs and resource potential, and to provide an incentive for local resource mobilization. To make grant allocation more responsive to differences in regional circumstances it is recommended to include the following factors as criteria for grant allocation: (i) population; (ii) area; (iii) equal shares; (iv) cost variations; (v) revenue potential compensation; and (vi) revenue collection incentive. 3.23 The population and area factors ensure that the allocation takes into account differential needs of local administrations. For specific grants the population factor should refer to the population target group, whereas the area factor should relate to the physical targets. For operations and maintenance expenditures the area factor should be based on inventories on existing infrastructure.Q The "equal shares" factor allows for the fact that administrative overheads are, up to a point, invariant with size of 8/ Specific ways in which this could be applied are presented in Chapter IV, paras. 4.55 and 4.56. - 57 - jurisdiction. The cost variations factor is meant to allow for differences in unit costs of service provision across jurisdictions. The revenue potential factor is an explicit revenue equalization factor. In the case of INPRES Dati I, for example, this could be inversely related to the proportion of motor vehicles registered in the province, while in the case of INPRES Dati II inversely related to the share of PBB valuations in the local jurisdiction. The incentive factor should be based on improvements in local tax collections. It should reflect tax collection effort rather than simply increases tax revenue, which also include the impact of increases in the tax base. 3.24 The relative importance (weight) to be attached to each factor should be considered independently for each of the different grant programs and implemented only after an assessment of the effects of alternative distribution formulae on a representative sample of local governments. The reform of the grant system, including the application of these allocation factors, is being studied by an interagency working group in order to formulate specific short and long range reform proposals (see also paras. 4.54 to 4.56). C. The Role of Property Taxation 3.25 Unlike most countries where the property tax is controlled largely by local governments, the property tax in Indonesia is not strictly a local tax. Although parts of it are collected by local governments, the tax is administered by the central government, and revenues from the tax are considered "assigned revenues" to local authorities. The property tax is also of far less importance in local government budgets than is typical in other countries, where it is often the largest single revenue source, sometimes accounting for over half of local revenues. In Indonesia, it has accounted for less than 5% of total local government revenues over the last eight years. The importance of the property tax in many other countries suggests that there may be a similar, potential role for the property tax in Indonesia. 3.26 The property tax has gone through several stages in Indonesia. It was established as a land tax in the early 17th century by the Dutch colonial government. Following the end of colonial rule in the 1940s, the tax became a tax on agricultural income; in 1965 the tax was renamed the Iuran Pembangunan Daerah, or IPEDA, and was modified to a rental value base in order to be applied more easily in urban areas. More recently, the IPEDA has been replaced by a new capital value base tax on land and buildings, called the Pajak Bumi dan Bangunan, or PBB. 9/ Examples of possible quantifiable indicators of tax performance are presented in Chapter II, para. 2.15. - 58 - Reform of IPEDA: PBB 3.27 On December 27, 1985, the Government of Indonesia passed the Law of the Republic of Indonesia on Land and Building Tax (Law Number 12 of 1985). This law eliminated seven ordinances that included the IPEDA, the wealth tax (Pajak Kekayaan), and the household tax (Pajak Rumah Tangga), and in their place introduced the tax on land and buildings, or PBB. The main features of the PBB are that it is imposed on the capital market value of land and buildings, and that it is levied at a flat rate of 0.5%; in addition, there is a Rp 2 million exemption for buildings, and the official assessment ratio is set initially at 201 of market value, so that the maximum effective tax rate is at present 0.1% of market value (although there is flexibility in the law to increase the assessment ratio to 100%). The PBB is consistent with other recent tax reforms at the national level as it simplifies the rate structure at the same time that it broadens the tax base. The new tax law became effective on January 1, 1986, before many of the details of implementation had been determined. Regulations for the administration of the PBB have been issued since by the IPEDA Directorate, which is still responsible for the administration of the property tax. Although somewhat lower than budgeted, PBB revenues during 1986/87 still proved to be 58% higher than IPEDA revenues during 1985/86. *3.28 The PBB continues to use many of the procedures established by the IPEDA, particularly in the responsibility and practices used for the assess- ment and collection of the property tax. However, in many ways the PBB represents a significant improvement over the old IPEDA system. The base is expanded, the rate structure is simplified, the incentives for evasion are reduced, and penalties for nonpayment are increased. 3.29 Valuation, Collection and Distribution of Revenues. The responsibility for valuation continues to rest with the central government (specifically, the Directorate for PBB and its 39 regional offices or inspectorates). Although for the time being valuation under the PBB will mainly continue to be based upon the values used under the IPEDA, all properties are in principle to be revalued every three years, based on the sale value of the properties. This revaluation provision is extremely optimistic iven past experience with the property tax in Indonesia and elsewhere.- Nevertheless, accurate valuation is essential for the tax to be an equitable and productive revenue source. Assessed values under the IPEDA were in general much lower than actual market values. One study found that 10/ See, for example, D. Holland, 0. Olmand and D. Lerche, "Jakarta Real Estate Tax Study", 1972; D. Lerche "The Revenue Potential of the Land Tax for Urban Finance in Indonesia", in J. Wong, ed., The Cities of Asia: A Study of Urban Solution and Urban Finance, 1976; R. L. Jefferies, "The Design and Implementation of a System of Market-Based Urban Property Valuation in Surabaya," 1980; and Johannes F. Linn, Roger S. Smith and Hartojo Wignjowijoto, "Urban Public Finances in Developing Countries: A Case Study of Jakarta, Indonesia", Urban and Regional Report No. 80-7, World Bank, 1976. - 59 - assessed values were on average one-fourth of market value; there was also a wide dispersion of effective tax rates, which reflected great differences in the degrees of underassessment. As a first step, the Government intends to initiate, with World Bank-financed technical assistance, the individual valuation of the highest value properties in Jakarta and two other cities, as well as improvements in the mass appraisal index system. 3.30 Responsibility for collection of the PBB is unchanged from the IPEDA. The central government will continue to collect the tax from estates, forestry, and mining, while local governments will collect the rural and urban PBB. Giving local governments more authority in the administration of the PBB should be considered. Greater local discretion would likely increase incentives for collection. 3.31 The distribution of PEB revenues has been altered from the previous system of IPEDA allocations. Under the new law, 10% is allocated to the central government to compensate for the abolition of the other taxes (para. 3.27), 9Z is assigned to cover valuation, assessment and collection costs, 16Z is allocated to provincial governments, and 65X is given to level II governments. IPEDA revenues were supposed to be used by local governments for development expenditures. However, there are now no formal requirements for the use of PBB revenues. All PBB revenues are channeled through the central government budget. The rationale for the new distribution formula for the property tax is not entirely clear. First, the percentage received by the central and provincial governments are small in relation to the national and provincial budgets, and it would have been simpler and more logical to allocate all of the PBB to Level II local governments where it is of much larger significance. Second, regional differences in PBB revenue capacity and performance are not considered, so no incentives are provided for strengthening the collection effort. 3.32 Base of the PBB. The PBB has changed the base of the property tax from annual rental value to capital market value based on the sales value of the property. Property tax systems in many other parts of the world are tending to move toward capital value base, although many systems are blends of capital and rental value bases. In principle, capital and rental value property taxes are equivalent. However, in practice there are some advantages to the use of capital value. First, it is often easier to obtain information on capital value; sales data for similar properties can be used. In fact, rental value in some systems is calculated by first measuring capital value and then taking a fixed percentage (as was the case with IPEDA). Second, there is some evidence that capital value responds more quickly to economic growth than does rental value. Its use therefore increases the elasticity of the tax, although growth in property tax revenues will still require changes in the rate, base, or collection efficiency of the tax. Third, the capital value base reflects the potential development value of the property due to the capitalization of potential future value in the current base of the tax; in contrast, the rental value base may not reflect this capitalization. The base of the capital value property tax may therefore be greater than that of the rental tax. Finally, a capital value base may have more beneficial effects on the efficiency of land use, encouraging the development of underutilized and vacant land and discouraging the speculative hnlding of land. However, the latter is only likely with tax rates considerably higher than 0.12. - 60 - 3.33 Exemptions in the PBB. The PBB has reduced the discretion of officials in granting exemptions by making explicit the properties that are exempt from the tax. Property that is exempt includes nonprofit organizations, graveyards, protected forests, national parks, grazing land, diplomatic offices, and international organizations. There is some potential for taxation of government properties and future regulations will specify the treatment of these properties. In addition, all buildings are given an exemption of Rp 2 million. 3.34 Rate Structure of the PBB. The PBB has simplified the IPEDA rate structure by imposing a 0.5% tax rate on the capital value of land and build- ings. Under the IPEDA, collection officials were required to use several rate structures. The PBB also applies the same rate to all property; there is no concession for residential property. The advantages of a flat rate are several. The administration of the property tax is much easier when only one rate is used. There is also no incentive for avoidance of the tax by reclassification of properties, in order to take advantage of preferential rates on certain categories of property. Because ownership of property is concentrated in higher income classes, a proportional tax rate should maintain tax buye,ns that rise with income, if the burden of the tax is borne by the owner.- 3.35 Penalties. The PBB establishes clear deadlines for payment and well-defined penalties for nonpayment. Penalties include fines and imprison- ment, and the government continues to have the right to seize and to sell property to recover arrears. These sanctions are improvements on the IPEDA system, where deadlines and penalties were not clearly defined. However, penalties must be applied to be effective deterents to evasion, and the sanctions under the IPEDA, although weaker than the current ones, were seldom used. Revenue Potential of the PBB 3.36 With PBB revenues in 1986/87 accounting for only 46% of potential urban property tax revenues and 55% of total property tax revenues (as shown in Appendix 3, Section D), it is clear that there is ample room for improve- ments in tax administration. There are a number of obviouu requirements that must be fulfilled in the administration of a property tax. Properties must be identified and registered; they must be accurately valued; and tax liabilities must be assessed and collected in a timely manner, with penalties enforced for late or nonpayment. The first two steps require skilled tax personnel; the last requires the will to prosecute delinquents. Technical assistance and training are urgently needed to implement and maximize the yield from the PBB. Valuation training in particular is essential. Some initial steps 11/ For a discussion of the incidence of the property tax, see Johannes F. Linn, "The Incidence of Urban Property Taxation in Colombia", and Charles E. McLure, Jr., "The Relevance of the New View of the Incidence of the Property Tax in Less Developed Countries," both in A.W. Bahl, ed., The Taxation of Urban Property in Less Developed Countries, (1979). - 61 - toward the development of a valuation capacity have been made by the existing IPEDA administration. A training program has been in place since January 1986 that will eventually train 200 officers in valuation techniques. This program is a necessary first step. However, the level of training is still rudimen- tary and the scale inadequate, given that there are already 5 million urban properties and 28 million rural properties listed. A large-scale training program is clearly required, one that provides both short-term foreign assis- tance for immediate valuation and training and long-term permanent training programs in Indonesia and abroad. The initial focus of any valuation program should be on commercial properties in urban areas. There are substantial revenues that could be gained from accurate assessments of these properties. In view of the limited valuation experience within Indonesia, short-term foreign assistance in valuing commercial properties in urban areas would be well worth their immediate cost in terms of the revenues that could be captured. Over time, valuation could then be extended to other urban and rural properties. A number of complementary organizational and administrative steps are now being undertaken to improve both the valuation of properties and the efficiency of tax administration. These include (a) the separation of the valuation function from tax administration; (b) improvement of taxpayer coverage and registration; (c) computerization of tax assessments or bills; and (d) improvement of the collection and enforcement system. Technical assistance in these areas has been obtained to ensure full implementation of the PBB. The World Bank-financed Urban Sector Loan is supporting GOI's efforts to improve property tax administration through two components of technical assistance, one for tax administration and the other for property valuation, cluding training of valuation personnel. As can be seen in Table 3.4 l the payoff of improved tax administration can be quite significant, with property tax revenues by 1990/91 40X higher than those obtained if no improvement in tax administration is pursued. 3.37 Besides improvements in tax administration, PBB's revenue potential could be further increased by changing its current low effective legal tax rate. At 0.1% this rate is among the lowest in the world. In the Philippines, for example, the effective legal rate ranges between 0.4% 1.4%. In Thailand and India, the rates are respectively 0.8% and 2.6%. In fact, if the property tax is to become a productive local revenue source, it is essential that consideration be given to increasing the effective tax rate. At first this can be achieved by increasing the official assessment ratio; only after this has reached 100%, would change in the statutory tax rate be required. It should nevertheless be clear that an increase in the effective legal tax rate should not be considered by government as a substitute for improved tax administration. It is only after significant improvements in tax administration are achieved that the government should start changing the effective legal tax rate. Table 3.4 illustrates the case where the official assessment ratio increases to 30% in 1988/89 and to 40% in 12/ The methodology as well as assumptions underlying the figures in this table are set out in Appendix 3, Section D. 13/ See Kelly (1986), op. cit. Table 3.4: PROPESRTY TAX: ESTIMATED REVENUE WITH AND WITHOUT AN INCREASE IN OFFICIAL ASSESSMENT RATIO (Rp billion) 1986/87 1987/88 1988/89 1989/90 1990/91 Reve- Z of Reve- Z of Reve- X of Reve- I of Reve- Z of nue GDP nue GDP nue GDP nue GDP uue GDP Wlthout Increase in O.A.R. /a Scenario I: Without enforcement 243.7 0.24 261.1 0.24 279.8 0.23 299.8 0.23 321.2 0.24 Scenario II: With enforcement 243.7 0.24 275.6 0.25 321.7 0.27 385.2 0.30 444.9 0.33 With Increase in O.A.R. Scenario III: Without enforcement 243.7 0.24 261.1 0.24 419.6 0.35 449.7 0.35 642.5 0.47 Scenario IV: With enforcement 243.7 0.24 275.6 0.25 482.6 0.40 577.8 0.45 889.8 0.66 /a O.A.R. - Official Assessment Ratio. In Scenario I and II, it remains at its present level, i.e. 202. - 63 - 1990/91. Together with improved tax administration, this option would lead to more than a three-fold increase in property tax revenues in four years time. D. Local Government Taxes 14/ 3.38 Local governments impose nearly one hundred taxes. Few of these taxes are individually very significant in local finances, and even in the aggregate, local taxes constitute a small proportion of total local government revenues. Level I governments collected Rp 293 billion in tax revenues in fiscal year 1983/84, which was only 15% of total routine revenues and 12% of total current ard development revenues. For level II governments, local taxes were Rp 45 billion in 1983/84, or only 7Z of current and 4% of routine and development revenues combined. Local tax revenues are extremely low in per capita terms, amounting to less than Rp 1,900 per capita for level I in 1983/84, and Rp 300 per capita for level II. It is clear that local govern- ment taxes currently generate very little revenue. As a result, and as part of the effort to increase local resource mobilization, greater utilization of existing and potential local tax sources has been declared a central goal of government policy. level I Taxes 3.39 Table A4.6 in Appendix 4 describes the structure of provincial revenues. Provincial governments derive the bulk of their tax revenues from only two taxes, both of which are related to vehicle use. The more important of these is the Bea Balik Nama atas Kendaraan Bermotor (BBN), which accounted for 51% of total provincial tax revenues in 1983/84. This is a transfer tax that is levied upon the value of a vehicle at the time of a change in ownership. The assessed vehicle value is based upon valuation tables that are prepared by the Ministry of Home Affairs. The tax rate is 10% for the first transfer and 5% for each subsequent transfer. Government vehicles are exempt from the tax. Motor car transfer duties have grown steadily in recent years, especially in DKI Jakarta where nearly 20% of all vehicles in Indonesia are registered. Revenues from this source increased in real terms, between 1978/79 and 1983/84, 11.1% p.a. for all provinces or 9.2% p.a. if DKI Jakarta is excluded. The variation in tax revenue by province has been substantial (see Appendix 4, Table A4.7). Jakarta raised by far the most taxes, at Rp 6,669 per capita; Kalimantan Timur ranks second (Rp 2,174 per capita), followed by Riau (Rp 1,881 ;,er capita) and Sumatera Utara (Rp 1,081). All other provinces generated less than Rp 1,000 per capita in 1983/84. 3.40 The other major source of level I tax revenues is the Pajak Kendaraan Bermotor (PKB), which yielded 36% of level I revenues in 1983/84. The PKB is an annual license fee on motor'zed vehicles. It is based upon the 14/ The most updated information available for the analysis presented in this Section goes only up to 1983/84. As there have been no changes in local government taxation during recent years, the conclusions derived from the analysis seem to be robust. The information is presented in Appendix 4, Tables A4.6 to A4.18. - 64 - age of the vehicle and the size of the engine. The rate structure is determined by the Ministry of Home Affairs, and is updated periodically to reflect changes in market values. The rates are the same in all provinces except DKI Jakarta, where a slightly different structure is allowed. The license fee is roughly equivalent to a 2% to 3% tax on the value of the vehicle. This tax has a number of positive features. It can be administered and collected at low cost. Because vehicle ownership is concentrated in higher income classes, it is a progressive tax. The PKB can be considered, to some extent, a user charge (see para. 4.59). And, finally, the tax is likely to reduce (at least marginally) problems arising from extensive vehicle uqe in Indonesia, such as congestion and 'ollution. Like the transfer duties, PKB revenues have grown steadily in nearly all provinces (on average 7.7% p.a. in real terms between 1978/79 and 1983/84) and substantial variation in tax revenues has been observed (with only DKI Jakarta, Kalimantan Timur and Riau generating more than Rp 1,000 per capita in 1983/84). Level II Taxes 3.41 Second level governments impose a wide range of taxes, but, like provincial governments they obtain most of their tax revenues from a limited number of taxes. As can be seen in Table A4.10 in Appendix 4, 76% of total level II tax revenue is derived from only four taxes: the entertainment tax, the restaurant and hotel tax, the street lighting tax, and the business registration tax. Other taxes include the tax on non-motorized vehicles (Pajak Kendaraan Tak Bermotor), the advertisement tax (Pajak Reklame), the slaughter tax (Pajak Potong Hewan), the foreigners tax (Pajak Bangsa Asing), the radio tax (Pajak Radio), the liquor tax (Pajak Minuman Keras), and the dog tax (Pajak Anjing). In total these other taxes generate little revenues, although they may be important in specific localities. It seems likely that in some cases these taxes cost more to collect than they yield in revenues. Of all level II governments it is clear that kotamadyas rely most heavily upon local taxes. On average, total local taxes represent 14% of total revenues in the fifteen largest kotamadyas in Indonesia (see Appendix 4, Table A4.14). 3.42 The most important level II tax is the entertainment tax, or Pajak Tontonan, which provided about one-third of total level II tax revenues in 1983/84. The entertainment tax is imposed as a specified percentage of theater and cinema tickets; local governments have some discretion in the choice of tax rates. Case studies in a number of regions indicate that tax collections are often below what might be expected, thereby suggesting considerable evasion. Collection costs appear to be relatively low compared to most other taxes. The entertainment tax is unlikely to have any major effects on behavior given its lov0 rates. It is also likely to be progressive s.nce expenditures on entertainment would tend to wise with income. The bulk of the revenues from the entertainment tax are generated in urban areas, and the revenues have grown steadily from 1978/79 to 1983/84. 3.43 The second largest level II tax is the Pajak Pembangunan I, or the restaurant and hotel tax. In total, this tax accounted for nearly one-fourth of level II tax revenues in 1983/84. This tax is imposed at a flat rate on the turnover in restaurants and hotels. The rate is 5% in tourist areas and 10% elsewhere, with no local discretion in the choice of the rates. Case - 65 stucies E so: me rsgi vgest twat evasion and collectiost v!ists are sub.;tAn;.il tax w ..;, for smaller restaurants and hoteis are often base-d ca t -- 't ' bet' ,ti tax officials and ewne-s. The tax has increased rapvt1y in < -rs, witht the bulk of the tax cldlected in urban and tour:st at-ai. 3.44 The street li' cax (Pajak Penerangan Jalan) has been the fastest growing level .. in recent years, and c',uld well be the largest level II tax source by no t accounted for 10% st t:otal level II tax revenues in 1983/84). Local governm!nts have subst%mitial discretion in the selection of tax rates and bases, and there is much variation in the form that this tax takes in specific localitiee. In some case-i the tax is a fixed annual sum on individual users. Mote typically, the tax is levied either upon individual consumption of electricity or upon instaUled power capacity. The tax rates are on average ro..ghly equivalent to a rate of 1% to 1.5% of elec- uricity sales. The tax is collected by the power company as part of its regular customer billing, with a collection fee in tile range of 5-10% of gross collections. 3.45 Another major tax source for second level governments is the busi- ness registration tax, known as the Pajak Perusahaar in some areas and the Pajak Pendaftaran Perusahaan in others. This tax is levied with substantial local discretion upon most businesses. The tax base is some physical charac- teristic of the business, such as the area of the pramises or the amount of power capacity, and the rate structure is typically progressive, increasing with the area and power capacity of the enterprise. The business registration tax is open to criticism on several grounds. Because the base of the tax is a r,hysical feature of the business rather than value, increases in revenues are ..ot automatic, and require some discretionary changeN in policies. Evasion of fhe tax is thought to be high, perhaps because payment of the tax is not a criterion for business registration. At its current low levels, it is unlikely to have a significant effect upon business decisions. 'Lncreasing Local Tax Revenue ^.46 A central conclusion of the above discussion is that local govern- -ients in Indonesia generate very little local tax revenues. In view of local ;overnments' responsibility for the provision of services (especially evel II) major efforts must be devoted to increase locally generated tax -evenues, though it is important to note that with the possible exception of ,he largest Kotamadyas, local tax revenue contributions will remain quite low .n relation to expenditure responsibilities. The broad options available for increasing local tax revenues are: (a) to utilize more effectively the existing local taxes; (b) to reform the local tax system; and (c) to introduce new local taxes. 3.47 Utilize Existing Taxes. There is substantial scope for increasing local tax collections in Indonesia by more efficient tax administration. - 66 - Yields are frequently low and collection costs often exceed 30% of tax revenues, even for the major taxes. 3.48 Locei tax administration is often deficient in three broad areas: registration oi taxpayers, assessment of tax liabilities, and collection of revenues and arrears. For example, on registration, there is no regional government that has a master list of all taxpayers with identification numbers assigned to each taxpayer. Each major local tax usually has its own separate taxpayer registry and there is little coordination between the staff of the separa.e tax units. In these circumstances, it is possi'le for a taxpayer to register a different name with each tax office, and there is no way of detecting this. Consequently, the local tax office has no clear idea of the total number of taxpayers in its jurisdiction and the total liability of each taxpayer. Assessment of tax liability is also problematic. Because there is no unique taxpayer identification number for all taxes, it is not possible to use information from one tax in the assessment of another. This is an important limitation when heavy reliance is placed upon self-assessment. It also appears that the information upon which assessments are made is often old and does not reflect current conditions. Collection of arrears is particularly deficient. There is often no fixed due date for payment of taxes, so that the taxpayer is never legally delinquent. For example, when a taxpayer's account appears unpaid, up to three reminders are sent; if the tax is still not paid, the reminders are then sent again. Seizure and sale of assets are rarely used, though the use of fines is more common. 3.49 In an attempt to remedy some of these administrative deficiencies, a new tax registration, assessment, and collection system was introduced on i pilot basis in six cities under the World Bank financed Urban IV project.- Under the pilot program a standardized organizational system will be used in all localities. The tax office will be reorganized along functional lines. Rather than have a separate staff for each tax, there will be one registration section that is responsible for registration of all taxpayers for all taxes; there will also be one assessment section in charge of all tax assessments; and there will be a section that is responsible for collection, another for enforcement, and another for planning. In all, there will be five sections in the reorganized tax office. Each taxpayer will have a unique identification number to be used for all taxes, and firm due dates for payment of taxes are planned, with setzure and sale of assets if taxes are not paid. 3.50 The reorganized administrative structure along functional lines is likely to improve local tax administration. Nonetheless, the system still relies too heavily on self-registration and self-assessment and too lightly on auditing and cross-chec.ing tax assessments with additional information. Efforts need to be made to ensure that all taxpayers are registered and that tax liabilities are properly assessed, on the basis of current, accurate information. It is important, therefore, to critically evaluate the 15/ The six cities are Banjarmasin, Denpasar, Padang, Palembang, Pontianak and Samarinda. - 67 - implementation and revenue impact of the reorganization, and to determine ways in which the approach may be improved. 3.51 Reform the Local Tax System. A second element in improving the local tax system is to reduce the number of taxes that are levied by level I and II governments. As described before, despite the presence of nearly one hundred taxes at levels I and II, few of these taxes are productive in terms of revenue. Taxes on motor vehicles account for 90% of level I tax revenues (97% if DKI Jakarta is excluded), while only four taxes at level II account for move than 75% of total level II tax revenues. Elimination of the less productive taxes would serve three purposes: it would reduce the distortions and misallocations caused by the presence of the taxes; it would reduce the costs of collecting and administering a large number of taxes; and it would allow local officials to redeploy their personnel so as to focus more of their efforts on those existing taxes that have been shown to be productive revenue sources. 3.52 The Government has initiated such changes in a draft local tax law which, if enacted in its present form, would eliminate all level I and II taxes except the following: (a) tax on motorized vehicles; (b) motor car transfer duties; (c) tax on non-motorized vehicles; (d) entertainment tax; (e) restaurant and hotel tax; (f) business registration tax; (g) advertisement tax; and (h) street lighting tax. The first two taxes are to be retained by provincial governments, and the next six are to be kept by level II governments. The slaughter tax may also be retained. Local governments would be given some limited discretion on the choice of the tax rates and bases. 3.53 While precise estimates of the immediate revenue loss from this simplification are not available, based upon 1983/84 revenue data, the loss appears to be small. Provincial governments (excluding Jakarta) would lose only Rp 6 ILllion, or 3% of total level I taxes. The revenue loss for level II governments would be slightly larger: RF 7 billion, or about one- sixth of total taxes. However, it should be remembered that the growth rates of the taxes to be eliminated have generally been much lower than the retained taxes. The buoyancy of the reformed tax system should increase. This, together with the more effective administration of the remaining taxes will allow the lost tax revenues to be recovered. Based on simple extrapolation of past trends in tax collections, Appendix 4, Tables A4.17 and A4.18 present revenue projections with and without local tax reform, for level I and level II taxes. They show that the elimination of the minor and unproductive taxes is not likely to have a significant impact on overall collections. In fact, removal of the minor, nuisance taxes may allow even faster actual growth than is indicated by the forecasts, if personnel freed by such streamlining can be more efficiently used elsewhere. 3.54 Introduce New Taxes. In addition to eliminating many unproductive taxes, the draft law on local taxes suggests the introduction of two new taxes for level II governments: a fuel tax and a betterment tax. The fuel tax is a tax on the consumption of fuel. It could be an extremely productive revenue source and it would be easy to collect. It is important, however, that in the design of the fuel tax (i.e., its rates and distribution among the different fuels) the long-term objective of rationalizing petroleum product prices is - 68 - considered, thereby ensuring that the prices of the various petroleum products reflect their opportunity cost to the country. Bearing this objective in mind, the fuel tax not only represents an attractive revenue source but offers the opportunity to reduce a serious distortion in the relation between current diesel and gasoline prices1gv the retail level. As discussed in the recent World Bank energy report, _ given the current crude oil price of about US$18 per bbl, the domestic retail price of gasoline is 51% above international prices, whereas diesel prices (both ADO and IDO) are 30-40% below their international parity price. Raising the retail price of ADO and IDO to.their international level (which could be accomplished with a 40% sales tax on 7DO and a 34% sales tax on IDO) therefore would not only generate revenue, MDO about Rp 650 billion p.a., but would also encourage the more economical use of fuel by consumers. Opportunities for the more economical use of fuel exist through the improved maintenance of diesel vehicles (with attendant reduction in air pollution) and industrial equipment, the substitution of diesel use by fuel oil, gas, coal or waste materials (e.g., woodwaste, bagasse, rice husks, etc.) in industrial boilers, and the substitution of diesel use for power generation in grid-supplied areas where PLN can generate electricity more economically with hydro, coal or gas. Finally, as part of the related local government revenue could be assigned for road maintenance, the tax could also be considered a user charge (see Chapter IV, para. 4.59). The incidence of such a tax on public transport costs is likely to be small, as fuel costs amount to only 10-15X of operating costs. On all basic criteria for a desirable tax--efficiency, equity, ease of administration, and yield--che diesel tax measures favorably. 3.55 The betterment tax is a tax on the increase in land values that results from new urban infrastructure. It is a way of recovering the costs of urban development from those who benefit via increased land values from the projects. The betterment tax is an attractive tax source for local governments. It is common in many South American countries. It has alsc been used in DKI Jakarta, where it is called the Pajak Khusus; however, its use in Jakarta has been on a small scale. The betterment tax is in principle levied upon the increases in land values that result from urban infrastructure projects. It can be an equitable tax, since those who benefit from develop- ment pay for the development costs. It can also be a productive revenue source, as seen from the example of Colombia, where it has financed a substan- tial part of project costs. Its main difficulty lies in its administration and cost of collection. Effective use of the tax requires accurate land valuation before and after the project, and prompt notification of landowners of their liabilities; failure to do the latter seems to have been the main 16/ Indonesia: Energy Options Review, World Bank, Report No. 6583-IND, August 25, 1987. 17/ The issue then becomes one of dividing this revenue between local governments and Pertamina. An option would be for Pertamina to simply recover its cost of production including an allowance for a margin (this would in turn eliminate the current budget subsidy) and local governments to receive the residual. - 69 - problem with the Pajak Khusus. Administration of the betterment tax therefore requires a properly functioning property tax. Because extensive improvements are required in property tax administration, wide-scale implementation of a betterment tax is not likely in the immediate future. Nevertheless, its use should be encouraged in the medium term. E. Other Sources of Financing for Local Goveinments User Charges 3.56 Analysis of the role and significance of user charges as a source of region8a revenues is complicated by the lack of comprehensive and detailed data,- as well as a lack of consistency in their treatment between regional budgets. User charges under the responsibility of the local tax office should be recorded as "retribusi" in the regional budget, while collections undertaken by departments responsible for running particular services should be recorded as "income from dinas-dinas". In practice, a charge classified under "retribusi" in one region may be included under "dinas income" in another. 3.57 If "retribusi" and "dinas income" are taken together to represent the total level of regional charges, it is clear that for level II governments as a whole, charges are the largest category of locally-generated income. In 1983/84 they produced twice as much income as local taxes (see Appendix 4, Table A4.19). In urban areas the ratio of user charges to local taxes is lower, though charges are still very significant, generating roughly the same level of income as that from local taxes. For provinces, however, income from such charges is much lower, both in absolute terms and in relation to revenue from local taxes (provincial retribusi and dinas income produced only some 12Z of the yield from provincial taxes in 1983/84). Data for 29 Kotamadyas (Appendix 4, Table A4.20) indicate, as in the case of local taxes, wide variations in per capita user charge revenues ranging from around Rp 1,000 to Rp 7,700 in 1983/84 (only five cities exceeded Rp 4,500). 3.58 Current law and regulations require provincial approval of proposals for charges and charge rates made by second level regions, and the approval of the Ministry of Home Affairs for provincial charges. For second leveL regions these controls are less onerous than those covering local taxes, which could account in part for the proliferation of small charges. The most significant user charges overall are probably those for water supply, as well as charges for markets, hospitals and health clinics, solid waste collection and disposal, parking, bus stations and taxi stands, building permits and the supply of official documents. However, there are many others; a Ministry of Finance questionnaire seeking to compile information on budget realizations for all regional governments lists 27 specific types of charges. Field studies undertaken for the Government at various times have indicated that many charges are set at a relatively low level and cost a great deal to 18/ As in the case of local government taxes, the most up-to-date information on user charges goes only until 1983/84. - 70 - collect, as is the case for many of the smaller regional taxes now proposed for abolition. 3.59 The Ministry of Home Affairs is currently considering legislation which will differentiate charges into three categories: (a) "Licenses" - items for which charges are levied but for which no direct service is rendered by the regional governments (examples are charges for building permits and for sand and gravel extraction), which would be covered by regulations restricting the activities which can be licensed and prescribing maximum fees; (b) "Rents" - fees for the rental of regional assets such as vehicles and buildings; and (c) "Service charges" - continuing the present approach in which regional governments have wide discretion on the levying of charges, subject to the approval of the provincial governor in the case of second level regions, or of the Ministry of Home Affairs in the case of provinces. Although the proposed legislation (which is now expected to be combined with the local tax reform mentioned in para. 3.52 above) is commendable as a first step in rationalizing local user charges, to be effective in increasing their role as a source of locai government revenue it needs to be supported by a program which includes: (a) the collection of comprehensive information on the role of all local charges from first and second level regiuns; (b) the formulation of guideliies on items which are appropriate for charges, including advice on possible charge levels (while not imposing too many restrictions on authorities' freedom to raise charge levels), as well as directives for their regular revision to ensure that income from this source grows sufficiently to cover the costs of providing services (field studies have shown that in some regions charge levels have not been raised fcr many years); (c) the specification of cost accounting and administration standards to improve financial administration of charpes, including costing of services for which charges are made, organization and costing of collection arrangements, and rationalization of the present budgetary and accounting treatment for charges, so that revenues, service costs and collection costs can be clearly related with one another, to assist both policy decisions and financial control; and (d) the use of surcharges on well-established tariffs (e.g., water tariffs) for related services, so as to avoid duplication of collec- tion efforts and the proliferation of small charges (surcharges on water tariffs are already being considered in Surabaya and Bandung for solid waste services and sanitation and drainage respectively). - 71 - None of these measures will necessaril:" require new legislation, &l,though some modifications to existing Ministerial regulations may be needed. Loan Finance 3.60 The aggregate contribution of loan finance to regional governments' total resources is presently very small (para. 3.12). Regional governments have the power to borrow subject to the agreement of the Minister of Home Affairs. Nevertheless, most borrowing is confined to particular central government-sponsored loan schemes for certain types of projects (generally revenue-earning activities such as water suppiy enterprises and markets). The terms of these loan schemes vary widely, some being very "soft" (indeed zero interest), while others are relatively "harder," although still considerably below domestic market rates. In addition to these loan schemes, a number of regional governments (largely Kotamadyas) have borrowed funds through Subsidiary Loan Agreements for donor-financed projects. 3.61 Data on loans to regional governments (and their enterprises) from various sources over the period 1976/77 to 1985/86 is sunmmarized in Appen- dix 4, Table A4.21. Total borrowing from all sources during this period was about Rp 610 billion. The largest loan scheme appears to be the INPRES Pasar program, which had lent about Rp 180 billion to regional governments for market facilities up to 1983/84, but with no new loan commitments in the following two years. Loans to regional governments for equity investments in their enterprises (primarily for water supply enterprises or PDAMs) amounted to nearly Rp 100 billion over the period. While foreign loan funds passed on to regional governments for urban development projects (mostly to the largest Kotamadyas) totalled about Rp 119 billion through 1985/86. 3.62 Regional governments tend to regard loans as an exceptional means of finance for special projects only, rather than as a normal means of financing a part of their development spending requirements. The current loan schemes suffer from a number of shortcomings: (a) the existence of rigidly earmarked soft loan schemes can lead to overinvestment in some sectors (e.g., the zero percent; loans provided through the INPRES Pasar program have probably led to the construction of unnecessary market facilities in some regions);= (b) soft loan terms do not encourage the setting of service charges at realistic levels and make it impossible to raise nongovernmental funds, thereby perpetuating the dependence on the central government budget; 19/ Sectoral cost recovery and user fee issues are discussed further in Chapter IV (see paras. 4.58 to 4.63). 20/ In Ujung Pandang, for example, only 5,000 market stalls, out of a total of 7,000, were occupied and paying rents in 1986. - 72 - (c) individual projects for loan finance are poorly evaluated; and (d) there is no general source of loan finance for local government projects which have significant future benefits and could therefore ensure service of the loans from associated future local revenues. 3.63 With the present constraints on central government grant finance and the prospect of a continuing scarcity of such funds, access to a reliable source of loan finance will become increasingly important for regional govern- ments in order to maintain overall development spending. This is particularly the case for projects which have significant future benefits and could there- fore be financed from loans, to be serviced from associated future local revenues. The establishment of a consolidated central source of loan finance for use by all regional governments (lending with a consistent set of terms and conditions, including realistic interest rates, and appraisal of loan projects in accordance with standard criteria) is therefore strongly recom- mended. Such a "Regional Government Loans Fund" (RGLF), as it has come to be known in Indonesia, could begin by maintaining the aggregate lending volumes of recent years (some Rp 80 billion per year) but should eventually mobilize additional resources to substantially expand regional loan finance from its existing levels, and should subsume the present array of small loan schemes. 3.64 A study carried out for the Ministry of Finance-li has suggested the broad objectives and requirements for a RGLF with funding from a mixture of domestic and foreign donor funds. The main objectives for such a fund would include the following: (a) to provide an accessible source of loan finance for local govern- ments, in order to: (i) facilitate more rapid development of infra- structure and services at the local level; (ii) promote the accepta- bility of loans as a aormal source of development project finance, along with grants and local revenues; (iii) encourage the mobiliza- tion of local revenues, and cost recovery through user charges; and (iv) make the best use of the available finance by encouraging thos' who can afford to borrow to do so for at least part of their devel- opment program, while channeling grant resources largely to poorer local governments; (b) to rationalize the present complex pattern of loan financing schemes for local development projects; (c) to provide loans on common terms for all types of development projects, and thertby to apply a measure of economic and financial discipline in project selection; 21/ Brian Binder and Nick Devas, "Analysis of the Proposal to Establish a Regional Government Loans Fund," Institute of Local Government Studies, University of Birmingham, UK, February 1986. - 73 - (d) to provide a standard mechanism for channeling donor loan finance to local governments, and for providing counterpart finance; (e) to provide loan finance through a system which encourages comprehen- sive planning and programming of a region's development, in the light of overall financial resources (grants, loans and local revenues); and (f) in the longer term, to provide a mechanism for mobilizing capital market or private sector finance for local government development programs. 3.65 The study also identified a possible need for loan-linked grants to regional governments to complement loans from the fund, since many of these governments might not be able to afford to finance all projects fully from loans (at the level of interest rates which would be necessary to ensure fund viability). This issue would have to be studied further and resolved in the context of the reform of the grant system (see paras. 3.22 to 3.24). However, it is important not to undermine the objectives of the RGLF through interest subsidies. It will be more effective to allocate grant funds to local governments separately from the RGLF, according to the criteria discussed in Section B and allow those governments who are willing and able to borrow from the RGLF to do so. The issue does, nevertheless, clearly indicate the need to closely coordinate the grant, DIP and loan systems to ensure balanced allocation of funds to local authorities. 3.66 The objectives of the RGLF (para. 3.64) now appear to have been accepted by GOI which has decided to pursue a phased approach, beginning with the establishment of a special account, the Regional Development Account (RDA), into which debt service repayments from some existing regional borrow- ings are to be paid. The RDA will serve as the starting point for the establishment of a central loans facility on a revolving funds basis. The development of the policy framework of the RDA as well as its operationaliza- tion are being assisted by consultant services financed by GOI and UNDP as part of the Urban Sector Loan. 3.67 With regard to the operation of the RDA and the evenutal RGLF, it is recommended that: (a) the RDA/RGLF should have consistent (possibly uniform) lending terms and conditions for all projects, charging an interest rate suffi- cient to assure its long-term financial viability; (b) the RDA/RGLF should confine itself exclusively to lending to regional governments for eligible projects; (c) the RDA/RGLF should be a separately accountable entity in a financial sense, keeping its own full set of accounts and producing a formal annual report and financial statements; and (d) a detailed analysis be undertaken of the portfolio and outstanding debt balances of the existing loan funds, to determine the expected repayment flows and their contribution to the capitalization of the RDA/RGLF. - 74 - CHAPTER IV GOVER2MENT EXPENDITURES: A FOCUS ON OPERATIONS AND MAINTENANCE IN INDONESIA A. Introduction 4.1 If the Government of Indonesia has been more successful than many other countries in the scale and pace of its development efforts, it has experienced a problem which is common throughout the developing world: namely, inadequate funding and implementation of operations and maintenance activities in the public sector. This is not to suggest that all essential services are deficient or that all major infrastructure in the country has been allowed to deteriorate visibly and rapidly. However, after two decades of a massive investment program there is increasing evidence that operations and mainte- nance (OUM) receives inadequate attention with very real economic consequences for the productivity of public sector programs and infrastructure. The importance of O&M has been recognized as recently as the President's budget speech in early 1987. 4.2 This Chapter discusses the so-called "O&M problem" in Indonesia, beginning with an overview of relevant economic policy issues and estimates of actual shortfalls in O&M expenditures (Section B). It examines the nature and causes of the O&M problem in five key areas: roads, irrigation, urban infra- structure, higher education and health (Section C); discusses planning and budgeting procedures, including fiscal relationships between different levels of Government, which affect efficient handling of O&M (Section D); and suggests a strategy for action in addressing the O&M problem (Section E). B. The Economics of Operations and Maintenance 1/ 4.3 In developing a policy toward O&M, several obvious questions arise. Should one pursue a strategy of routine and periodic maintenance of infra- structure? Or, instead, should one deliberately defer maintenance expendi- tures and accept the eventual need for frequent, and perhaps more costly, rehabilitation in the future? What is the appropriate level of operational outlays for a program? What priority should be assigned to operations as distinct from maintenance? How do the economic returns to O&M compare to those for new investments or a program of rehabilitation? What are the O&M implications of new investments? Should one borrow for rehabilitation projects? How large is the O&M problem? 1/ For the purpose of this Report, O&M is defined as the operations and maintenance activities associated with the provision of public services (e.g., irrigation, education, health). An overview of the economics of O&M and the related analytical framework used in this Chapter is presented in Appendix 5. Although this Section provides a brief summary, the interested reader is encouraged to read the more detailed Appendix. - 75 - 4.4 Formulating a Strategy. O&M choices begin 6ith relatively straight- forward questions about how long it will take an asset to deteriorate without maintenance or the impact of operational inputs on output. The final choice must be economic and based on the evaluation of costs and benefits. How do the costs of providing O&M, compare with the immediate benefits (such as initially higher output or services) and the longer-run benefits of deferring expensive rehabilitation and extending the normal economic life of an asset or program (thus prolonging the stream of benefits of the same assets as long as possible)? Answers to these questions will vary with the nature of the sectoral assets and programs involved, the extent of knowledge and public resources available, and the importance one attaches to future benefits. If current financial circumstances are tight, a strategy of deferred maintenance may be the most logical solution, but one must be aware of the economic consequences of a failure to provide O&M. 4.5 How Much Should be Spent on Operations? Expenditures for operations not only affect the current level of production or services offered, but also sometimes determine the rate of depreciation of a capital asset, and hence its potential for subsequent production. This "production function" will of course vary enormously across a range of public services. In actual practice, decision-makers have limited information and are not always able to apply cost-benefit analysis. As a result, they may establish "norms" for certain facilities or services, which have been known to yield acceptable results. However, these norms may themselves become important policy issues, as they are very sensitive to current budget constraints, the cost of inputs, the potential for user charges, sector objectives and the nature of the "produc- tion function". Such "norms" are usually an acceptable compromise, but they make it very difficult--in periods of fiscal retrenchment--to assess the benefits of shifting resources for operations within or between sectors. All they allow is a reasonable sense of likely outputs for a specific level of spending. 4.6 How Much on Maintenance? Proper maintenance brings immediate and future benefits by enhancing current productivity and retarding the deprecia- tion of assets. "Routine maintenance" is meant to protect the usefulness of infrastructure and assets in given circumstances (e.g., rate of use, patterns of operation, and climate). "Periodic maintenance" addresses actual break- downs (such as malfunctioning equipment, potholes, etc). "Rehabilitation" corrects major problems and wear-and-tear so as to restore a facllity to good working condition. 4.7 These different forms of maintenance should be complementary and self-reinforcing, as each on its own will have limited benefits. In parti- cular, deferred maintenance is usually less productive than prompt corre tion of emerging difficulties. Indeed, once a physical facility has been allowed to deteriorate beyond a certain point, both routine and periodic maintenance may prove of little value. Once an asset reaches this stage, the only choice may be to rehabilitate it entirely or provide only such minimal maintenance as to ensure that it has some minimal value at all (e.g., ensure that a road is not entirely impassable). Current failures to maintain infrastructure will render future maintenance less productive and of lower value. - 76 - 4.8 As with other kinds of expenditure, as important as the amount of money spent on maintenance is the efficiency with which it is used. In planning programs of maintenance, attention must be paid to possible administrative leakages of funds or inappropriate maintenance technologies. 4.9 The Balance Between Operations and Maintenance. The two "halves" of OEM are obviously interdependent: the greater the use of infrastructure, the more rapid its deteriocation, and the greater the need for maintenance. The quality of operations will also affect the functioning of infrastructure and its tendency to wear-and-tear. While operations can be relatively "independent" for a short period of time--that is, the lack of maintenance may not reduce productivity immediately--a balanced approach will be most cost- effective over the medium term. Failure to provide maintenance may not reduce the short-run productivity of operational inputs but in the medium term, deterioration in plant and equipment may seriously impinge on the quality and quantity of public output. 4.10 Despite this obvious need for balance between the two, there is often conflicting pressures that lead to a bias as between these aspects of O&M. Skimping on operational inputs to a sector may have less visible conse- quences than the decline of basic capital stock. For example, a pothole- filled road or silted-up irrigation canal may receive more public, and hence C,overnment, attention, than reduced output in the education and health sectors, where the effects are more subtle or private, in the form of limited learning, higher morbidity and mortality, and lower productivity from labor. The output lost may be less visible but it it still real and important. Or the other hand, it is often easier to cut back on materials and supplies than employment, and this may affect maintenance more adversely. 4.11 Design Standards and Maintenance. As all assets deteriorate, a critical investment issue is the design standard of the original construction. In planning new facilities or services, the choice of a lower quality of desigf ill usually have two important consequences. It wail entail a higher rate o~. depreciation (and hence earlier need for rehabilitation) and it will make routine and periodic maintenance all the more important. 4.12 New Investments vs. Rehabilitation. While both new investment and rehabilitation have the same noriinal effect, in increasing the public sector's aggregate capital stock, the former adds to the stock c infrastructure needing maintenance. and the latter strengthens the quality of existing facilities, without necessarily increasing the overall need for maintenance. As in other aspects of the O&M question, choices must depend on the net present value of additional schools or roads compared with the foregone benefits arising from failure to prevent the deterioration of existing capital assets. 4.13 The same reasoning applies to possible borrowing decisions in this area. Like any investment, rehabilitation will have low or high returns, and these can be measured. The choice may be to introduce public facilities, where there were none before, or to upgrade existing ones which have failed to function altogether or to operate efficiently. The source of funding for such investments is less important than the comparison of net benefits involved. - 77 - In either case, one must make realistic assumptions concerning the design standard to be implemented, and the level of maintenance likely to occur. If the priority attached to maintenance remains low, the likely returns to rehabilitation will be less. 4.14 The "Payoff" to OEM. There are few quantitative estimates of the rate of return to adequate O&M in Indonesia; however, the few analyses avail- able suggest that it is high. For example, recent World Bank studies in the irrigation sector suggest an expected rate of return to efficient O&M of 117% in Java and 90X off Java, and a rate of return to special maintenance projects of 31% in Java and 26X outside Java. These studies have also confirmed the direct relationship between levels of O&M expenditures and the economic lives of projects. In the transport sector, recent studies indicate that Rp 250 billion in specific road improvements would reduce vehicle operating costs by about Rp 3.2 trillion: a return of Rp 13 for each rupiah expended. The equity and employment benefits of proper O&M may also be considerable. The poor are more dependent than others on effective health and education services, and O&M activities in the public sector tend to be more labor-intensive than other economic activities. 4.15 How Large is the O&M Problem in Indonesia? It is not easy to quantify the results of past neglect or conservatism in O&M policy. However, policy-makers are obviously interested in the overall size of t12 current "problem". How much resources are required to meet current shortfalls in spending? Can these needs be met through cutbacks in other budget areas or satisfied only over a longer period of time? 4.16 In trying to answer this question, an important caveat is in order. Undertaking O&M is not simply a matter of adequate financial resources. It requires the development of an institutional capacity for planning and follow- up which cannot be set in place very quickly. Recent World Bank-financed studies on O&M in roads, irrigation and urban infrastructure in Indonesia clearly demonstrate that it will take a long time to "close" the O&M gap. Lacking chis institutional capacity, the estimates below are likely to be underestimates of the true cost of financing the current shortfall in O&M. 4.17 In the first instance, there is a backlog of special maintenance and rehabilitation required for much of the existing infrastructure in irrigation and roads, so as to raise it to a level alequate for productive O&M. These needs are estimated at about Rp 4.7 trillion, equivalent to 4.7% of GDP and about 22X of general government consolidated expenditures in 1986 (see Table 4.1). As this rehabilitation takes place, it is estimated that the average annual expenditure required, over and above current outlays, to adequately provide for O&M on the five sectors examined is about Rp 909 billion, or about 1! of GDP in 1986 (see Table 4.2). C. O&M Problems in Selected Sectors 4.18 Nature of O&M Problem Across Sectors. The initial consequences of inadequate operations and maintenance are felt at the operational or micro- economic level. They may be visible, in the form of deteriorated infrastruc- ture or frequent breakdown of equipment, or readily apparent only to those - 78 - intimately involved in a sector, and less obvious to the casual observer. Initially, the damage which results may be intangible and become apparent only later in lost output. Table 4.1: INDONESIA: BACKLOG OF SPECIAL MAINTENANCE AND REHABILITATION REQUIRED: ROADS AND IRRIGATION SECTORS (Rp billion) Sector Amount required Roads /a 2,400 National/provincial roads 1,400 Kabupaten roads 1,000 Irrigation /b 2,282 Requiring special maintenance (including upgrading) 642 Requiring rehabilitation 1,640 Total 4,682 (as a percent of 1986 general government consolidated expenditures) (21.9) (as a percent of GDP, 1986) (4.7) /a To fully rehabiiitate the existing road network over a period of six years. lb To restore irrigation network to a condition amenable to efficient O&M. Source: Preliminary staff estimates. - 79 - Table 4.2: INDONESIA: ADDITIONAL OUTLAYS REQUIRED TO PROVIDE ADEQUATE 014 ON SELECTED SECTORS (Rp billion p.a.) Current Additional Sector Needed outlays outlays amount needed Roads: maintenance 480 /a 335 '45 National/provincial 320 270 50 Kabupaten 130 45 85 Municipalities 30 20 10 Irrigation: OEM 93 /b 40 53 Nondefense buildings: Maintenance 400 90 310 Health: OM 630 /c 267 363 Hospitals 310 174 136 Puskesmas 250 68 182 CDC 70 25 45 Higher Education - - 38 Total 909 (as a percent of 1986 general government con- solidated expenditures) (4.3) (as a percent of GDP, 1986) (0.9) /a Average annual amount needed, over the next six years, to adequately maintain the present road network. /b Based on 4.5 million ha of irrigated and reclaimed swamp areas. 7T Based on 1985/86 estimates. Source: Preliminary staff estimates. 4.19 In the roads sector, the consequences of inadequate maintenance are clear. A recent Highway Department inventory of the national and provincial road network suggests that 52 percent of the network has major surface distresses. In a study of 65 kebupatens, only a third of their road network was in good or fair condition. In irrigation, inadequate O&M shows up in excessive silt deposits in weirs, intakes and canal structures, leading to a loss in carrying capacity, and breakdowns and inefficiencies in the delivery of water to farmers' fields. Estimates suggest that only 450,000 hectares are in a suitable condition for efficient OM, despite the rehabilitation of about 1.4 million hectares of irrigaLion systems over the last fifteen years. As a - O - result, irrigation systems often have an economic life of 5-10 years instead of the 15-20 years assumed at the planning stage. Weaknesses in the operation of irrigation systems also emerge in informally sanctioned or unsanctioned misallocatione of water, with water wastage reaching high levels in some systems. In the urban sector, where 22% of the population lives, despite the doubling of annual development expenditures in 1974-84, there has been an accumulation of deteriorating infrastructure in need of rehabilitation, and a significant backlog of infrastructural needs. There is a general neglect of routine maintenance of urban roads; drainage systems are cleaned infrequently; and there appears to be almost nao normal upkeep of public buildings, except for prestige sites. 4.20 In health and medical care, one must be cautious in assessments of deficiencies in O&M. Nonetheless, there are various indicators that the system is not operating efficiently and that the quality of service is poor. Low occupancy of hospital beds is common, averaging 50% nationally. Using Ministry of Health norms, issued in 1986, there seems to be shortage of non- nursing, paramedical and non-medical staff and a relative surplus of medical staff. There are also large disparities in levels of service and access to health care across the country. At the health centers, the shortage of material inputs is also common. Budget allocations per vehicle cover the cost of petrol for less than 300 kilometers per year. Funding for many drugs and vaccines is so low that control of many communicable disease3 is simply not carried out. Maintenance of facilities and equipment has also not received any visible priority in the budget of the Ministry of Health, with allocations for this purpose substantially below what is minimally necessary. The techni- cal capacity for maintenance, particularly on sophisticated equipment, is quite limited. The consequences are apparent in the deterioration of *nfra- structure, the breakdown of equipment, and a lack of spare parts. 4.21 In higher education, the magnitude of the operations problem can only be guessed at. However, discussions with sector officials indicate a decline in the overall quality of education over the last five years, partly as a result of budget pressures in the face of sharply rising enrollments; low use of equipment; lack of instruction materials, especially in the physical and biological sciences; highly inefficient use of building space; and faculty devotion of less than 30% of the -work-week to the needs of their students. The maintenance problem in the sector is more visible, but still difficult to quantify. Only 3.5% of the Routine Budget for universities and polytechnics was allocated to maintenance in 1986/87. While invisible, the decline in the quality of education may have mucL more serious implications than problems which can be measured more easily. And the relative newness of the capital stock in the sector (mainly buildings) almost certainly disguises incipient or emerging requirements for maintenance. General Sources of the Problem 4.22 While there are sector-specific causes contributing to inadequate O&M, which will be discussed below (paras. 4.33 and 4.34), the most important sources of the problem are general ones: - 81 - 4.23 Rate of Past Investment. Indonesia's economic development over the last two decades has been impressive, and some of the current O&M problem is the obverse side of this success. For example, the more extensive the road network and its use, the greater the need for routine maintenance. High quantity targets for new roads were often realized by lowering design and longevity standards and by poor quality of construction. This led to greater maintenance needs and more rapid deterioration, than would have emerged from a more quality-intensive road construction strategy. New roads w2re also promoted, at times, at the expense of adequate ma;ntenance of existing ones. This impetus to expand and diversify public services as rapidly as possible was felt in other sectors and had the unintended effect of eclipsing the O&M needs of infrastructure already developed. A rather unintended consequence has been the low priority attached to O&M in general, and a persistant bias towards new investment. In the health and medical sector, the Ministry has attempted to redress this by focusing on the strengthening and upgrading of the present hospital and preventive care systems. However, pressures persist --from donors and provincial authorities, among others--for investments in new specialist-care hospitals, at the inevitable expense of services in existing facilities. Something similar takes place in the higher education sector where persistent pressure to build new campuses exists. 4.24 Lack of Pro-Maintenance Policy. In most sectors there is neither a formal strategy or policy towards O&M nor a well-articulated priority attached to O&M. Sectoral policies towards O&M have emerged in an ad hoc way, with little forethought for the appropriate balance and phasing of O&M. In some sectors, such as urban, maintenance seems to arise out of crisis, rather than planning, and there are very few organizational units devoted specifically to this work. Municipal authorities also question why the cities should be responsible for O&M on infrastructure constructed by the central government. For district roads, Government policy appears to assume that a road will progressively deteriorate over its design life until an unstable or critical condition is reached. Policies do not ensure maintenance of a stable road through strengthening and rehabilitation. In fact, some districts and municipalities seem to prefer to see roads deteriorate, as they can then make a strong case for a rehabilitation project financed by the central or provin- cial government or external donors. If roads are kept in good condition, no such additional funding is likely. 4.25 The low priority attached to O&M is also reflected in the organiza- tional structure of the technical Ministries. Despite its economic impor- tance, routine maintenance tasks are generally performed by low-status units or by appendages to other units. Talented personnel are not always assigned to this work and they are not attracted to it either, given the lack of income supplements (see para. 4.29). 4.26 Inadequacy of Funds. Recent pressures on the national budget have exacerbated the longstanding problem of inadequate funding of O&M, as indi- cated in para. 4.17 above. Even in the roads sector, where in 1987/88 financing of new construction was cut to the minimum required to sustain ongoing contracts in order to substantially increase maintenance outlays, maintenance expenditures are still about 70% of the minimum requirement implying further deterioriation of the road system. In the irrigation sector, - 82 - the annual allocation of Rp 13,000/hectare is about half the amount required to provide a reasonable standaid of O&M. In the medical and health sector, O&M funding comes from a number of sources, and some of it is earmarked for particular purposes, making reallocations impossible. A significant share of O&M spending in recent years has occurred through the development budget allocations to the health sector (equivalent to 60Z of DIPs in 1984-87 and 89X of INPRES funds in 1987/88). As a result, the recent cut in the development budget has led to an absolute decrease in total recurrent spending, even though the routine budget itself has remained intact. This has particularly affected outlays on materials and supplies and salary supplements, and is likely to have a very deleterious impact on the functioning of the health and medical systems, particularly in preventive medicine. In higher education, the limits to increasing student-teacher ratios have probably already been reached, and further cuts in O&M--especially salary supplements and materials and supplies--are probably having serious effects on the quality of higher education. 4.27 Rigidities Arising from the Planning and Budgeting Process. The length of the planning and budgeting process forces consideration of mainte- nance priorities long before the fiscal year begins. The budget system lacks adequate flexibility to accommodate major shifts in maintenance priorities. Since the funds from different sources are often allocated for specified purposes, the manager is often denied flexibility to shift them in light of daily operating requirements. Funding for materials from different sources may arrive at different times, making it difficult to synchronize the imple- mentation of maintenance activities. Careful planning is also disadvantaged because multiple urcertainties attend the amount of funding that wil. evLntually be disbursed from each source. Finally, officials at the opera- tional level are said to perceive the procedures required to accommodate midstream revisions in annual budgets as excessively burdensome. The irriga- tion sector is particularly vulnerable to inefficiencies in the planning process, as the need for flexibility in the allocation of O&M funds is probably greatest in this area. 4.28 Biases as between Different Elements of O&M. In addition to being low, O&M budgets have in practice differentially favored some types of O&M activities. In the roads sector, periodic maintenance and rehabilitation appears to have been often preferred to routine maintenance, and government guidelines on the use of INPRES funds for maintenance have reinforced this emphasis. In the irrigation sector, the bias has been towards operations (which involves mainly salaries) and against maintenance (which requires supplies, equipment and part-time workers: the first to be cut in any retrenchment effort). 4.29 Effects of Personnel Incentives. The prevailing structure of civil service compensation tends to compromise public service delivery and to bias expenditures towards investments at the expense of maintenance. Base salaries for all government personnel are low, and the relative flatness of the salary scale provides little incentive for performance. A widespread response to this compensation structure is low staff motivation and multiple job holding, which frequently compromises the quality of job performance either directly or through absenteeism. Moreover, an important means of supplementing salaries - 83 - is through official honoraria provided for involvement in specific development projects. These supplements may be quite substantial, compared with base salaries, and give rise to a bias by officials to favor work on new investments rather than O&M. In contrast, those civil servants primarily concerned with O&M may not always have the versatility or opportunities to benefit from such supplements, and they in turn may seek part-time employment in the private sector, at the expense of their O&M work. Furthermore, as salary supplements cannot be funded from the routine maintenance budgets, there is an obvious temptation to allow roads and irrigation canals to deteriorate, with a view to having them repaired through rehabilitation projects, which carry the normal salary supplements for those involved. 4.30 Project Aid Agreements often require that equipment be obtained from the donor country involved. Such procurement conditions may disadvantage O&M in three ways: (i) spare part availabilities are limited in many parts of Indonesia; (ii) the lack of standardization of such capital stock raises the unit cost of purchasing spares; and (iii) the lack of standardization demands a higher level of technical manpower in the repairs function. 4.31 Limited Technical and Management Capacity. There is limited capa- city for planning, management and supervision of maintenance, especially at the district and municipal levels of government. Elaborate programs of education and training in most sectors have provided only modest support for O&M activities. Technical guidelines and standards are lacking for repair work. Surveillance of existing facilities is infrequent, and inventories on the physical condition of each system are rarely available. These deficien- cies have affected the quality of new construction, aggravating the subsequent problem of maintenance. Weak inspection and audits also hamper the effective use of maintenance funds. In the irrigation sector, village authorities and the water users' association often lack the expertise required to operate and maintain the tertiary systems for which they are responsible. In the urban sector, the central government's heavy involvement in the supervision and control of municipal budgetary decisions has constrained the grcwth of an autonomous management and implementation capacity. 4.32 Weaknesses in Monitoring, Supervision, and Auditing. Of all the management functions performed by the public service in Indonesia, oversight is perhaps the weakest. Projects are subjected to routine financial audits, but rarely to thorough program audits. Individual staff performance appraisals are generally not undertaken. Fact-finding supervisory visits in the field are only infrequently undertaken by senior officials. Since govern- ment work represents only a part-time job for civil servants, supervisors demand and accept only limited performance from subordinates and do not monitor closely their accomplishment of tasks. Routine maintenance suffers the most from this deficiency, since it requires the greatest degree of monitoring and supervision because of its highly labor-intensive character. - 84 - Sector-Specific Features of O&M 4.33 In addition to these general causes, there are specific factors i- the individual sectors which have contributed to inefficiencies in the funding or carrying out of O&M: (a) Roads. In the roads sector, there appears to be a reasonably clear division of responsibility for maintenance of different sections of the road network among levels of government. However, in practice, coordination is often inadequate. Until recently, when a Road Maintenance Management System for national taud provincial roads was established, the absence of a comprehensive Road Inventory has precluded the possibility to plan, schedule, and budget maintenance works appropriately. While there is no shortage of basic equipment for road maintenance, there is a chronic problem of equipment breakdowns, owing to a lack of spare parts and low capacity for maintenance. Similarly, budgeting for materials separately from maintenance and betterment, is said to lead at times to imbalances and shortages of supply. Delays in project implementation several months into the fiscal year also crowd-out maintenance close to or into the rain season, which is an inefficient period for road maintenance._ (b) Irrigation. In the irrigation sector, OM is a provincial responsi- bility; yet provincial resources do not appear sufficient to match financial requirements of OM. Equally critical, allocations within O&M budgets appear inefficient, with only half of outlays actually spent at the field level, given the high share spent on administrative overhead at the central and provincial levels of government. There is a bias in outlays toward operations relative to maintenance. Whereas operations do not require much beyond the cost of salaries, in most cases, maintenance can only be done if resources are available for supplies, equipment, and daily workers. Shortfalls in funding typically affect these items first (see para. 4.43). (c) Urban Infrastructure. In the urban setting, the problem of planning, budgeting and managing O&M is further complicated by the need to coordinate the effort in different urban subsectors. The urban sector is therefore particularly sensitive to the lack of managerial capacity at the local level. The past fragmentation of national and regional funding sources and institutional responsibi- lities for the various urban infrastructure subsectors (roads, water supply, drainage, solid waste, and sanitation) has frustrated integrated planning and progrAmming and distorted expenditure priorities. 2/ There are differing perceptions on this issue by field-based officials and the Ministry of Finance. A brief study of the timeliness of OM disbursements to operational units would help resolve this conflict. - 85 - (d) Health and Medical Care. A major obstacle to the comprehensive planning and budgeting of O0M in the l._lth sector is the excessive fragmentation of funding channels. Even if individual programs were planned in meticulous detail, it would be difficult to determine if overall priorities are beirg met or whether there are inconsisten- cies in program objectives. Rigidities in the budget system limit the flexibility of institutional managers to shift funds across functions, thus constraining the efficiei;cy of operational units. The health sector appears particularly sensitive to O&M problems arising from skewed personnel incentives. As in other sectors, the development budget in recent years has effectively provided supple- mentary payments to many health and medical staff. Informal "user charges" are said to be prevalent in the sector, indicating inade- quate salaries for staff already employed. Recent budgetary cutbacks are likely to increase pressures on government health workers to seek additional private employment, at the expense of their regular duties, or to limit their incentive to participate in many preventive health activities. This will have particularly damaging consequences for the operation of the Communicable Disease Control Program. Pressures for absorbing staff from paramedical training programs may also deepen the imbalance between personnel and non-personnel expenditures in the sector. (e) Higher Education. Personnel incentives also play a critical role in determining the quality of 0&M in the higher education sector. Roughly 25 percent of the development budget in higher education has been effectively allocated to honoraria, or salary supplements, for faculty members. Hence, recent budget cuts are likely to have a disproportionate impact on the incomes of university staff. The shortage of teaching staff within universities and institutes is yet another source of operational problems, as the numbers of new staff cannot keep pace with enrollments. There may be some scope for more cost recovery in the sector, although students already pay about 20- 25X of the total on-campus costs of their education. Fees were raised last year, and this proportion will rise over the next few years, but additional increases--which are determined by the central government--are viewed understandably as a matter of national policy. 4.34 These general and specific features of the OM problem suggest certain sector-specific directions for policy change over the next few years: (a) Roads. The priority that has recently been attached by GOI to the maintenance of national and provincial roads has led to: (i) the development of a Road Inventory and a Road Maintenance Management System; (i) a shift of resources towards maintenance expenditures; and (iii) an improvement in implementation by the use of contractors for most of the routine and periodic maintenance. This effort now needs to be extended to the district roads. In order for this to be possible, there is the need to increase the technical and managerial capacity of the regions. Overall, there is also the need to promote - 86 - accourtability at all levels, refine contracting arrangements for maintenance works and improve the capacity to supervise contractors* (b) Irrigation. In the last two years, the Government has clearly recognized the severity of the 9 K problem in this sector. Accordingly, GOI has recently 3- formulated a set of policies which are aimed to address the main issues related to O&H in the sector, among others: - providing adequate and timely funding of O&M on all government controlled irrigation systems at a level sufficient to achieve efficient O&M; - gradually reducing the need for Government funding by imple- menting a direct cost recovery system, an irrigation service fee, which eventually finances all costs of efficient O&M of irrigation systems through increased contributions from irrigation beneficiaries, and shifting responsibility for the management of smaller systems to the Water User's Associations; - ensuring that provincial governments take a gradually increas- ing financial responsibility for the O&M budget of main irriga- tion systems, by Increasing local go-ernment revenue generation through a long-term program to raise PBB revenues on irrigated areas in all provinces; - attaching higher priority to improved management of O&M, e.g., by strengthening the organizational set-up of Provincial Irrigation Services (PRIS) and other agencies at provincial and district/sub-district levels dealing with O&M of irrigation systems; - establishing sound criteria and procedures for allocation and monitoring of funds to meet the actual needs for O&M of each irrigation system; and - improving tht 'ormulation of priorities for existing and programmed irrigation investments, taking into account the likely availability of funds from different sources as well as implementation capacity. (c) Urban Infrastructure. The Government's recent proclamation of KEPRES 14/1987 defining the respective responsibilities among central and regional government agencies for development and O&M of infrastructure, and its comprehensive Statement of Urban Development Policies are clear indications of GOI's commitment to strengthen 3/ See the Subsector Policy Statement and Action Plan presented in Indonesia: Irrigation Subsector Project, Staff Appraisal Report, World Bank, Report No. 6813-;JD, October 15, 1987, pp. 58-69. - 87 - local governments to enable them to m_et their expenditure responsi- bilities and adequately provide for O&M. Strengthening of O&M in local governments has begun through various initiatives supported by the Bank, UNDP and other donors intended to improve budgeting and accounting systems, introduce systematic planning and implementation methods, strengthen organizations, and develop manpower and finan- cial resources, as well as strengthen monitoring, particularly in respect of water supply operations. Further improvements should continue these initiatives but will require clear guidance and support from central government in the following areas: - formulation and coordination of local government OM policy and institutional development programs among subsectors and insti- tutions through the government's inter-agency Ccordinating Team for Urban Development; - improved manpower development and training by Ministries of Home Affairs and Public Works, including on-the-job instruction in management, organization and implementation of O&M; - establishment of organizational units in local governments with direct acco-mtability for O&M in given u-.ban services, ensuring adequate coordination among them; - setting-up of technical support units at provincial level for the planning, budgeting and execution of O&M functions; - development of periodic monitoring and reporting systems at provincial level; - strengthening of accounting and auditing procedures to allow greater accountability in the use of funds and materials and permit more accurate budgeting; - development of technical standards and performance guidelines for the execution of O&M tasks; and - introduction and maintenance of dsset registries. (d) Health and Medical Care. Until recently, Ministry of Health policy has been aimed at expanding the rural health center infrastructure, without adequate attention to the provision of OM funds. Apart from additional resources, which would be part of the solution in the health sector, the following measures need to be considered: - more ambitious cost recovery and adaptation of the INPRES Kesehatan program into more of a sectoral block grant program; - higher compensation for medical and health staff; - linking new investments more closely to future availability of O&M resources; - 88 - - establishing guidelines for unit costs; and - development of a manpower plan, including measures to raise productivity, rationalize the deployment of staff, strengthen incentives, ensure occasional retraining and strengthen stper- vision. (e) Higher Education. As in the health sector, up to now, O&M issues have received very limited attention from GOI in higher education. In the universities and other institutes, - decisions to increase enrollments must be balanced against prospective declines in quality of instruction; - more priority must be assigned to maintenance of capital stock and technical staff must be trained in the upkeep of equipment, especially high-technology items; - some portion of student fees should be used for routine maintenance; and - tuition fees should be increased again, provided low-cost credit programs are available to needy students. D. Planning and Budgeting for O&M 4.35 Responsibility for O&M. The responsibility for carrying out O&M measures is widely distributed in Indonesia across the different levels of government (see Table 4.3). In practice, the delegation of responsibilities may be blurred by indirect forms of involvement by the central government. For example, beyond its own direct O&M responsibilities (for secondary and higher education, national roads, Class A & B hospitals), in other sectors the central government provides considerable technical guidance and supervision to the regions, and may finance supplementary O&M, selectively, through DIPs. In primary education, primary health care and irrigation, the central government specifies standards and procedures for O&M. In other areas, the provincial governments execute the central government's responsibilities (e.g., maintain- ing national road segments within their boundaries). There are some ambigui- ties in this division of labor, and even when it is clear, regional authori- ties sometimes question whether they should be responsible for O&M on infra- structure developed, and often still owned by the central government. 4.36 Financing. Formally, O&M is financed from the budgets of the responsible level of Government, but in practice, 80Z of O&M is funded, directly or indirectly, from the central government. Such financing is provided from different channels in the routine and development budgets, under the control of such central government ministries as the Ministry of Finance, BAPPENAS, MENPAN, Ministry of Home Affairs and the sectoral ministries. O&M needs may only implicitly enter among the many criteria determining such budgetary transfers. Regions are expected to supplement these resources, - 89 - Table 4.3: INDOInSAt DIVISION OF RUStOUUI ULITT AND SOURCUS Of FINCING POR o0H IN TI"! SECTOlS Sector and subsector Respomnibility ter O) Budget channlo -of financo for ON Rods --YoTi roads Toll Road Authority Tolls National roads (excluding Central Cover-ment: Directorate APB*-Routine tr 11 roads) GC .-nl of Mighupys APRN-DIP (i) maintenance (ii) asphalt (iii) betterment Provincial roads Directorate General of Highways APFN-Routine APIN-DIP0 (nattonal artories) Province INPUS Danti-I Own revenue sources S ~~~~~~~~~~~~~~~~~~~~SDO Xabupaten/Kotaaadya roads Directorate General of Urban ) Development (KIP roads) ) AFPU-4outine, APSN-DIPs *lna arga (national arteries) ) Kabupaten/Kotsaadya INPRES Dati-lI Own revenue sources SDO Education Primary education Central Government: Ministry of AP8N-Routine: salaries, Education and Culture, Ministry materials and supplies of Religious Affairs (technical educational quality) Provi-cial Dines (infrastructural SDO-83U0 support-maintenence) Provincial Dinao (operWr onal costs) 50W salaries Student fees INPRES Sekolah Dasert for rehabilitation Own Provincial Rovenues Secondary education Central Government: Mnuistry of APRI-Routine: IDEC: salaries Education and Culture, Ministry supplies and of Relisious Affairs saterials Other ainistries| Student fees Higher education Central Goveraont: Ministry of APBN-Routine. salaries ) Education and Culture mterials and ) supplies ) APPN-DIPs: research ) laboretory expenses ) some mterials ) eeas (sPF) Own revenue of universities fron outside sources Realth and Medical Care Hospitals Speciality hospitals Nostly Central Government (Ministry APBN-RoutiLa: salaries Class A & 8 hospitals of Bealth) materials and ) supplies ) Some provincial hospitals drugs ) AP/SN-DIPs (MoH) ) Patient fees ) 90- Table 4.3: (coet'd) Sector end subeector Rocponeibillty for 04W udget channele of finance for 0U Health and ediceal Care (eont'd) Hospitala (contd) ClAe C Nospitale Provinces or tabupaten SDO: melaree and saw nondrus materials Patient fees INPRES Clame D Roapitala Xabupatrns SDOt salaries *nd some nondrug materials Patient fees Puskemres and Poeyandu Rabupaten Preventive Realth Inputs (salary: SDO) (nonealary: APBN-DIPe) APB3-Routine External aid CuratvIat SDO: shlireue Drugs: INPRES Keehatan Village Water Supply: INPRES K eehatan Puske ee Rehabilitation: INtPRES Kesehatan AP11-Routine APbN-DIPs External aid Irrig Lton PriMary and secondary canals Central Governommt: Directorate APBN-DIPe Major rehabilitation General of Water Resources AINM-Routine Technical superveiion Development of O&M Implementation of O& Provincial Dines INPRIES Dati-I Own Provincial Rtvenues SDO Tertiary canals Villages Own village revenues Como nal organizations Informal fees Water User Aesocietions INPRES Data-Un Urban Infrastructure Clean water supply Central Government: Director Water charges ) General of Urban Development APBN-DIPe ) through VPAN enterprises ) IKK enterprises ) Local Government enterprisest PDAN Water charges ) Other urban infrastructure MunicipaL Government INMRES Doti-II (excluding transport--see Own Revenues (including share of above) PSI receipts) - 91 - through local taxes or user fees, but legal restrictions tightly limit the extent to which local governments can do this (see paras. 3.10 and 3.12). As a result, the aggregate resources potentially available for O&M by the regions may bear only limited relationship to the relative rmagnitude of O&M responsibilities. 4.37 The routine budget of the central government has been the c>;tral source of funding for basic inputs to O&M. It covers the wages and sftaries, as 'Qell as pension qnd insurance benefits, of all permanent civil servants-- directly, in the case of central government employees, and indirectly, in the case of provincial and district governments. Salaries of the latter governments are financed through direct budget transfers--the Subsidi Daerah Otonom (SDO). The routine budget also pays for materials and supplies needed to maintain central government programs and infrastructure, and 10% of the SDO to the regions is intended to meet non-salary O&M L3sts of primary schools and hospitals. 4.38 In the last decade, the development budget has also been used to finance O&M through specific projects or DIPs. Besides nonpersonnel costs, some have financed the hiring of temporary labor, consultants and engineers, and salary supplements for civil servants associated with projects; others have provided for the specific rehabilitation of deteriorated infrastructure ("deferred maintenance"). In fact, most of the periodic maintenance and betterment of the national and provincial road system has been financed through specific DIPs to Bina Marga. 4.39 The development budget includes the INPRES program of budget tr-is- fers to the regional governments. Annual grants to the provinces (INPRES Dati I) amount to Rp 10 or 12 billion, depending on the population of tihe province concerned. A specific part of this--determined by the Ministry of Home Affairs in accordance with the extent of such facilities in each province-- must be spent on maintaining roads and irrigation networks (see Appendix 4, Table A4.3). As the distribution of these funds is relatively equal, and the density of population and infrastructure is highly uneven, the adequacy of this support varies widely across the country. Unlike INPRES Dati I, grants to the kabupaten and kotamadya (INPRES Dati II) are made strictly on a per capita basis. A quarter of these funds are expected to be used for road maintenance. Two thirds of the remaining funds tend to be used for road construction or rehabilitation (see Appendix 4, Table A4.4). 4.40 Other INPRES transfers have supported the rapid expansion of social services and infrastructure--in primary education (INPRES Sekolah Dasar), primary health care (INPRES Kesehatan), district roads (INPRES Jalan), and local markets (INPRES Pasar). While some are earmarked to O&M expenditures, such as drugs for health centers, most of these grants have exacerbated pressures toward new investment and away from O&M. 4.41 These separate budget channels are controlled by different coordi- nating ministries in the central government. The Ministry of Finance has principal responsibility for allocation and administration of the Routine Budget, as well as short-term issues of aggregate budget management. The Ministry for the State Apparatus (MENPAN) authorizes new staffing positions, - 92 - in coordination with the National Civil Service Institute (BAKN). BAPPENAS formulates the development budget, in coniunction with the sectoral ministries and the Ministry of Finance. The Ministry of Home Affairs supervises the budgeting and planning process in the regions and the allocation of transfers to the provinces (INPRES and SDO). As each Ministry focuses on its own aspect of the budgetary process, none has a comprehensive picture of what is spent on O&M, as distinct from new investments or rehabilitation. Furthermore, even agencies and provinces which seek a rational internal process in cvaluating their needs and proposing effective solutions are forced by the budget structure to adopt a fragmented approach to O&M funding. 4.42 Budgeting for O&H. In the past, O&M has not been high on the policy agenda of those Ministries (MOF, BAPPENAS) responsible for the budget. Tt-'re has not been an integrated approach for evaluating the adequacy of O&M resources, whether it be for a particular institution or a specific mainte- nance program on physical infrestructure. Institutionalir, decisions and data are not organized to make such an analysis possible. For example, the central government budget does not show the amount spent on operations or maintenance in a particular sector. There is budget data for some inputs, but for others, such as salaries under the SDO, even an aggregate sectoral breakdown is not possible. Rational budgeting for O&M is difficult when even the amount of resources presently allocated for such purposes or the balance between different types of inputs is unknown. 4.43 Materials and Supplies. Materials and supplies for O&M are financed from several different budgetary sources, with little coordination to ensure their sufficiency for specific sectoral programs. They tend to be treated as a "'residual category" in the routine budget, partly because they are seen as using domestic resources which could be applied to supporting externally- funded development projects. As a result, in a period of budgetary restraint, this element of the Budget bears more than its "fair share" of cuts. In 1987/88, allocations for materials and supplies were cut by 14X in nominal terms, 'with particularly heavy consequences for the maintenance of buildings and equipment. 4.44 The recent practice of using the development budget to fund some O&M has also been curtailed. Before 1986/87, this was an important source of financing for O&M including, inter alia, specific road maintenance projects, some higher education costs (research and special training) and preventive health activities. The growth of such funding was ad hoc, allowing particular 04M problems to be addressed, rather than the outgrowth of a process whereby a sectoral overview was made of O&M needs relative to O&M resources. Over time, what emerged in effect, was an unstated practice of "routinizing" a part of the development budget for O&M, with the implicit expectation that it would grow pari passu with the growth in government revenues. What was not foreseen was the prospect of an absolute shrinkage of domestic budget revenues. This has led :o a sharp cutback in DIPs, with the cuts affecting O&M especially severe: down from Rp 4.1 trillion for all Ministries (except Defense) in 1985/86 to Rp 1.1 trillion in 1987/88 (see Table 4.4). This has had a severe impact on preventive health and higher education. - 93 - 4.45 The INPRES block grants have proven a more reliable source of O&M funding, as they have roughly tripled since 1979. Despite drastic cutbacks in the overall 1986/87 and 1987/88 development budgets, INPRES Dati I and II grants have been held constant at their 1985/86 levels. The sectoral INPRES programs have been less fortunate. Cutbacks in primary school construction have been only partly offset by reallocation of funds to rehabilitation projects under the INPRES Sekolah Dasar program. Only the IP.RES Kesehatan has remained a significant vehicle for O&M funding. Table 4.4: CENTRAL GOVERNMENT: RECENT BUDGET TRENDS, 1985/86 - 1987/88 (Rp trillion) 1985/86 1986/87 1987/88 /a Routine Budget 11.95 14.12 18.39 Personnel 4.01 4.31 4.69 Materials and supplies 1.37 1.36 1.36 Subsidy Daerah Otonom (SDO) 2.49 2.65 2.86 Personnel 2.25 (2.37) (2.59) Nonpersonnel 0.24 (0.27) (0.27) Debt service 3.32 5.10 9.00 Development Budget of which 10.87 8.33 10.61 INPRES 1.33 1.29 1.18 INPRES Dati I and II 0.48 0.48 0.50 INPRES Sekolah Dasar 0.53 0.50 0.10 INPRES Kesehatan 0.11 0.11 0.08 INPRES Jalan 0.07 0.07 G.13 Ministries (DIPs) of which 4.06 1.74 1.06 Wages and salaries 0.32 0.2 Supplies and materials 0.35 0.2 /a Preliminary staff estimates. 4.46 Issues in Planning. In contrast to revenues, relatively little attention is given to forecasting medium-term expenditures for O&M and almost no effort is made to estimate the likely impact on future O&M needs from new or ongoing investment projects. Neither the Ministry of Finance nor BAPPENAS evaluates the aggregate O&M implications of the program of investments, with a view to assessing either the likely availability of funds or the measures needed to ensure that resources are programmed for these needs. The result is that projects are generally planned and implemented without knowing whether their O&M costs can be sustained. Formal project documentation does not reqiire the specification of subsequent financial and personnel require- ments for O&M. - 94 - 4.47 In general, there also are no procedures to ensure that additional resources are provided for the incremental O&M funding needs of the respon- sible. line agency. There is no coordination between DIP and grant alloca- tions. The exceptions are the INPRES Sekolah Dasar and INPRES Kesehatan programs, where there is a direct link between the completion of a facility and the creation of staff posts through the routine budget. Some non-salary costs associated with a new primary school are also provided. Another exception is the limited central government term financing that may occur for an irrigation or clean water supply project, although in the former case, this is limited to two years. Beyond this, the linkage is uncertain. MENPAN has norms for staff complements at different institutions but is usually constrained by budgetary ceilings from enforcing them. Provision of non- personnel resources is even more problematical. The weakest linkage of all is in physical infrastructure, for which the regions can depend on no additional resources of any kind to operate or maintain an expanded system. 4.48 The importance of proper data bases for OM has already been mentioned. Without adequate informaticn about the condition of the infra- structure base (roads, irrigation networks, school facilities) and on the operating features of particular programs, there can be no coherent program of repair and maintenance. Data are necessary on the nature of assets, as well as their age, condition and maintenance history. In developing such invento- ries, some effort should be made to standardize formats. Inventories must be updated periodically, so that they can be used reliably for annual planning of O&M. 4.49 Also required are sector guidelines for an appropriate pattern of maintenance and budgeting benchmarks for different types of OM work. These could include measures of OM effectiveness and reporting arrangements for assessing the results of specific maintenance efforts. E. A Strategy for Action 4.50 Several conclusions emerge from the discussion above. First, there is, at most, only an embryonic consensus within Indonesia on the role and importance of effective operations and maintenance in the public sector. This is reflected in a budgeting and planning process which fails to consider OM issues comprehensively. Second, the failure to attend to O&M is likely to have serious costs in growth, equity, and employment. Third, the financial resources currently allocated to O&M are substantially lower than required and the regional governments do not have the means of carrying out their existing O0M responsibilities effectively. And fourth, the funds allocated to OM are being used inefficiently as a result of limited institutional capacity, technical knowledge and information, and distorted incentives for decision- making. 4.51 The Government should develop and strongly promote a national policy on OM, stressing the importance of maintaining the quality of public infra- structure and of realizing the highest productivity in its use. For this policy to prove successful there is the need to reform the current planning and budgeting process for 06M at the central, sectoral and regional levels, as well as to build up the institutional capacity to do OM. Furthermore, the - 95 - Covernment should indicate that the population at large will be expected to participate in this effort to deal with the "O&M problem" by sharing some of the costs when they derive direct benefits from improved programs. 4.52 Central Planning and Budgeting. Reform in the planning and budget- ing of O&M must begin with the Ministries of Finance and Home Affairs, BAPPENAS and MENPAN: (a) There should be a single locus of responsibility for O&M, for assessing the adequacy of resources allocated to it, for promoting a better approach to O&M throughout the Government, and for evaluating the use of O&M resources. The logical candidate would be the Ministry of Finance or BAPPENAS, with the Ministry of Home Affairs responsible for regional aspects of O&M. (b) Efforts should be made to improve the government accounting system in order to identify the magnitude and composition of sectoral budget outlays for O&M more precisely, and the method of coordinating budgetary and personnel allocations for sectoral O&M from different budget sources should be re-examined. The criteria for allocating INPRES funds should also be revised (see paras. 4.55 and 4.56). (c) Project evaluation procedures should include projection of O&M requirements, and effort should be made to (i) develop a revised data format for sectoral project submissions on both new projects and projects currently being implemented with explicit data cn O&M requirements; and (ii) develop a computerized system of "project profiles". (d) Some effort should be made to develop an "indicative" macro-model to assess the medium-term O&M implications of the investment program. The affordable t&te of expansion of O&M (including staff salaries) should influence the rate of expansion of physical infrastructure and hence the size of the investment budget. (e) Proposals (including a timetable) for developing sectoral asset registries on public infrastructure should be developed as soon as possible. Initially, these could focus on central government programs, but could eventually be extended to the regions. BAPPENAS could require that a progress report on inventory development accompany each proposal for DIPs. (f) In the short-term, efforts could be made to explore the feasibility of the "project format" for essential routine maintenance activities. (g) In the medium term, the Ministry of Finance should consider simplifying procedures for mid-year budget changes. This recommendation should be linked to improvements in monitoring and supervision (see para. 4.57 (d)). - 96 - 4.53 Sector Reforms. Improved O&M procedures and data collection at the central government level will only have significant effects if corresponding changes occur at the sectoral level. Sectoral agencies are the source of technical expertise on O&M needs and are ultimately responsible for meeting them. (a) Sectoral O&M objectives need to be defined, with sectoral strategies developed for striking an appropriate balance between operations, routine and periodic maintenance, rehabilitation and investments. Sectoral task forces should be established to define these strategies, with representatives from BAPPENAS, the respective technical ministries, and (where appropriate) regional governments. (b) Detailed estimates of O&M requirements should be developed, includ- ing data on assets presently in maintainable or operable condition, the cost of rehabilitating deteriorated infrastructure and the likely financial implications of maintaining rehabilitated infra- structure. (c) Unit cost and staffing requirements should be defined for different programs and infrastructure. (d) Indicators of operating effectiveness are urgently needed, especially for the social service sectors. (e) The possibility of transferring funds directly to "operational" units responsible for O&M should be explored. Consideration should also be given to -privatizing"t some O&M activities. 4.54 Regional Policies. In the medium term, several issues need to be examined and resolved regarding the regional role in O&M. First and foremost, the central government needs to reassess the current level of O&M resources allocated to the regions. This evaluation must take into account the regions' O&M responsibilities, their ability to mobilize local resources, and their capacity to implement investments and O&M. It also requires close coordina- tion between the DIP budget and the grant system to ensure balanced allocation of O&M funds to local authorities. 4.55 While many political factors have shaped the current transfer system, and general reforms are required to address its deficiencies (see paras. 3.22 to 3.24), to increase O&M resources to the regions two approaches should be considered. First, the INPRES block grants could be made more responsive to the relative sizes of infrastructure stocks in the provinces. Second, the sectoral INPRES transfers could be recast as more routine block grants for O&M. This would entail merging O&M funds currently provided from central government DIPs. To make them more accountable, the recipient regions could be asked to prepare a consolidated budget showing the use of all resources for sectoral services, in conformity with national priorities and locally determined needs. - 97 - 4.56 The following adaptations to sectoral INPRES programs could be considered: (a) Roads. The INPRES Jalan could be redesigned to provide funds for routine and periodic maintenance, with distribution related to the size and condition of the district road infrastructure. (b) Irrigation. A separate INPRES program for irrigation could be established, with particular support for provincial dinas under- taking O& on primary and secondary irrigation canals. Additional funds could be used to strengthen the capacity of village irrigation authorities and the Water User Associations to operate and maintain tertiary systems. (c) Health. The INPiES Kesehatan could provide additional funding for preventive and curative services by the local health centers. There could also be fewer restrictions on the use of these INPRES funds. Funds for preventive health services in the Ministry of Health's DIPs could be "folded" into the INPRES grant. (d) Education. Consideration should be given to targetting INPRES Sekolah Dasar grants at poorer kabupatens, for the purpose of rehabilitation and O&M. (e) Urban Infrastructure. More INPRES Dati II funds could be allocated to kotamadyas, as they develop a greater capacity for O&M. 4.57 Institution-Building. Resolution of the O&M problem will be a medium-term process. The emphasis must be placed on increasing the capacity to do O&M rather than simply doing O&M. To build-up this institutional capacity: (a) The organizational structure and status of O&M needs to be strengthened. (b) Incentives and disincentives in the civil service compensation system need to be addressed head-on if there is to be increased emphasis on effective O&M in the public sector. (c) It would be desirable to introduce administrative changes simultan- - eously with the introduction of new personnel incentives. Support units should be established in provincial, district and municipal offices to provide technical and policy guidance to line units responsible for O&M and policy guidance on O&M needs to budgeting and planning units. Pilot projects in building O&M capacity for roads and irrigation facilities could be undertaken in selected provinces and districts. Recent budget reductions for new projects should make engineering and management expertise available for temporary reallocation for this purpose from Bina Marga and DGWRD. (d) There should be better monitoring and supervision of O&M, including a system of periodic "performance audits" by supervisory - 98 - personnel. Until such auditing becomes widespread and effective, there will be little progress in increasing budget flexibility at the operational level (see para. 4.52 (g)). There should be clearer specification of work to be undertaken and clearer measures of successful job performance. (e) Manpower planning, which identifies both technical and managerial personnel required for O&M, needs to be part of both central and local government responsibilities. 4.58 Cost Recovery. Given the limits on central government revenues and the need to promote a more efficient use of resources, the appropriateness of user fees in each sector should be examined. The case for these will vary widely, depending on the social and economic circumstances of the major users, the nature of the service, the extent of "informal" fees already charged, the ease w:th which they could be collected, the potential for abuse, the amount of revenues they would raise, and most importantly, the likelihood that they would bring improved services to all concerned. 4.59 In the roads sector, there is ample room to increase the user charges paid by truckers as they are currently paying only a fraction of the actual wear and tear which trucks inflict to the road network. This could be done in a variety of ways, among others: (i) an excise tax on diesel (see para. 3.54); and (ii) an increase in the annual license fee for trucks (see para. 3.40), which would take into account the greater road deterioration due to heavy axle loads. Part of the related revenue could be used to maintain the status quo on the national, provincial and district road network. The economic return from such allocations would be very high, and a stable source of funding might ensure more timely disbursements of O&M resources. To ensure an efficient use of these resources, the time period over which such augmented funding would be introduced would have to be sufficient to ensure a pari passu improvement in the capacity to execute road maintenance. 4.60 In the irrigation sector, the Government is already moving towards a cost recovery policy which includes among its objectives the financing of O&M by irrigation beneficiaries (in those systems in an adequate condition to be maintained) and enhancement of property tax revenues. However, unless the Government also tackles the financial and management problems associated with O&M in the sector, the expensive and ineffective practices of the last fifteen years will continue. 4.61 In higher education, as mentioned earlier, there is scope for higher student fees, complemented by increased student access to Government- subsidized or -guaranteed loans. Under-utilized classroom space could also be leased to other users, especially if the revenues raised were retained by the universities and partly allocated to the maintenance of physical plant. 4.62 In health services, some caution is necessary, in view of limited health insurance and evidence of existing informal fees which have already raised the real cost of government services to patients. There should also be some differentiation in health and medical services subject to cost recovery. - 99 - 4.63 In urban infrastructure, user charges are al sady common for water supply services and could be extended to solid waste disposal. Local govern- ment departments and enterprises should be allowed to raise sufficient revenue by reviewing and raising such user charges regularly. 4.64 Donor Policies. To support a national policy on O&M, external financing agencies should place increased emphasis on estimating the recurrent cost implications of projects and sharing this information with BAPPEU * and the Ministry of Finance. Donors should also play a more active role in post- project performance audits, with particuilar reference to O&M issues. Finally, donors should provide as much support as possible to Government efforts to strengthen its O&M capacity and to improve cost recovery in public services. 4.65 REPELITA V. The preparation of the next f.ve-year development plan provides a timely opportunity to introduce many c. the recommendations of this Report. An "O&M Improvement Program" could well oe an important thrust of the plan, reflecting the Government's commitment to the productivity of invest- ments already made, as well as its desire to shift priorities slightly toward new standards of quality relative to some degree of quantity. In fact, if O&M is to achieve higher priority in Indonesia, it seems necessary that this theme be an integral part of REPELITA V. Appendix 1 -100 - Page 1 INDONESIA A SOURCES AND USES OF FUNDS FRAMEWORK 1. The sources and uses of funds framework is an accounting framework used to systematically integrate the major macroeconomic accounts of the economy: the basic economic management accounts--those for the government sector, the balance of payments and the monetary sector--plus the national accounts and a private sector account. To achieve compatibility and consis- tency of data, the framework makes extensive use of the double-entry account- ing principle in which payments (uses of funds) by one sector are at the same time the receipts (sources of funds) of another sector. The transactions between sectors are distinguished between current and capital transactions. The current account of the sources and uses of funds framework focuses on the transformation of GDP into disposable income by sector and its breakdown between consumption and savings, *nsuring consistency of aggregate savings and investment via the current account deficit of the balance of payments. The capital account focuses on the channels by which resources are transferred from the sectors that are net savers to those that are net investors in the economy. In particular, it highlights the role played by the banking system and the capital transactions with the rest of the world in financing invest- ment. 2. The accounting framework used to integrate the macroeconomic accounts of the Indonesian economy is shown in Talble A1.l in both the matrix format and as a set of identities. It consists of six sectors: (a) central government; (b) provincial and local governments; (c) monetary system; (d) balance of payments; (e) "availabilities equals uses" identity from the national accounts; and (f) private sector, and uses thirty-nine intersectoral flow variables. In the matrix presentation the total for each row (sources) is equal to the total for the corresponding column (uses). The identities are simply the variables in rows and columns (with some reordering to approximate the conventional tabular presentations of the data). In so far as independent accounts are available for each sector, there are two sources of data for each entry. They will often conflict and, in preparing the sources and uses of funds matrix, one must choose which source to use. This is done on the basis of the quality of the information and the appropriateness of the definitions and concepts. Ultimately, the process assures consistency in the basic data, thus increasing its usefulness for analysis. The next paragraphs describe the sources of data used for the different accounts, as well as the required con- sistency adjustments undertaken in the process of constructing the sources and uses of funds matrices for the Indonesian economy, for the period 1978-86. Derivation of Sources and Uses of Funds Accounts 3. National Accounts. The set of BPS national accounts statistics for 1978-85, with 1983 as the base year, provides the basic data for this account. Two adjustments are made. First, the national accounts statistics derive the change in stocks, and not private consumption as is the usual practice, as the residual of the accounts. By using direct information on the change in stocks of crude oil, petroleum products and rice, and assuming that - 101 - Appendix 1 -101- ~~~~~~Page 2 the change of the rest of inventories, as presented in the 1980 Input-Output table, maintain a constant relation to the change in GDP, an estimate of the changes in stocks is derived. Private consumption in turn is derived as the residual. Second, the national accounts statistics do not disaggregate gross fixed investment into private and government investment. This disaggregation is obtained by using the government investment figures derived in the govern- ment accounts. The resulting national accounts for the period 1978-86 are presented in Table A1.2. As in all accounts, 1986 figures are preliminary. 4. Government Accounts. Both central government and provincial and local governments accounts are based on the general government accounts for 1978-85 produced by BPS. Because these statistics are based on national income accounts methodology they overcome two problems, in terms of consis- tency with the rest of the data, of the budget figures. First, they are presented in a calendar year basis instead of a fiscal year basis. Second, government consumption figures incorporate the part of development expenditure which refers to recurrent expenditure items, and therefore directly matches with government consumption in the national accounts statistics. In addition, these accounts are presented for all levels of Government, separately. This made feasible the task of disaggregating general government into central and provincial and local governments in the sources and uses of funds framework. 5. Central Government Accounts. Central government accounts are not on a cash basis and do not cover all central government financial operations. The adjustments adopted are as follows. The deficit is calculated directly as the sum of net foreign and net domestic financing. The first is taken from external debt data from the World Bank and the second is derived as changes in net claims of the banking system on the Government from the monetary survey. Tax revenue recorded in the budget differs from cash revenue because oil revenue in the budgetary account is not on a cash receipts basis. To get actual cash revenues, an adjustment to direct taxes needs to be made. This involves adding to the budget figure, the change in the outstanding balance in the oil transitory account during the course of the calendar year, adjusted for valuation changes (since it is a foreign exchange account). Transfers from rest of the world have also been adjusted, taking the corresponding figure from balance of payments. The residual item in the adjustment has been investment, which now reflects actual expenditures and not authorized expenditures. The resulting central government accounts are presented in Table A1.3 6. Provincial and Local Government Accounts. The only adjustment to the provincial and local government accounts from BPS was to substitute the figures for transfers from central government to local governments with data from central government budget. This was done because there was a significant discrepancy with budget figures which could not be accounted for by BPS. The residual item in the adjustment was domestic financing. The resulting provincial and local government accounts are presented in Table A1.4 7. Monetary Accounts. The monetary survey from BI is the basic source of information for this account. The main adjustment is related to the Government's foreign currency account #652 which iE used to register Government's syndicated loan proceeds and up until March 1987 was not included Appendix - 102 - Page 3 in government deposits with BI. To include them, one needs to substract the undrawn balances on this account from claims on Government in the monetary survey and add them, as they are a foreign exchange account, in net foreign assets. This reclassification presents both a better picture of net foreign assets and the Government's position with the banking system. Following IMF's standard adjustment net foreign assets exclude drawings from the IMF under the Buffer Stock Facility and the Compensating Financing Facility. As no informa- tion is provided in the monetary survey in reference to credits to provincial and local governments, this information is taken from the provincial and local governments accounts, with the credit to the private sector being therefore the residual item. The resulting monetary accounts are presented in Table A1.5. 8. Balance of Payments. The main figures for this account: merchandise exports, merchandise imports and net services, are taken from balance of pay- ments data, on a calendar year basis, from BI. Using IFS imformation on current government transfers from the rest of the world, the current account balance is derived. The rest of the adjustments are as follows. The figure for net non-factor services is derived by substracting BI's merchandise exports and adding BI's merchandise imports to the resource gap data in the national accounts. This in turn is substracted from the net services figure from BI to obtain net factor services, which is then divided into: government interest payments and other factor services. The first is obtained from the external debt data from the World Bank and the second is then the residual. On the capital account of the balance of payments, net government external financing is obtained from the external debt data from the World Bank. The change in net foreign assets is taken from the monetary accounts and therefore private sector net flows are the residual. The resulting balance of payments accounts are presented in Table A1.6. 9. Private Sector Account. This account has been treated as a residual account in the sources and uses of funds system. The resulting private sector account is presented in Table A1.7. 10. Most of the above adjustments to the individual sector accounts come from putting together the accounts in the sources and uses of funds frame- work. This process ultimately leads to a set of sources and uses of funds matrices which ensure the consistency of the data. These annual matrices are presented in Tables Al.8-Al.16. Both the individual sector accounts and the annual sources-and-uses-of-funds matrices are then presented using percentages of GDP in Tables Al.17-Al.31. IRDONESIA PIBNLIC RISOURCE NANAIZENT STUDY Sources and Uses of Funds Accountine ramwuork Central Local Private Monetary Balance of Netional TOTAL Matrix form government governesnt sector syatem PVyments accounts SOURCU% Accounting identities Currant Account Central governmnt - - Tdc+TPXc - - Ftxc+Tic-S.ubc Central XoDvrnmA*t: Local government Tcl - Tdl+Tpgl - - FYtl*TilI-Subl Tdc+Tpgc+ottgc4T c-Sace+Tci+TRtP4Vf+TRf +Cgftclc Prtvate aector Tgtep TgP - - - FTp Sgc+Lfq4lmg.tIgc4CTcI+CT%p Monetary system _ _ _ _ _ _ Balance of paywnts Fqf+Ttf - Ppf - - BC Private sector: attional accounts PflTgCp+TglymTdC+T dl+Tsc+Tsgl+fpf4.sSP Consumption Ctgc Cql CP - S P +p4DPIioth+LmvtCTgp-W 2lWP'IP Saving Sgc Sgl So - SI Monetary sector (capital account onlv): TOTAL USCS 2+MDL-NPAtA*LmP+ Lgc- e!l C Ptitj..hcront Local gtovernment: CIentra gove nt - - - Lc e Lfg Sgc Tdl+Tpl*PYgl+Tl*+Tcl.Suhl+TElpyCgl+Sti Local governmnt CTel - - LOKI - SR SlI+LmxlICTcl.Txt Prtvate sector CTgp - LtoP O o160th Sp Monetary system - MS+NOL - B alance of PWvtstq (whera C-*-IX): Balance of payments - - - KFA - Sf RG+rgf+Txf+Fpf-sf Nattonal accounts Igc Il TIr - - _ SftLfq+DPliothd?FA TOTAL USES Nattonal accounts (where PVg+PYp4Tt-SubGCDP): FYgc+rYgl4FY tIc+TL I-Subc-SubI+ECt+CcI4CgL4CpS4gc+Sgt+SpSfI SgceSgl+SneSf-lcc+Iltt+!s The 19 tlrm vsrtahles are: Tdc Direct taxes collected by central government Tdl Direct taxes collected by provinctal and local government Tpgc Non-tax current transfers, private to central government Tpgl Non-tax current transfers, Private to provincial and local government F'Rc Property incomes and operatinq suirnius, central s;overnment Fygl Property incomes and overating surplus, provinctal and local government Tic Lidirect taxes collected by central government Til Indirect taxes collected by provinciAl and local government Sube Substdtes fro" central gnvernment Rubl Subsidies from provinetal and Local government Tcl Current transfers, central go0ernwent to provincial and local government TRIP Current transfers, provincial and local governmnt to prtivte Tgcn Current transfers, central government to private Cgl Provincial and local government consumpttOn Fgf Interest paymnts on foreign public debt Sgc Central government savings T7f Current transfers, government to foreign Sgl Provincial and local governmeldt savingts Cgc Central government consumption FYh CDP at cu rrent factor cost minus Flgc,l Fpf Net factor oayments atbroad by prtvste sector igc Central Rovernment investment Cp Prtvate constmption LAWI Net domesttc credit to provincial and local government Sp Private savings Igl ProvincLal and local govern_mnt tnvestment RC Excess of IMPGNFS over ExPCNrS Lop Net dometic credit to Private sector Sf Cuarrent account deficit of balance of Payments DFI&oth Foreign capital flows to prtvcte sector (includitng errors and emissions) Lagc Net domestic credit to central governmnt MnOs Broad money suoply Lfg Net external borrowing by government NOL Met other liabilities of banktng system CTcl Capital transfer, central government to provinctal and local government 1o Private tnvestment CTgcp Capital transfer, central government to private NFA Nat foreign seets CTglp Capital transfer. provincial and local government to private Zi NATIONAL ACCOUNTS, 1978-86 (Rp billion) 1978 1979 1980 1981 1982 198S 1984 1965 1986 GDP Gross Domestic Product 24002.5 34344.7 48913.5 58421.3 62644.5 73697.6 67535.5 96060.4 99642.4 Cp Private Consumption 15230.3 20513.6 25680.6 33768.6 38999.2 48112.2 57295.0 64721.6 70799.9 Cgc+Cgl Government Consumption 2556.5 3277.4 5147.7 6452.0 7228.7 8077.3 9220.2 11423.7 11397.7 Ig+Ip Gross Inveetment 5628.9 8152.2 11808.7 15833.6 16165.5 18295.6 17756.4 18343.3 19423.6 Igc+Igl Government Investment 1138.2 1702.0 1726.1 3390.4 5711.0 6969.2 5508.1 6585.5 6430.4 Ip Private Investment 4490.8 6450.2 10082.6 12443.2 10454.5 11326.4 12246.3 11757.8 12993.2 -RG Resource Gap 586.8 2401.5 6276.5 2367.1 253.1 -787.5 3263.9 1577.8 -1776.8 Memorandum ites:t Total Change in Stocks 134.8 484.5 1258.9 1699.1 343.1 -678.2 -2049.5 -1270.2 -974.4 Crude Oil -26.5 197.7 783.2 1007.5 148.5 -966.3 -1270.3 -885.0 -1068.9 Petroleum Products 105.7 64.7 120.9 495.3 79.2 38.2 -1052.2 -579.1 5.1 Rice -27.9 -9.0 29.2 -16.2 20.9 2.9 -36.3 3.2 2.1 Other 83.5 231.1 325.6 212.5 94.4 247.0 309.3 190.7 87.2 II CENTRAL GOVERNHENT ACCOUNTS, 1978-1986 (Rp billion) 1978 1979 1980 1981 1982 1983 1984 1985 1986 Current Receipts 4089.5 6389.9 9963.9 12121.5 12095.3 14535.8 18172.9 18845.2 15995.5 Tdc Direct Taxes 2875.1 4878.1 8040.0 9880.2 9672.3 11718.4 15054.7 13893.5 $553.0 Tic Indirect Taxes 1028.7 1304.8 1605.8 1752.2 1923.6 2224.3 2355.8 3539.1 5232.1 Tpgc Transfers from Private Sector 78.5 70.1 89.6 78.1 105.0 124.6 184.1 322.6 406.9 -Tgf Transfers from Rest of the World 6.2 18.7 34.5 157.9 88.6 94.6 117.0 122.2 190.4 FYgc Property incomes and OS 101.0 118.2 194.0 253.1 305.8 373.9 461.3 967.8 1613.1 Current Expenditures 2830.0 4120.5 6717.2 8433.1 8644.1 9188.5 10982.7 12661.1 12970.6 Cgc Consumption 1817.1 2358.6 3854.7 4773.2 5021.2 5179.0 5916.7 7436.0 p792.4 Subc Subsidies 266.6 685.9 1413.1 1863.6 1570.4 1396.5 1435.1 1156.3 395.0 Fgf Interest on External Debt 190.3 381.9 435.3 516.6 655.3 1005.2 1535.5 1731.2 2643.2 Transfer Payments Agcp To Private Sector 44.7 61.1 114.5 128.6 108.3 118.8 296.2 0.0 0.0 Tcl To Local Govt. 511.3 633.0 899.6 1151.1 1288.9 1469.0 1799.2 2337.6 2640.0 Sgc Government Savings 1259.5 2269.4 3246.7 3688.4 3451.2 5347.3 7190.2 6184.1 3024.9 Government Capital Expenditure 1275.2 1968.7 2217.5 4059.7 6083.4 7438.5 6392.6 7341.5 7496.6 CTgp Capital Transfers to Private Sec. 138.1 221.7 420.6 479.8 372.7 527.9 400.0 393.3 258.6 CTcl Capital Transfer to Local Govt. 413.6 509.2 737.7 1047.2 1096.4 1349.2 1484.8 '1498.8 1549.4 Igc Investment 723.4 1237.8 1059.2 2532.7 4614.3 5561.4 4507.8 5449.4 5688.6 Deficit Fin ncing 15.7 -300.7 -1029.2 371.3 2632.2 2091.2 -797.6 1157.4 4471.7 Lmgc Banking System -342.0 -740.0 -1921.0 -647.0 527.0 -1392.0 -3389.0 -470.0 257.0 Lfg External Borrowing 357.7 439.3 891.8 1018.3 2105.2 3463.2 2591.4 1627.4 4214.7 Memorandus items: Non-oil Tax Revenue 1685.1 2129.0 2731.2 3159.2 3671.4 4247.9 4689.5 5934.8 8211.0 Adjusted Oil Revenue 2218.7 4053.9 6914.6 8473.2 7924.5 9694.8 12721.0 11497.8 5574.1 I PROVIUiCIAL AND LOCAL GOVERNMZiT ACCOUNTS, 1978-1986 (Rp billion) 1978 1979 1980 1981 1982 1983 1984 1985 1986 Current Receipts 900.9 1056.0 1498.0 1932.9 2329.2 2875.3 2839.6 3451.9 3799.6 Tdl Direct Taxes 88.1 109.5 164.7 213.3 291.9 367.8 252.6 314.2 327.0 Til Indirect Tazes 76.0 87.3 117.8 137.1 169.3 21M6 169.8 223.1 232.2 Tpgl Transfers fron Private Sector 158.5 145.3 213.0 101.6 413.7 565.9 422.3 369.8 364.6 Tcl Transfers from Central Govt. 511.3 533.0 899.6 1151.1 1268.9 1489.0 1799.2 2337.6 2640.0 FYgi Property incomes and OS 67.0 80.9 102.9 129.8 165.4 213.0 195.7 207.2 215.6 Current xzpenditures 777.6 938.6 1308.0 1701.7 2234.7 2930.8 3389.0 4026.1 4645.2 Cgl Consumption 739.4 918.8 1293.0 1678.8 2207.5 2698.3 3303.5 3967.7 4605.3 Subl Subsidies 31.3 12.0 5.7 8.4 10.8 13.9 56.0 5.4 5.6 Fgf Transfer Payments Tglp To Private Sectt. 6.9 7.8 9.3 14.5 16.4 18.6 27.5 33.0 34.3 Sgl Government Savings 123.3 117.4 190.0 231.2 94.5 -55.5 -549.4 -574.2 -645.6 Government Capital Expenditure 414.7 464.2 666.9 857.7 1096.7 1407.8 1000.3 1136.1 741.8 CTglp Capital Transfers to Private Sec. 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 IgI Investment 414.7 464.2 666.9 857.7 1096.7 1407.8 1003.3 1136.1 741.8 Deficit Financing 291.4 346.8 476.9 626.5 1002.2 1463.3 1549.7 1710.3 1587.4 CTc1 Capital Transfer from Central Gov 413.6 509.2 737.7 1047.2 1096.4 1349.2 1484.6 1498.6 1549.4 Lagi Banking System -122.2 -162.4 -260.6 -420.7 -94.2 114.1 64.9 211.5 36.0 MONETARY SECTOR, 1978-1986 (Rp billion) 1978 1979 1980 1981 1982 1983 1984 1985 1986 NFA Not Forelgn Assets 678 1655 3101 360 -1524 3130 3686 2027 2696 Not Domestic Credit 1146 186 -253 1701 3476 1040 447 3374 4133 Lmgc Central Govt. Finance -342 -740 -1921 -647 527 -1392 -3389 -470 257 Lagl Local Govt. Finance -122 -162 -261 -421 -94 114 65 212 38 Lap Private Sector Credit 1610 1088 1929 2769 3043 2318 3771 3633 3838 Total Assets - Total Liabilities 1824 1841 2848 2061 1952 4170 4133 5401 6629 M2 Money and Quasimoney 678 1414 2468 2025 1359 3588 3274 5216 4702 Money 482 898 1609 1490 636 448 1012 1523 1429 Quasiaoney 196 516 859 535 723 3140 2262 3693 3273 NOL Net Other Liabilities 1146 427 380 36 593 582 859 18S 2127 Memorandum itemss Adjustments to Net Foreign Assets and Claims on Central Government 122.3 126.4 225.3 1143.7 2189.9 4723.4 Balance of Syndicated Loan Account 122.3 196.4 677.3 1440.7 2230.9 4767.4 Liabilities to WMP -70.0 -452.0 -297.0 -41.0 -44.0 BALANCE OF PAYMENTS, 1978-1986 (Rp billion) 1978 1979 1980 1f81 1982 1983 1984 1985 1986 Merchandise Exports (FOB) 4871.4 9911.0 14175.6 14950.6 13061.1 16993.2 21292.4 20500.2 17153,5 Merchandise Imports (FOB) 3705.3 6197.0 8436.8 10450.6 11809.0 16117.5 15437.3 13974.4 15056.5 Services (net) -1800.0 -3120.9 -4012.1 -4815.3 -4862.1 -6733.1 -7876.1 -8460.4 -7955.4 Factor Services (net) -1220.7 -1808.4 -4549.8 -2682.4 -3863.1 -5069.9 -5284.9 -3512.4 -4079.6 -Fgf Interest in Govt. Budget -190.3 -381.9 -435.3 -516.6 -655.3 -1005.2 -1535.5 -1731.2 -2643.2 -Fpf Other Factor Services (net) -1030.4 -1426.5 -4114.5 -2165.8 -3207.8 -4064.7 .3749.4 -1781.2 -1436.4 Non-factor Services (net) -579.3 -1312.5 537.7 -2132.9 -999.0 -1663.2 -2591.2 -4948.0 -3875.8 -RG Resource Balance 586.8 2401.5 6276.5 2367.1 253.1 -787.5 3263.9 1577.6 -1778.8 -Tgf Current (Povernment Transfers 6.2 18.7 34.5 157.9 88.6 94.6 117.0 122.2 190.4 -Sf Current Account Balance -627.7 611.8 1761.2 -157.4 -3521.4 -5762.8 -1904.0 .1812.4 -5668.0 Capital Account 627.7 -611.8 -1761.2 157.4 3521.4 5762.8 1904.0 1812.4 5668.0 Lfg Budget Financing 357.7 439.3 891.8 1018.3 2105.2 3483.2 2591.4 1627.4 4214.7 O DFI&Oth Private Sector Net Flows (incl. e&o) 948.0 603.9 448.0 -500.9 -107.8 5409.6 2998.6 2212.0 4149.3 -NFA Changes In Reserves -678.0 -1655.0 -3101.0 -360.0 1524.0 -3130.0 -3686.0 -2027.0 -2696.0 PRIVATE SECTOR ACCOUNT. 1978-86 (Rp billion) 1978 1979 1980 1981 1982 1983 1984 1985 1986 Disposable Income 18848.8 26890.8 35813.8 45525.2 48097.6 55353.2 66506.6 75642.6 82376.2 FYp Factor Income 23027.7 33451.4 48311.8 58021.1 61663.6 72077.2 85846.0 92290.9 93450.0 Fpf Net Factor Income from Abroad -1030.4 -1426.5 -4114.5 -2165.8 -3207.8 -4064.7 -3749.4 -1781.2 -1436.4 Tgp Transfer from Govt. 51.6 68.9 123.8 143.1 124.7 137.4 323.7 33.0 34.3 -Td - Direct Taxes -2963.2 -4987.6 -8204.7 -10093.5 -9964.2 -12106.2 -15307.3 -14207.7 -8880.0 -Tpg - Transfer to Govt. -237.0 -215.4 -302.6 -379.7 -518.7 -690.5 -606.4 -692.4 -791.7 Uses of Disposable Income 18848.8 26890.8 35813.8 45525.2 48097.6 55353.2 66506.6 75642.6 82376.2 Cp Private Consumption 15230.3 20513.6 25680.6 33768.6 38999.2 48112.2 57295.0 64721.6 70799.9 Sp Private Savings 3618.5 6377.2 10133.2 11756.6 9098.4 7241.0 9211.6 10921.0 11576.3 Capital Sources 6314.8 8291.2 12930.6 14504.2 12406.5 15496.4 16381.3 17158.8 19822.2 Sp Private Savings 3618.5 6377.2 10133.2 11756.6 9098.4 7241.0 9211.6 10921.0 11576.3 Lmp Loans from Banks 1610.2 1088.4 1928.8 2768.7 3043.2 2317.9 3771.1 3632.5 3638.0 CTgp,cl Capital Transfers from Govt. 138.1 221.7 420.6 479.8 372.7 527.9 400.0 393.3 258.6 DFI&oth External Financing 948.0 603.9 448.0 -500.9 -107.8 5409.6 2998.6 2212.0 4149.3 Capital Uses 6314.8 8291.2 12930.6 14504.2 12406.5 15496.4 16381.3 17158.6 19822.2 Ip Real Investment 4490.8 6450.2 10082.6 12443.2 10454.5 11326.4 12248.3 11757.8 12993.2 MDOS+NOL Money & Quasi-Honey 1824.0 1841.0 2848.0 2061.0 1952.0 4170.0 4133.0 5401.0 6829.0 SOURCES AND USES OF FUNDS: INDONESIA, 1978 (Rp billion) Central Local Private Monetary Bal. of National TOTAL Gov. Gov. Sector System Payments Accounts SOURCES Current Account Central Gov. 2954 863 3817 Local Gov. 511 247 112 870 Private Sector 45 7 23028 23079 Monetary System 0 Bal. of Payments 184 1030 -587 628 National Accounts 23416 Consumption 1817 739 15230 17787 Saving 1259 123 3618 628 5629 TOTAL USES 3817 870 23079 0 628 23416 Capital Account Central Gov. -342 358 1259 1275 Local Gov. 414 -122 123 415 Private Sector 138 1610 948 3618 6315 Monetary System 1824 1824 Bal. of Payments 678 628 1306 National Accounts 723 415 4491 5629 TOTAL USES 1275 415 6315 1824 1306 5629 I& D , SOURCES AND USES OF FUNDS: INDONESIA, 1979 (Rp billion) Central Local Private Monetary Bal. of National TOTAL GoV. Gov. Sector System Payments Accounts SOURCES Current Account Central Gov. 4948 737 5685 Local Gov. 633 255 156 1044 Private Sector 61 8 33451 33520 Monetary System Sal. of Payments 363 1427 -2402 -612 National Accounts 31943 Consumption 2359 919 20514 23791 Saving 2269 117 6377 -612 8152 TOTAL USES 5685 1044 33520 0 -612 31943 - Capital Account Central Gov. -740 439 2269 1969 Local Gov. 509 -162 117 464 Private Sector 222 1088 604 6377 8291 Monetary System 1841 1841 Bal. of Payments 1655 -612 1043 National Accounts 1238 464 6450 8152 TOTAL USES 1969 464 8291 1841 1043 8152 H I 0. SOURCES AND USES OF FUNDS: INDONESIA, 1980 (Rp billion) Central Local Private Monetary Bal. of National TOTAL Gov. Gov. Sector System Payments Accounts SOURCES Current Account Central Gov. 8130 387 8516 Local Gov. 900 378 215 1492 Private Sector 115 9 48312 48436 Monetary System 0 Bal. of Payments 401 4115 -6277 -1761 National Accounts 42637 Consumption 3855 1293 25681 30828 Saving 3247 190 10133 -1761 11609 TOTAL USES 8516 1492 48436 0 -1761 42637 Capital Account Central Gov. -1921 892 3247 2218 Local Gov. 738 -261 190 667 Private Sector 421 1929 448 10133 :.2931 Monetary Systm 2848 2646 Bal. of Paymaets 3101 -1761 1340 National Accounts lOS9 667 10083 11809 TOTAL USIS 2218 667 12931 2848 1340 11809 It :1> O H SOURCES AND USES OF FUNDSt INDONESIA, 1981 (Rp billion) Central Local Private Monetary Bal. of National TOTAL Gov. Gov. Sector System Payments Accounts SOURCES Current Account Central Gov. 9958 142 10100 Local Gov. 1151 515 259 1925 Private Sector 129 15 58021 58164 Monetary System 0 Bal. of Payments 359 2166 -2367 157 National Accounts 56054 Consumption 4773 1679 33769 40221 Saving 3688 231 11757 157 15834 TOTAL USES 10100 1925 58164 0 157 56054 w Capital Account Central Gov. -647 1018 3688 4060 Local Gov. 1047 -421 231 858 Private Sector 480 2769 -501 11757 14504 Monetary System 2061 2061 Bal. of Payments 360 157 517 National Accounts 2533 858 12443 15834 TOTAL USES 4060 858 14504 2061 517 15834 ,0 al SOURCES AND USES OF FUNDS: INDONESIA, 1982 (Rp billion) Central Local Private Monetary Bal. of National TOTAL Gov. Gov. Sector System Payments Accounts SOURCES Current Account Central Gov. 9777 659 10436 Local Gov. 1289 706 324 2318 Private Sector 108 16 61664 61788 Monetary System o Bal. of Payments 567 3208 -253 3521 National Accounts 62393 Consumption 5021 2208 38999 46228 Saving 3451 95 9098 3521 16166 TOTAL USES 10436 2318 61788 0 3521 62393 Capital Account Central Gov. 527 2105 3451 6083 Local Gov. 1096 -94 9S 1097 Private Sector 373 3043 -108 9098 12407 Monetary System 1952 1952 Bal. of Payments -1524 3521 1997 National Accounts 4614 1097 10455 16166 TOTAL USES 6083 1097 12407 1952 1997 16166 SOURCES AND USES OF FUNDS: INDONESIA, 1983 (Rp billion) Central Local Private Monetary Bal. of National TOTAL Gov. Gov. Sector System Payments Accounts SOURCES Current Account Central Cov. 11843 1202 13045 Local Gov. 1489 954 419 2861 Private Sector 119 19 72077 72215 Monetary Systm 0 Sa. of Payments 911 4065 78 5763 Iatiosal Accouats 7U45 Comsiptloc 5179 2696 8112 51o Saving 5347 -56 7241 5763 182W TOTAL USES 13045 2561 72215 0 5763 74465 Capital Account Central Ccv. -1392 3483 5347 7439 Local Cov. 1349 114 -56 1408 Private Sector 528 2318 5410 7241 15496 Monetary System 4170 4170 Bal. of Payments 3130 5763 8893 National Accounts 5561 1408 11326 18296 TOTAL USES 7439 1408 15496 4170 8893 18296 SOURCES AND USES OF FUNDS: INDONESIA, 1984 (Rp billion) Central Local Private Monetary Bal. of National TOTAL Gov. Gov. Sector System Payments Accounts SOURCES Current Account Central Gov. 15239 1382 16621 Local Gov. 1799 675 308 2782 Private Sector 296 28 85846 86170 Monetary System 0 Bal. of Payments 1419 3749 -3264 1904 National Accounts 84272 Consumption 5917 3304 57295 66515 Saving 7190 -549 9212 1904 17756 TOTAL USES 16621 2782 86170 0 1904 84272 Capital Account Central Gov. -3389 2591 7190 6393 Local Gov. 1485 65 -549 1000 Private Sector 400 3771 2999 9212 16381 Monetary System 4133 4133 Bal. of Payments 3686 1904 5590 National Accounts 4508 1000 12248 17756 TOTAL USES 6393 1000 16381 4133 5590 17756 IIt SOURCES AND USES OF FUNDS: INDONESIA, 1985 (Rp billion) Central Local Private Monetary Bal. of National TOTAL Gov. Gov. Sector System Payments Accounts SOURCES Current Account Central Gov. 14216 3351 17567 Local Gov. 2338 684 425 3447 Private Sector 0 33 92291 92324 Monetary System 0 Bal. of Payments 1609 1781 -1578 1812 National Accounts 94489 Consumption 7436 3988 64722 76145 Saving 6184 -574 10921 1812 18343 TOTAL USES 17567 3447 92324 0 1812 94489 Capital Account Central Gov. -470 1627 6184 7342 Local Gov. 1499 212 -574 1136 Private Sector 393 3633 2212 10921 17159 Monetary System 5401 5401 Bal. of Payments 2027 1812 3839 National Accounts 5449 1136 11758 18343 TOTAL USES 7342 1136 17159 5401 3839 18343 IIt SOURCES AJD USES OF FUNDS: INDONESIA, 1986 (Rp billion) Central Local Private Monetary Bal. of National TOTAL Gov. Gov. Sector System Payments Accounts SOURCES Current Account Central Gov. 8960 5950 14910 Local Gov. 2640 712 442 3794 Private Sector 0 34 93450 93484 Monetary System ° Bal. of Payments 2453 1436 1779 5668 National Accounts 101621 Consumption 6792 4605 70800 82198 Saving 3025 -846 11576 5668 19424 TOTAL USES 14910 3794 93484 0 5668 101621 co Capital Account Central Gov. 257 4215 3025 7497 Local Gov. 1549 38 -846 742 Private Sector 259 3838 4149 11576 19822 Monetary Systems 6829 6829 Bal. of Payments 2696 5668 8364 National Accounts 5689 742 12993 19424 TOTAL USES 7497 742 19822 6829 836A 19424 II NATIONAL ACCOUNTS, 1978-86 (As percentage of GDP) 1978 1979 1980 1981 1982 1983 1984 1985 198I GDP Gross Do estic Product lOO.OS 100.0? 100.01 100.0l 100.0 100.0 100.0l 100.01 100.0 Cp Private Consumption 63.52 59.7Z 5.52 57.8? 62.32 65.3? 65.SZ 67.4? 70.9t Cgc+Cgl Government Consumption 10.7? 9.5Z 10.5? 11.0 11.5? 11.0? 10 .5 11.9? 11.41 Ig+Ip Gross Investment 23.5? 23.7? 24.1S 27.1? 25.8? 24.8? 20.3? 19.1? 19.5? Igc+Igl Government Investment 4.7? 5.02 3.5 5.8Z 9.1? 9.5? 6.32 6.91 6.4? Ip Private Investment 18.7? 18.8? 20.6? 21.3? 16.7? 15.4? 14.0? 12.2? 13.0S -RG Resource Gap 2.4? 7.0? 12.8? 4.1? 0.4? -1.1? 3.7? 1.6? -1.8? Memorandum items Total Change in Stocks 0.6? 1.4? 2.6? 2.9? 0.5? -0.9? -2.3? -1.3? -1.0? ",ude Oil -Ol. 0.6? 1.6? 1.7? 0.2? -1.3? -1.5? -0.9? -1.1? Petroleum Products 0.4S 0.21 0.2? 0.8? 0.1? 0.1? -1.2? -0.6? 0.0? Rice -0.1? 0.0? 0.1? OO. 0.0? OO. OO. OO. 0.0? Other 0.3Z 0.7? 0.7? 0.4? 0.2? 0.3? 0.4? 0.2? 0.1? it' CENTRAL GOVERNMENT ACCOUNTS, 1978-1986 (As percentage of GDP) 1978 1979 1980 1981 1982 1983 1984 1985 1986 Current Receipts :7.01 18.61 20.41 20.71 19.3t 19.71 20.61 19.6t 16.0S Tdc Direct Taxes 12.01 14.21 16.41 16.91 15.41 15.91 17.21 14.51 6.61 Tic Indirect Taxes 4.3Z 3.86 3.3Z 3.01 3.1S 3.0S 2.71 3.7S 5.2S Tpgc Transfers from Private Sector 0.31 0.21 0.21 0.11 0.2Z 0.21 0.21 0.31 0.4S -Tgf Transfers from Rest of the World 0.01 0.11 0.11 0.31 0.11 0.11 0.11 0.1S 0.21 FYgc Property incomes and OS 0.42 0.31 0.42 0.41 0.5S 0.51 0.51 1.01 1.6S Current Expenditures 11.86 12.01 13.7Z 14.4? 13.86 12.51 12.5S 13.21 13.01 Cgc Consumption 7.61 6.92 7.91 8.21 8.01 7.01 6.62 7.71 6.81 Subc Subsidies 1.12 2.01 2.91 3.22 2.51 1.92 1.61 1.21 0.9t Fgf Interest on External Debt 0.86 1.1t 0.9? 0.9? 1.02 1.4S 1.8? 1.8S 2.621 Transfer Payments Tgcp To Private Sector 0.21 0.2Z 0.21 0.22 0.21 0.21 0.31 0.0S 0.01 o Tcl To Local Govt. 2.1S 1.6S 1.8Y 2.01 2.11 2.01 2.11 2.42 2.61 Sgc Government Savings 5.21 6.61 6.61 6.31 5.51 7.3Z 8.21 6.41 3.01 Government Capital Expenditure 5.3Z 5.72 4.52 6.91 9.72 10.12 7.32 7.61 7.51 CTgp Capital Transfers to Private Sec. 0.61 0.62 0.92 0.82 0.62 0.72 0.5 0.42 0.31 CTcl Capital Transfer to Local Govt. 1.7Z 1.52 1.51 1.8? 1.86 1.82 1.72 1.62 1.61 Igc Investment 3.0S 3.6Z 2.22 4.32 7.42 7.5Z 5.1? 5.71 5.71 Deficit Financing 0.12 -0.91 -2.11 0.62 4.21 2.86 -0.92 1.21 4.52 Lmgc Banking System -1.42 -2.2S -3.92 -1.11 0.8? -1.91 -3.9Z -U.5 0.31 Lfg Ezternal Borrowing 1.52 1.31 1.81 1.71 3.4Z 4.72 3.02 1.71 4.22 Memorandum items: Non-oil Tax Revenue 7.01 6.22 5.61 5.41 5.91 S.6S 5.41 6.22 6.22 Adjusted Oil Revenue 9.22 11.81 14 11 14.51 12.62 13.22 14.51 12.02 5.61 co PROVINCIAL AND LOCAL GOVERNMENT ACCOUNTS, 1978-1986 (As percentage of GDP) 1978 1979 1980 1981 1982 1983 1984 1985 1986 Current Receipts 3.82 3.1S 3.11 3.3Z 3.72 3.92 3.2S 3.6S 3.8S Tdl Direct Taxes 0.42 0.3Z 0.3Z 0.4Z 0.52 0.52 0.3S 0.31 0.32 Til Indirect Taxes 0.3Z 0.3Z 0.2Z 0.22 0.3Z 0.31 0.2Z 0.22 0.21 Tpgl Transfers from Private Sector 0.7S 0.42 0.42 0.52 0.7S 0.81 0.52 0.42 0.41 Tcl Transfers from Central Govt. 2.12 1.82 1.82 2.02 2.12 2.02 2.12 2.42 2.61 FYgl Property incomes and OS 0.32 0.22 0.22 0.22 0.32 0.32 0.22 0.22 0.21 Current Expenditures 3.22 2.72 2.72 2.92 3.62 4.02 3.92 4.22 4.72 Cgl Consumption 3.12 2.72 2.62 2.92 3.52 3.92 3.82 4.21 4.62 Subi Subsidies 0.11 0.02 0.02 0.02 0.02 0.02 0.12 0.02 0.02 Fgf Transfer Payments Tglp To Private Sector 0.02 0.02 0.02 0.02 0.02 0.02 0.02 0.02 0.02 Sgl Government Savings 0.52 0.32 0.42 0.42 0.22 -0.11 -0.62 -0.62 -0.82 Government Capital Expenditure 1.7Z 1.42 1.4Z 1.52 1.82 1.91 1.12 1.22 0.72 CTglp Capital Transfers to Private Sec. 0.02 0.02 0.02 0.02 0.0Z 0.0S 0.02 0.02 0.02 Igl Investment 1.72 1.42 1.42 1.52 1.82 1.92 1.12 1.22 0.72 Deficit Financing 1.22 1.02 1.02 1.12 1.6S 2.02 1.82 1.82 1.61 CTcl Capital Transfer from Central Gov 1.7S 1.52 1.52 1.82 1.8Z 1.82 1.7Z 1.62 1.62 Lmgl Banking System -0.52 -0.52 -0.52 -0.72 -0.22 0.22 0.11 0.22 0.02 MONETARY SECTOR, 1978-1986 (As percentage of GDP) 1978 1979 1980 1981 1982 1983 1984 1965 1986 NhA Net Foreign Assets 2.8S 4.82 6.32 0.62 -2.4Z 4.22 4.22 2.1S 2.7Z Net Domestic Credit 4.81 0.51 -0.5 2.9Z 5.5Z 1.42 0.51 3.52 4.1Z Lmgc Central Govt. Finance -1.4S -2.21 -3.92 -1.1 0.8S -1.92 -3.91 -0.52 0.31 Lrgl Local Govt. Finance -0.52 -0.52 -0.52 -0.72 -0.22 0.22 O.1Z 0.21 0.0O LMp Private Sector Credit 6.72 3.22 3.92 4.72 4.92 3.12 4.32 3.81 3.02 Total Assets - Total Liabilities 7.62 5.42 5.82 3.52 3.12 5.7Z 4.72 5.62 ..82 N2 Money and Quasimoney 2.82 4.1S 5.02 3.52 2.22 4.92 3.7Z 5.42 4.72 Money 2.02 2.62 3.32 2.6Z 1.0 0.62 1.2Z 1.6S 1.41 Quasimoney 0.82 1.52 1.82 0.92 1.22 4.32 2.62 3.82 3.32 NOL Net Other Liabilities 4.82 1.22 0.8Z O.12 0.9S 0.8S 1.01 0.2S 2.1Z Memorandum items: Adjustments to Met Foreign Assets and Claims on Central Government 0.22 0.22 0.32 1.32 2.32 4.72 Balance of Syndicated Loan Account 0.22 0.32 0.92 1.62 2.32 4.82 Liabilities to flU O.O. -0.12 -0.62 -0.32 O.O O.O BALANCE OF PAYMENTS, 1978-1986 (As percentage of GDP) 1978 1979 1980 1981 1982 198' 1984 1985 1986 Merchandise Exports (FOB) 20.3Z 28.9S 29.0S 25.61 20.81 '3.11 24.31 21.31 17.21 Merchandise Imports (FOB) 15.42 18.01 17.21 17.91 18.91 21.91 17.61 14.51 15.11 Services (net) -7.51 -9.12 -8.21 -8.22 -7.81 -9.11 -9.01 -8.86 -8.01 Factor Services (net) -5.11 -5.31 -9.31 -4.62 -6.21 -6.91 -6.0S -3.7? -4.12 -Fgf Interest in Govt. Budget -0.82 -1.1 -0.91 -0.92 -1.02 -1.4S -1.82 -1.81 -2.61 -Fpf Other Factor Services (net) -4.31 -4.21 -8.41 -3.71 -5.12 -5.51 -4.31 -1.9S -1.41 Non-factor Services (net) -2.4S -3.82 1.12 -3.71 -1.61 -2.32 -3.02 -5.2S -3.91 -RG Resource Balance 2.42 7.02 12.81 4.11 0.4? -1.11 3.72 1.6? -1.81 -Tgf Current Government Transfers 0.01 0.1S 012 0.3? 0.1? 0.11 0.1S 0.1? 0.22 -Sf Current Account Balance -2.62 1.8S 3.61 -0.3Z -5.61 -7.8? -2.22 -1.9? -5.71 Capital Account 2.61 -1.81 -3.61 0.31 5.62 7.81 2.21 1.91 5.7? Lfg Budget Financing 1.5? 1.32 1.81 1.71 3.4Z 4.72 3.0S 1.72 4.21 w DFI&Oth Private Sector Net Flows (incl. e&o) 3.92 1.82 0.92 -0.9? -0.21 7.3? 3.4? 2.3? 4.22 -NPA Changes In Reserves -2.81 -4.8? -6.3? -0.6? 2.4? -4.21 -4.21 -2.11 -2.71 II PRIVATE SECTOR ACCOUNT, 1978-86 (As percentage of GDP) 1978 1979 1980 1981 1982 1983 1984 1985 1986 Disposable Income 78.51 78.32 73.22 77.9? 76.8S 75.1l 76.0S 78.72 82.51 FYp Factor Income 95.91 97.41 98.81 99.31 98.41 97.81 98.11 96.1S 93.61 Fpf Net Factor Income from Abroad -4.3Z -4.21 -8.42 -3.71 -5.11 -5.51 -4.31 -1.91 -1.41 TSgp Transfer from Govt. 0.2Z 0.2Z 0.3Z 0.2Z 0.21 0.21 0.42 O.O01 O.O0 -Td - Direct Taxes -12.31 -14.51 -16.81 -17.31 -15.91 -16.4Z -17.51 -14.82 -8.91 -Tpg - Transfer to Govt. -1.01 -0.61 -0.61 -0.62 -0.8? -0.9S -0.71 -0.72 -0.81 Uses of Disposable Income 78.51 78.31 73.22 77.92 76.82 75.1? 76.01 78.71 82.S5 Cp Private Consumption 63.5S 59.71 52.51 57.81 62.3Z 65.32 65.51 67.41 70.91 Sp Private Savings 15.11 18.61 20.7Z 20.11 14.51 9.81 10.51 11.41 11.6S Capital Sources 26.31 24.11 26.41 24.81 19.81 21.01 18.71 17.92 19.92 ~ Sp Private Savings 15.11 18.61 20.71 20.11 14.51 9.82 10.51 11.42 11.61 Lap Loans from Banks 6.7Z 3.2 S 3.9Z 4.71 4.92 3.12 4.31 3.86 3.8S CTgp,cl Capital Transfers from Govt. 0.6Z 0.62 0.92 0.81 0.6Z 0.72 0.51 0.42 0.31 DFI&oth Zxternal Financing 3.92 1.81 0.91 -0.91 -0.21 7.32 3.42 2.32 4.21 Capital Uses 26.31 24.11 26.42 24.82 19.82 21.01 18.71 17.91 19.92 Ip Real Investment 18.7Z 18.82 20.61 21.31 16.71 15.41 14.01 12.21 13.01 MDOS+NOL Money & Quasi-Money 7.61 5.41 5.81 3.51 3.11 5.71 4.7S 5.6S 6.81 SOURCES AND USES OF FUNDS: INDONESIA, 1978 (As percentage of GDP) Central Local Private Monetary Bal. of National TOTAL Gov. Gov. Sector System Payments Accounts SOURCES Current Account Central Gov. 12.3? 3.6S 15.92 Local Gov. 2.12 1.0 0.52 3.62 Private Sector 0.2? 0.0? 95.9? 96.2? Monetary System 0.01 Bal. of Payments 0.8? 4.3Z -2.4? 2.62 National Accounts O.O0 Consumption 7.6? 3.12 63.5? 74.12 Saving 5.22 0.52 15.1? 2.6? 23.5? TOTAL USES 15.9? 3.62 96.2? 0.0? 2.6? 97.62 Capital Account Central Gov. -1.42 1.5? 5.2? 5.3? Local Gov. 1.7? -0.52 0.5? 1.7? Private Sector 0.62 6.72 3.9? 15.1? 26.32 Monetary System 7.6? 7.6? Bal. of Payments 2.8Z 2.6? 5.4? National Accounts 3.0? 1.7? 18.72 23.5? TOTAL USES 5.3Z 1.7? 26.3? 7.6? 5.4Z 23.52 I SOURCES AND USES OF FUNDS: INDONESIA, 1979 (As percentage of GDP) Central Local Private Monetary Bal. of National TOTAL Gov. Gov. Sector System Payments Accounts SOURCES Current Account Central Gov. 14.42 2.12 16.61 Local Gov. 1.8Z 0.7Z 0.52 3.02 Private Sector 0.2? 0.02 97.42 97.62 Monetary System 0.02 Bal. of Payments 1.12 4.22 -7.02 -1.82 National Accounts 0.02 Consumption 6.92 2.72 59.72 69.32 Saving 6.62 0.3Z 18.6Z -1.82 23.72 TOTAL USES 16.62 3.02 97.62 0.02 -1.82 93.02 Capital Account Central Gov. -2.22 1.32 6.62 5.72 Local Gov. 1.52 -0.52 0.3Z 1.42 Private Sector 0.62 3.22 1.82 18.62 24.12 Monetary System 5.4Z 5.42 Bal. of Payments 4.82 -1.82 3.02 National Accounts 3.62 1.42 18.82 23.72 TOTAL USES 5.72 1.42 24.12 5.42 3.02 23.72 SOURCES AND USES OFP UNDS: INDONESIA, 1980 (As percentage of GDP) Central Local Private Monetary Dal. of National TOTAL Gov. Gov. Sector Systm Payments Accounts SOURCES Current Account Central Gov. 16.61 0.61 17.41 Local oy. 1.61 081 0.41 3.11 Private Sector 0.21 0.01 OS.$ 99.01 Monetary Systm 0.*@ Sa. of Pay ents O 0.81 .4 -12.61 -3.61 National Accounts 0.0O Consuption 7.9Z 2.61 52.51 63.01 Saving 6.61 0.41 20.7Z -3.61 24.11 TOTAL USES 17.41 3.12 99.0? 0.01 -3.61 877.2 Capital Account Central Gov. -3.91 1.$6 6.61 4.5? Local Gov.. 1.5 -0.51 0.41 1.41 Private Sector 0.92 3.91 0.92 20.'? 26.42 Monetary System 5.82 5.8U Bal. of Payments 6.31 -3.61 2.71 National Accounts 2.22 1.41 20.61 24.12 TOTAL USES 4.5Z 1.42 26.4Z 5.81 2.72 24.12 i' SOURCES AND USES OF FUNDS: INDONESIA, 1981 (As percentage of GDP) Central Local Private Monetary Bal. of National TOTAL Gov. Gov. Sector System Payments Accounts SOURCES Current Account Central Gov. 17.OZ 0.2Z 17.3? Local Gov. 2.OZ 0.9? 0.4Z 3.32 Private Sector 0.2S 0.02 99.3Z 99.6? Monetary System 0.*0 Sal. of Payments 0.61 3.7? -4.1? 0.3Z National Accounts O.O0 Consumption 8.2? 2.9? 57.8? 68.*8 Saving 6.32 0.4? 20.1? 0.3? 27.11 TOTAL 1Ss 17.31 3.3? 99.6? 0.0? 0.3? 95.9? Capital Account Central Cor. -1.1? 1.7? 6.3? 6.9? Local Cow. 1.6? -0.7? 0.4? 1.5? Private Sector 0.5? 4.7? -0.9? 20.11 24.81 IbAotary System 3.51 3.5? Sal. of Paymnts 0.6? 0.31 0.91 national Accouts 4.3X 1.5? 21.3? 27.1? t0AL nus 6.9 1.51 24.81 3.5? 0.9? 27.1? SOURCES AND USES OF FUNDS: INDONESIA, 1982 (As percentage of GDP) Central Local Private Monetary Bal. of National TOTAL Gov. Gov. Sector System Payments Accounts SOURCES Current Account Central Gov. 15.62 1.1 16.72 Local Gov. 2.12 l.l 0.5Z 3.72 Private Sector 0.22 O.O 98.42 98.62 Monetary System 0.02 Bal. of Payments 0.92 5.1T -0.42 5.62 National Accounts 0.0z Consumption 8.02 3.52 62.32 73.82 Saving 5.5Z 0.22 14.52 5.62 25.82 TOTAL USES 16.72 3.72 98.62 0.02 5.6Z 99.62 Capital Account Central Gov. 0.82 3.42 5.52 9.72 Local Gov. 1.8Z -0.22 0.22 1.82 Private Sector 0.62 4.92 -0.22 14.5Z 19.82 Monetary System 3.12 3.12 Bal. of Payments -2.42 5.62 3.22 National Accounts 7.42 1.82 16.72 25.82 TOTAL USES 9.72 1.82 19.82 3.12 3.22 25.82 iit SOURCES AND USES OF FUNDS: INDONESIA, 1983 (As percentage of GDP) Central Local Private Monetary Bal. of National TOTAL Gov. Gov. Sector System Payments Accounts SOURCES Current Account Central Gov. 16.12 1.6S 17.7S Local Gov. 2.OZ 1.32 0.6Z 3.9Z Private Sector 0.22 0.02 97.82 98.0Z Monetary System 0.02 Bal. of Payments 1.2Z 5.52 1;12 7.82 National Accounts 0.02 Consumption 7.0Z 3.92 65.32 76.22 Saving 7.32 -0.12 9.82 7.82 24.82 TOTAL USES 17.72 3.92 98.02 0.0Z 7.8Z 101.12 Capital Account Central Gov. -1.92 4.72 7.32 10.12 Local Gov. 1.82 0.22 -0.1Z 1.92 Private Sector 0.7Z 3.1Z 7.32 9.82 21.02 Monetary System 5.7Z 5.72 Bal. of Payments 4.22 7.82 12.12 National Accounts 7.5Z 1.9Z 15.42 24.82 TOTAL USES 10.1Z 1.92 21.0Z 5.7Z 12.1Z 24.82 11. > 0 _ SOURCES AND USES OF FUNDS: INDONESIA, 1984 (As percentage of GDP) Central Local Private Monetary Bal. of National TOTAL Gov. Gov. Sector System Payments Accounts SOURCES Current Account Central Gov. 17.4Z 1.6S 19.0S Local Gov. 2.11 0.8S 0.4O 3.21 Private Sector 0.3S 0.01 98.11 98.41 Monetary Syste_ 0.0O Di. of Paymnts 1.61 4.32 -3.72 2.21 National Accots 0.01 Ccasu ptim 6.6x 3.61 65.51 76.01 Savig *.21 -0.02 10.51 2.21 20.31 TOtAL USS 19.01 3.21 98.41 0.02 2.21 96.31 Capital Account Central Cov. -3.92 3.02 8.21 7.31 Local Cov. 1.71 0.11 -0.61 1.11 Private Sector 0.51 4.32 3.41 10.51 16.71 Monetary Systen 4.71 4.72 Da. of Payments 4.22 2.22 6.4* National Accounts 5.1Z 1.11 14.0 20.3Z TOTAL 1538 7.51 1.11 18.72 4.71 6.42 20.32 SOURCES AND USES OF FUNDS: INDONESIA, 1985 (As percentage of GDP) Central Local Private Monetary Bal. of National TOTAL Gov. Gov. Sector System Paymenta Accounts SOURCES Current Account Central Gov. 14.8r 3.51 18.31 Local Gov. 2.41 0.72 0.4S 3.61 Private Sector 0.02 0.01 96.1S 96.1S Monetary System 0.01 Bal. of Payments 1.71 1.91 -1.61 1.91 National Accounts 0.01 Consumption 7.71 4.21 67.4Z 79.32 Saving 6.42 -0.61 11.42 1.92 19.11 TOTAL USES 18.31 3.6Z 96.11 0.01 1.9S 98.41 S Capital Account Central Gov. -0.51 1.71 6.41 7.61 Local Gov. 1.6S 0.2Z -0.61 1.2S Private Sector 0.42 3.81 2.31 11.41 17.91 Monetary System 5.6 * 61 Sal. of Payments 2.11 1.91 4.01 National Accounts 5.71 1.21 12.2Z 19.11 TOTAL USSS 7.61 1.21 17.9Z 5.61 4.01 19.11 'It SOURCES AND USES OF FUNDSt INDONESIA, 1986 (As percentage of GDP) Central Local Private Monetary Bal. of National TOTAL Gov. Gov. Sector System Payments Accounts SOURCES Current Account Central Gov. 9.0Z 6.02 14.91 Local Gov. 2.6Z 0.7Z 0.4Z 3.8Z Private Sector 0.02 O.OZ 93.62 93.6Z Monetary System 0.02 Bal. of Payments 2.5Z 1.42 1.82 5.7Z National Accounts 0.01 Consumption 6.8Z 4.62 70.91 82.3Z Saving 3.0Z -0.8Z 11.6Z 5.72 19.51 TOTAL USkIS 14.92 3.82 93.62 O.OZ 5.7Z 101.82 Capital Account Central Gov. 0.32 4.2Z 3.02 7.5Z Local Gov. 1.6Z 0.02 -0.8Z 0.72 Private Sector 0.32 3.8Z 4.2Z 11.6Z 19.92 Monetary System 6.82 6.82 Bal. of Payments 2.7Z 5.72 8.42 National Accounts 5.7Z 0.72 13.02 19.52 TOTAL USES 7.5Z 0.7Z 19.92 6.8Z 8.4Z 19.5Z >I Appendix 2 - 134- Page 1 THE NON-OIL TAX SYSTEM A. Tax Reform 1. The tax reform consisted of the introduction of a new income tax covering both individuals and corporations, a value-added tax (VAT) with a separate sales tax on luxury goods, a new land and buildings tax (PBB) and a stamp duty tax. The reform was operational-zed t yough an overall law concerning General Tax Provisions and Procedures _ 2/pproved by the Indonesian Parliament in December 1983 and four separate laws.- The new income tax lAw became effective as of January 1, 1984. It replaced the Corporate Income Tax Law of 1925, the Individual Income Tax Law of 1944, and the tax law on Interest Dividends and Royalty of 1970. The VAT and the luxury sales tax were introduced in April 1985 and the 1951 Sales Tax Law was revoked. On January 1, 1986, both the new law regarding land and buildings (property tax or PBB), and the new stamp duty law became effective. In terms of broad income categories, they replace IPEDA (the land tax), the n 3e wealth tax, the Stamp Duty Regulation of 1921 and seven earlier ordinances.' Principles 2. As recognized by the tax reform team, the twin objectives of increased revenue from non-oil taxes, and an improvement in administrative efficiency in transferring resources to the pablic sector called for the following basic principles in designing the new tax laws: (a) tax laws should be unambiguous and simple; (b) nominal tax rates should be low and rate differentiation should be kept at a minimum; (c) official assessment should be replaced by a system of self-assessment and depersonalization in the determin- ation of tax liabilities; and (d) the tax base should be as broad as possible. 3. The four laws covering the tax reform as originally passed by the Parliament are largely free of ambiguity. Extensive definitions of taxable objects and subjects with quantified criteria feature in the laws themselves 1/ Law of the Republic of Indonesia, number 6, year 1983, Concerning General Tax Provisions and Procedures. 2/ These are Laws of the Republic of Indonesia: (a) number 7, year 1983 concerning Income Tax; (b) number 8, year 1983 concerning Value Added Tax on Goods and Services and Sales Tax on Luxury Goods; (c) number 12, year 1985 regarding Land and Building Tax; (d) number 13, year 1985 regarding Stamp Duty Tax. 3/ These are: Houshold/Domestic Tax Ordinance 1908; Realty Ordinance of Indonesia 1923; Realty Ordinance 1928; Property Tax Ordinance 1932; Road Tax Ordinance 1942; Article 14 letters j, k, and 1 of Emergency Law No. 11 year 1957 regarding General Provisions on Regional Taxes; and Government Regulation in lieu of Law No. 11 of year 1959 regarding Tax on Agricultural Products. Appendix 2 - 135- Page 2 identifying the statutory tax bases. This is in sharp contrast with the old system in which a multitude of decrees were to provide the legal framework for the l4yying of taxes, without clear overall definitions of the taxable sub- ject.-' Accounting standards were particularly ill defined. The new tax system is simple in the sense that it allows for very few exemptions and deductions. Special tax incentives, aimed at achieving nonrevenue objectives, such as the investment allowance, tax holidays and special accelerated depre- ciation schemes were abolished altogether. This was done with the awareness that the incentives had proven to be ineffective and represented a consider- able burden in tax administration. Under the new tax reform laws, nominal tax rates are lowered and rate differentiation is reduced. Only 3 rates (15%, 25Z and 35Z) apply on income of corporations and individuals as compared to 17 rates under the old individual income tax alone. Luxury sales tax is now levied at rates of 10% and 20% only. Unique rates are imposed through the other taxes: 59X for VAT and an effective rate of 0.1% for the Land and Buildings Tax.- The higher tax brackets of the old system could be abolished from a revenue generating point of view for the following reasons. First, they were not broadly applied as was illustrated by a sample of 900 firms used by the tax-reform team: only 13% of all foreign multinational corporations paid the maximum corporate income tax rate of 45%. No record could be found of any individual paying income tax of 50% which legally applied on annual income levels exceeding US$12,000. Second, the lower rates were believed to be largely offset by the complete removal of the tax incentives, the limita- tion of tax exemptions and an overall broadening of the tax base. The appli- cation of low and uniform tax rates in a newly created, unique legal framework were thus considered to be most effective in obtaining an administrable and enforceable tax system. 4. Self-assessment means that the responsibility in determining taxes due lies primarily with the taxpayers themselvus and that the obligation o° a taxpayer to pay taxes, does not depend on the receipt of a tax assessment.- Depersonalization implies a considerable reducticn in the frequent contacts between tax administrators and taxpayers, and an elimination of bargaining opportunities. This is a clear departure from the previous system of univer- sal official assessment which created an enormous administrative burden for the tax department having both to identify and to determine the taxes due by each taxpayer. Moreover, the individual behavior of each tax administrator was impossible to monitor, making side-payments an attractive method, for both taxpayer and tax administrator, to settle taxes due. Under the new principles, enforcement is potentially enhanced through effective selective auditing and internal checking. The increase in revenue was to be achieved through a broadening of the base on which taxes are to be levied. An effec- 4/ Definitions of "resident taxpayer" and "small firms," for example, were not made explicit. 5/ The tax rate on the land and buildings in 0.5% applied on 20% of the value of the object. 61 See Law NJumber 6, year 1983, Azt i-e 12. Appendix 2 - 136 - Page 3 tive way to get new people into the system was the tax amnesty, pardoning 71 taxes evaded between 1979 and 1983. It lasted from April 1984 through June 1985. Approximately 195,300 individuals and 25,700 companies applied for the amnesty. The new tax laws also explicitly provide the Minister of Finance with the authority to further broaden the statutory tax base. Under the present law, for example, the VAN,can be extended to the retail level without additional legislative approval. "The laws also provide for a change in the tax rates. By government regulation the VAT rate can be changed to not less than 5% and not more than 15%. The luxury sales tax can be changed to not more than 35%. The property tax rate can be effectively increased to 0.5% by changing the official assessment ratio to 100%. Hence, the legal framework of the tax reform itself provides ample flexibility to policy-makers by allowing changes in both tax base and tax rates. Individual Taxes 5. The following paragraphs briefly describe the individual taxes that resulted from the reform. An overview of old and new taxes is presented in Table A2.1. The income tax law covers in principle all resident and nonresi- dent individuals and organizations including corporations, state-owned enter- prises, foundations and associations. Individuals present in Indonesia for more than 183 days in a consecutive 12-month period and organizations estab- lished in Irdonesia are considered resident. Nonresident tax subjects pay taxes on income received or accrued from Indonesia. These definitions of taxable subjects are broader than in the old system and made more explicit. The Minister of Finance has the authority to designate government enterprises exempt from income tax. The income tax rates are 15% for taxable income up to Rp 10 million p.a., 25% on the next Rp 40 million and 35% on additional income exceeding Rp 50 million p.a. Under the old system, 17 rates from 5% to 50% applied for individuals and rates of 20%, 30% and 45% for corporations. Personal Income Tax 6. Other differences with the old tax system concerning the personal income tax can be summarized as: 7/ The amnesty introduced a pardon for taxes evaded between 1979 and 1983. It covered individual and corporate income tax, wealth tax, withholding tax, sales tax, tax on interest, dividend and royalties and employee income tax. For those who had properly filed for income tax in 1983 and property tax in 1984, a penalty of 1% applied on taxes not paid. In other cases 10% was applied under amn -tv. 8/ Other examples include a change in the level of tax free income or a modification of the Rp 60 million p.a. turnover criterion under which firms are exempt from VAT. - 7 ~~~~~~Appendix 2 - 137 - Page 4 (a) civil servants are taxable subjects; government agencies and pension funds shall withhold income taxes; (b) fringe benefits, gifts, inheritances and payments from insurance companies from taxable income are not taxable and life insurance premiums are no longer deductible from taxable income; and (c) the family size-related tax-free income is increased to a maximum of Rp 3 840 000 p.a. as opposed to Rp 1,080,000 under the old system.Y No additional tax free income is granted for more than three dependents compared to five under the old system. The present tax-free income effectively exempts approximately 91Z of the Indonesian population from income tax. In addition, 5% of gross regular income with a rximum of Rp 30,000 per month can be deducted in calculating taxable income. Interest income from time and savings deposi ls,is exempted from the personal income tax as was the case under the old tas. _1Interest received on promissory notes is taxable. 7. Personal income tax is withheld at the applicable statutory rates on wages and salaries. A withholding rate of 15% applies on payments of divi- de.:$a, rent, royalties and interest other than that received on time and savings deposits. Payment of income to noYnesidents is withheld at 20% unless tax treaties provide for different rates.- Corporate Income Tax 8. With respect to the previous corporate income tax the main differ- ences are as follows: (a) Income tax based incentives including investment allowances, tax holidays and accelerated depreciation schemes are removed; (b) fringe benefits and charitable contributions can no longer be deduc- ted from taxable incomet 9/ The deductions allowed for are: Rp 960,000 for the individual taxpayers, an additional Rp 480,000 for a married taxpayer, an additional Rp 960,000 for a wife earning income unrelated to her husband's, an additional Rp 480,000 for each dependent up to a maximum of three. Under the old law this was Rp 240,000 for the individual taxpayer, Rp 240,000 for each legal wife and an additional Rp 120,000 for each dependent up to a ma-imum of five. 10/ Circular Director General of Taxation No. SE-25/PJ.23/1986, May 22, 1986. 11/ The main rationale for the interest exemption is a fear of capital flight, essentially to Singapore. 12/ See Income Tax Law, number 7, year 1983 Articles 21, 23 and 26. Appendix 2 - 138 - Page 5 (c) simplified and more unified depreciation schemes 131 are applied leading in general to more rapid depreciation; (d) operating losses can be carried forward only for a period of five to eight years; and (e) special concessionary tax rates for firms using public accountants or selling part of their shares publicly, are abolished. 9. Corporate income tax is withheld on dividends, rent, royalties and interest similarly to personal income tax. Income tax is also withheld at 1.51 on payments made from the state budget. When import activities are undertaken by a corporation, 2.5% of the value of the imports is withheld when the importer has an import identification number, 7.5% when he does not. 10. Dividend payments are subject to a withholding tax of 15% as a pre- payment of the income tax of the recipient. Dividends cannot be deducted as a business cost for corporations. Interest received from time and saving deposits on the other hand, is exempt from income tax and interest payments can be deducted as a business cost to the extent that they exceed interest received on time and savings deposits. Under the original implementing regulations for the income tax, a maximum debt-to-equity ratio of 3 to 1 was established to curb the customary loophole of overstating interest expendi- tures and underreporting income. However, shortly afterwards this provision was suspended under pressure from business groups who argued that if correctly applied, a debt-to-equity ratio should be defined more specifically and should vary between sectors with different production structures. Consequently, the debt-to-equity ratio was abolished and the provision was operationalized that interest expenditures are only deductible in excess of interest receipts on time and savings deposits. 11. The i e,atment of income derived from foreign-aid-financed projects is as follows. _ Personal income derived from projects is fully taxable at the normal statutory rates and should be withheld by the employer. Corporate income is not taxable. For employers also obtaining income from other sources, a distinction is to be made on the source of the income, i.e., whether or not it is derived from a foreign-aid project. 12. Recent developments with respect to corporate income tax are the following: 13/ Vintage accounting using historical costs is now replaced (with an exception when a 5% depreciation rate is applied) by the declining balance method using the written down scheme as the basis for depreciation. Four different rates apply, as opposed to ten previously. 14/ See Presidential Decree 29/1986, July 12, 1986. -139 - Appendix 2 - 139 - ~~~~Page 6 (a) Firms may revalue their assets for depreciation purposes following the September 12 devaluation of the rupiah. Losses incurred as a result of the devaluation can only be deducted from taxable profits when the losses are realized. This creates an incentive for firms to refinance foreign loans. The timing of this refinancing enables firms to plan their tax liabilities; (b) operating los lg incurred before August 1983 may no longer be carried over._ According to business circles, this regulation came unexpected and is contrary to the original reform laws allowing for the carrying over of losses from five to eight years; and (c) firms with an annual turnover of less than Rp 120 million may apply special lglculation norms for the determination of taxable income.- The turnover limit used to be Rp 60 million. Value-Added Tax 13. The main difference between the value-added tax and the old sales tax is that taxes paid on inputs can now be deducted from the output tax through the tax credit technique. Apart from encouraging record keeping, the big advantage of the VAT is that cascading, the imposition of tax on tax is in principle avoided. A uniform rate of 10% applies on all taxable value-added and on all taxable imports. In addition, rates of 10Z and 20% are levied on the sall price or import value (both excluding VAT) of certain luxury goods.- /A list of luxury goods with their respective rates is attached in Table A2.2. Under the old system, sales tax varied between 0% and 20Z for domestic goods while taxes were levied at rates ranging from 0% to 80% on imports. Tobacco products are now subject to both VAT and excises, whereas only excises were levied under the old system. VAT is also levied on petro- leum products which were previously exempt from the sales tax. The VAT tax base for petroleum products is the retail price. For all other products VAT is levied at the point of import for imports and at the manufacturers' level for domestic products. As a result, the ratio of tax to retail price is not the same for all commodities as would be the case for a consumption-type VAT, levied at the retail level. Unprocessed foodstuffs and activities such as growing of crops, raising of livestock, fishing and farming are exempt from 15/ Circular Directorate General of Taxation SE-34/PJ. 22/1986, August 5, 1986. 16/ Decree of Ministry of Finance No. 759/KMK.04/1986, August 25, 1986. 17/ In contrast to VAT, luxury sales tax cannot be credited against the output tax. Hence, cascading will occur when a luxury good is used as an input for a final good subject to VAT. Appendix 2 - 140 - Page 7 VAT. The oyiy taxable services are construction services.181 Exports are zero rated._ In addition there are certain end-use exemptions such as combis used for public transport. Small firms defined as those with an annual turnover of less than Rp 60 million do not have to levy VAT on their output. 14. There are three aspects to VAT borne by the Government. Firstly, Government as a purchaser of taxable goods must pay VAT. Until now, this aspect of the VAT, has de facto been suspended. According to the Directorate General of Taxation there are plans to fully implement this provision and to collect VAT on government purchases units in 1987. It is still unclear whether this VAT is to be actually paid for by the government unit to the deliverer of the goods or whether, and at which rate, it should be withheld by the governmental unit. Implementation of this provision will increase both government revenue and expenditure. Second, Government bears VAT on the import and delivery of certain goods and services such as medical equipment, water, cati^/ and poultry feed, machines equipment, software and basic materials,- that cannot be produced domestically. Obviously, VAT borne by the Government cannot be credited from the output tax when the above-mentioned goods are used as an input. As a result, revenue is not significantly affec- ted when goods on which VAT is borne by the Government are intermediate products. Third, VAT ?Y,goods used in projects financed through official foreign aid and loans - are borne by the Government. 15. Suspension of VAT. Under the VAT provisions, input tax paid on capital goods can be credited against the output tax. However, because of cash-flow considerations, collection of input tax 2o7 capital goods purchased by taxable firms has been suspended indefinitely.' Consequently, such input tax also cannot be deducted from the output tax, and revenues are not signi- ficantly affected. The payment of VAT on imports of capital goods by selected services such as hotels, shopping centers and fishing vessels, approved by 18/ This is to prevent the evasion of taxes on buildings through an artifical division between building materials (taxable) and, for example, "engineering services" (otherwise nontaxable). 19/ The important difference with an exempted item is that input taxes paid may be credited for exports and not for VAT exempted items. 20/ Presidential Decree No. 19, May °, 1986. While recent data are not available, the loss of revenue between April and November 1985, due to this provision was estimated by the Directorate of Taxation to be Rp 3.9 billion. 21/ Ministerial Decree No. 58, July 25, 1985 and retroactively enforced as of Kay 6, 1985. 22/ Decree of the Ministry of Finance 827/84. - 141 - Appendix 2 Page 8 BKPM, can be postponed to a maximum of five years.231 As these services do not levy VAT on their output, this postponement implies an immediate loss of revenues as it is not offset by reduced deductions. Moreover, locally produced capital goods are discriminated against. VAT on imported goods and materials 2Wch are used in the manufacturing of export commodities is also suspended.- This provision affects only cash flow and does not lead to a loss of government revenue since exports are zero-rated. Property Tax (PBB) 16. The tax on land and buildings (property tax or PBB) effective January 1, 1986, is levied at a rate of 0.5% of 20% of the sales value of land and buildings. Th2' represents an impressive simplification compared to the taxes it replaced._ / IPEDA was imposed on both income (from land, taxed at 5%) and capital value (of buildings taxed at 1% in the urban sector). The seven ordinances which were replaced by PBB each had different tax rates, and other forms of wealth (including items such as jewelry) were also in principle taxable. Total revenues are distributed in the following proportions: central government receives 19%, first level governments (provinces) 16.2%, and leWg3 II governments (municipalities) are being allocated the remaining 64.8%.- Under the new tax, the first Rp 2 million of each building is exempt. No such exemption applies for land. This may overburden tax administration without commensurate increase in tax revenue. Additional administrative difficulties may arise as it is not ar whether the user or the owner of land and buildings is the tax subject. The objective determination of the value of land and buildings, presently categorized in, respectively, 50 and 17 values per square meter, will also prove difficult. 17. The complicated 1921 Stamp Duty Law app1png both specific and ad-valorem rates has been replaced. The new law - effective January 1, 1986 levies only two specific rates of Rp 500 and Rp 1,000 on agreements of a civil nature, notarial and authorized land deeds, bank drafts, promissory notes, securities and other documents mentioning amounts in excess of Rp 1 million. The rate depends on the type of document or the nominal amount mentioned in the document. Few implementing regulations have been issued oi, this law. Administrative sanctions for nonpayment are 200% of unpaid duty. 23/ Presidential Decree 37/1986, August 13, 1986. 24/ Ministry of Finance, decree No. 485/KMK.01/1986, June 4, 1986. 25/ See footnote 3. 26/ The precise distribution formula is: 10% for central government. Of the remaining 90%, 10% is allocated to central government as collection cost. Of the remaining 81%, 80% is given to level II governments and 20% to level I governments. 27/ See Law Number 12, year 1985 regarding Land and Buildings Tax, Article 4. 28/ Law Number 13, year 1985 regarding Stamp Duty Tax. Appendix 2 -142 - Page 9 B. Other Taxes Trade Taxes 18. The Government has recently taken measures which directly reduce the incidence of import licensing and represent a new approach to trade reform. The two decrees announced by the Government on October, 1986 signalled the start of this new approach. The first, issued by the Department of Trade, revoked six previous decrees under which 329 items had been restricted to approved importers. Over half of these items were shifted to the general- importer (IU) category, while the remaining items were reclassified into four approved-importer license categories: IP, for actual users of the imports; AT, for agents licensed to import a particular brand of products; PI, for producers of the same item being imported; and IT, for the six state trading companies. Two of these categories (IP and AT) potentially represent a significant relaxation of previous license restrictions. The second decree, issued by the Department of Finance, altered the import duty applicable to 306 product groups and stipulated a list of 33 imported goods which could have a surcharge imposed. About half of the tariff changes were increases, to moderate the effects of license removal on domestic manufacturers. The tariff reductions were for inputs not produced domestically, to offset the impact of the recent devaluation. 19. The Government followed up with two similar decrees on January 15, 1987. This package affected import licensing arrangements for 616 items, of which 99 were shifted to the general-importer category, and most of the remainder reclassified into the license format developed on October 25.22 Unlike the October 25 package, there were no tariff increases to offset the removal of license restrictions. However, tariffs on another 55 items were reduced to the 0-10 range. 20. The major impact of these measures was to remove or relax import restrictions on 548 items, accounting for 37Z of all items and 60Z of total import value (see Table A2.3). These reforms focussed on a number of highly protected activities: most chemicals, paints and dyes, tires and tubes, hides and leather, paper, glass and non-batik textiles. However, there has so far been little movement on import license restrictions in the agriculture sector. And, within manufacturing, a number of important import license restrictions remain, particularly for basic iron and steel, plastics, batik fabric/clothing, and food and beverages. 21. Although not related to the trade reform program, another improve- ment was made in the administration of customs duties. Effective April 1985, a contract was given to the Swiss-based Societe Generale de Surveillance (SGS) to undertake inspection of the bulk of imported goods previously handled by 29/ 84 items remained restricted to three sole importers: BULOG, P.T. Krakatau Steel and P.T. Tambaus Timah. Appendix 2 - 143 - Page 13 the Customs Department.301 As a result, 50% of Indonesia's 13,000 customs officers have been made largely redundant. Only a limited range of goods is being handled by customs. These include crude oil, gems and precious metals, and goods with a f.o.b. value of less than US$5,000. The inspection takes place at the point of supply. SGS or its affiliate checks whether the quality and the quantity of the goods being shipped to Indonesia are in accordance with the purchase contract. SCS also verifies whether the price is consistent with reasonable limits of the price range prevailing in the exporting country. If everything is found to be in order a clean report of findings (LKP: Laporan Kebenaran Pemeriksaan) is issued by SGS. This LKP provides the basis for assessment and payment of import duties and taxes. Once this is done and certified with appropriate receipts, imported goods can be collected without further inspection at the point of arrival. The main purpose of this scheme is to prevent underinvoicing which would lead to lower import duties. About 75% of total imports to Indonesia are inspected by SGS. On September 17, 1987 GOI announced that SCS will have their contract renewed for another three years, starting next April. 22. Point-of-arrival inspection of Indonesian exports by SGS, (plywood, textiles and glassware) has been abolished. This arrangement verified that goods eligible for export certificates and refunds by the Treasury, were in fact exported. Export taxes are still levied on a selected number of goods including mineral products and wood. The importance of export taxes in total revenue, amounting to less than 1% of total non-oil tax revenue in 1985/86, is limited. Excises 23. Indonesia has a very limited system of exci3el. More than 90% of total excise tax revenue comes from cigarettes alone.- Additional excisable items include alcoholic products and sugar. For cigarettes, the excise cax base is the banderole price. The excise rate structure for cigarettes is quite complex. The rates are ad valorem and vary according to the type of cigarette (i.e., whether kretek or white); by the method of production (i.e., whether machine made or not); and by the production level of the taxable firm. The rate structure is designed to provide protection not only against imports, but also to the manually made kretek cigarettes, especially by the smaller producers. Lower rates for manually produced cigarettes are designed to protect and promote employment in the tobacco industry. The share of 30/ This was affected under Presidential Instruction Inpres IV 1985. 3ii DaEa provided by che iiniscry of Finance. Appendix 2 - 144 ~ Page 11 manually made cigarettes 4gq lined nevertheless from 42Z in 1981 to 38Z of the total production in 198S.- 24. Excise taxes on other products are essentially specific in nature. For revenue protection it is essential that the real value of specific duties is not allowed to be eroded by inflation. For example, the rate o 0p 250 per liter excise tax on beer has been in existence since October 1983, As the rate of inflation for 1984 to 1986 is estimated to be 16X, the real value of excises on beer has been reduced substantially. The rate structure for excises is summarized in Table A2.4. 32/ Data provided by Directorate General of Customs and Excises. The drop in the share of revenues for manually made cigarettes was much greater, falling by 12 percentage points between 1981 and 1985. At present more than two-thirds of the total revenue from cigarettes is derived from the machine-made cigarettes. 33/ Information provided by the Directorate General of Customs and Excises. AD Nndtx 2 Table A2.1I - 145 - al INDONESIA PUBLIC RESOURCE MAIAGCt¢NT STUDY: NON-OIL TAX REVENUES Overview Direct and Indirect Taxes Covered by Tax Reform A. Individual Income Tax Provision New law Old law Taxpayers All residenta and nonresidents earning income Individuals residing in Indonesia are resident in Indonesia, Including civil servants, but taxpayers. An Indoneti*n citizen residing out- excluding diplomatic personnel and represen- side Indonesia may be regarded as nonresident tatives of certain international organiza- taxpayer. Civil servants and diplomatic per- tion. sonnel are excluded. Definition of income All realized accretions to wealth except for Income is the total amount of money or money interest on time deposits and other exeap- value earned in a year from buminess, property, tionr. and rights to periodic payments. This includes investment income, except for interest on cer- tain time deposits. Fringe benefits are taxed under various special rates. For example, leave and education allowances, the use of a company automobile, coupany housing, work clothes and meals are all subject to apecial provisions. Furthermore, a distinction is made between management and nonmanagement employees with regard to what is considered taxable income. Worldwide or Indonesian Nonresidents are taxed only on income from Resident taxpayers are taxed on worldwide source? Indonesian sources. Residents are taxed on income, though credit for taxes paid in other worldwide income, but are eligible for credit countries on foreign source income. A nonresi- for foreign taxes paid. Nonresidents are dent is taxable only on income derived from taxed on gross income, whereas residents are Indonesian sources. taxed on gross Income minus allowable deductions. Tax rates First Rp 10 million - 152. Progressive rates ranging between 51 on annual Next Rp 40 million - 25X. income below Rp 240,000 to 502 on income above Excess above this - 351. Rp 10 million. These rates are applied to the taxable income of the taxpayer, subject to various adjustments and credits. The rates and allowable deductions are *mended annually. Income exempt from Interest on time and saving deposits Interest on certain time deposits tawation Fringe benefits received in kind Capital gains Gifts unrelated to business Inheritan:es Payments from Insurance companies Others Indivtdual deductions Rp 960,000 for the individual taxpayer. Approved business or occupational expenses. An additional Rp 480,000 for a married Contributions to a recognized penaion fund *nd taxpayer. workers' social insurance. An additional Rp 960,000 for a wife who has Life insurance premiums. income from business that ti unrelated to the Rp 240,000 for the individual taxpayer. business of her hiusband or another family An additional Rp 240,000 for each legal wife. member. An additional Rp 120,000 for each related An additional Rp 480,000 for each family dependent and foster child, up to a mximum of 5 member by blood or marriage in a straight per family. ltne who is a full dependent, up to 3 indivi- duals per family. These deduction levels are, at present not indexed for Inflation. Withholding Employers withhold taxes on wages, salaries, Employee withhold on wages and salaries. honorariums, etc., paid to employees. Companies withold taxes on dividends, interest Government agencies and pension fund organi- and royalties. zations do likewise. If the recipient is a resident the withholding Corporations withhold 151 of domestic pay- is considered an advance payment of income ments of dividends, interest, rent and royal- tax. If the recipient is a nonresident, the ties and 201 of umch paymnts abroad. withholding is a final tax. An Individual who hL no Inwc e o;thr thea Tne witnholding rate is 20S on dividends, work Income subject to withholding is not interest and royalties. The interest on liable for any further income tax than that foreign-based loans is withheld at a 101 rate. which ti withheld, i.e., be need not file a tax return. - 146 - W6 2 S. Corporate Income Tax Provision New law Old 1la Taxpeyers Resident and nonresident organizations Corporations, companies, pertwerebipe and earning inco,e in Indonesia, including cor- cooperatives earning incom in Indonesia. porations, partnerships, foundations and Companiee in certain fields are subject to a cooperatives, corporate income tax which differs in various ways from the normal system. Subject to tax All realized accretions to wealth except for All profits of a business enterpriee (including interest on time deposits and other exemp- capital gains) are taxable, whether or not they tions. are distributed to shareholders. Worldwide or Indonesian Nonresident companies are taxed only on Resident companies are taxed on worldwide source? income from Indonesian sources. Resident income, though credited for taxes paid in other companies are taxed on worldwide income, but countries on foreign source income. A nonresi- are eligible for tax credits for foreign dent is taxable only on income derived from taxes paid. Indonesian sources. Tax rates First Rp 10 million - 152. Taxable profit up to Rp 25 million - 20S. Next Rp 40 million - 252. Next Rp 50 million - 302. Excess above this - 352. Balance of taxable profit - 452. Concessional rat A D ndlx 3 - 164 - Table A3. INDONESIA PUBLIC UBSOUitC KU ANIAGET STtDY Estiwated Prepsrtv Tax Revenue in Basic Scenario A 1986/87 1987/86 19U8/89 1989/90 1990/91 Urban PBR Gross urban PBS base (Rp trillion) 165.0 181.5 199.7 '19.6 241.6 Total urban exeuptions (Rp trillion) 10.0 10.0 10.0 10.0 10.0 Net taxable urban .'BB base (Rp trillion) 155.0 171.5 189.7 200.6 231.6 Statutory tax rate (Z) 0.5 0.5 0.5 0.5 0.5 Official assessment ratio (2) 20.0 20.0 20.0 20.0 20.0 Effective tax rate (X) 0.1 0.1 0.1 0.1 0.1 Urban PBB potential (Rp billion) 155.0 171.5 189.7 209.6 231.6 Coverage ratio Valuation ratin Collection efficLency ratio Administrative efficiency ratio 0.4638 0.4638 0.4636 0.4636 0.4638 Estimated urban PBB revenues (Rp billion) 71.9 79.5 88.0 97.2 107.4 RurAl PBB Geoss rural PBS base (Rp trillion) 206.1 216.4 227.2 238.5 250.5 Total rural exemptiocs (Rp trillion) 50.0 50.0 50.0 50.0 50.0 Net taxable rural PBB base (Rp trillion) 156.1 166.4 177.2 188.5 200.5 Statutory tax rate (2) 0.5 0.5 0.5 0.5 0.5 Official assessment ratio (2) 20.0 20.0 20.0 20.0 20.0 Effective tax rate (2) 0.1 0.1 0.1 0.1 0.1 Rural PBB potential (Rp billion) 156.1 166.4 177.2 188.5 200.5 Coverage ratio Valuation ratio Collection efficiency ratio Administrative efficiency ratio 0.4638 0.4638 0.4638 0.4638 0.4638 Estimated rural PBB revenues (ftp billion) 72.4 77.2 82.2 86.4 93.0 Estates, Forestry. Mining (EFM) PBB Gross EFM PBB base (Rp trillion) Total EFM exemptions (Rp trillion) Net taxable EFM PBB base (Rp trillion) 132.6 139.2 146.2 153.5 161.1 Statutory tax rate (2) 0.5 0.5 0.5 0.5 0.5 Official assessment ratio (X) 20.0 20.0 20.0 20.0 20.0 Effective tax rate (2) 0.1 0.1 0.1 0.1 0.1 EMH PBB potential (tp biilion) 132.6 139.2 146.2 153.5 161.1 Coverage ratio Valuation ratio Collectiou efficiency ratio Administrative erficiency ratio 0.7500 0.7500 0.750 0.7500 0.7500 Estimated EnM PBB revenues (tp billion) 99.4 104.4 109.6 115.1 120.9 Total PBB Potential (tp billion) 443.6 477.1 513.0 551.6 593.2 Total Estimated PBB Revenue (Rp billion) 243.7 261.1 279.8 299.8 321.2 Estimated Revenue as 2 of Potential 54.93 54.73 54.54 54.34 54.16 Estimated Revenue as X of GDP 0.24 0.24 0.23 0.23 0.24 /a Basic scenarios: No Increase in addinistrative efficiency ratio. No increase In official assesemant ratio. Exemption levels not indexed. Appendix 4 - 165 - LOCAL GOVERNMENT FINANCES: STATISTICAL APPENDIX I".r maslmata nw th trat Ijtam ont ltabitad Iebis objetite Cat_ t_ of ratmd e*peditara Atlocatles eriteria tlipactativa "id. dateile Apertias c15a n. to Program 133 tgldfl To lagWrM orchrecsatnm hetmac. rai re" i-.rcw_eett.atesa - elant great for moll - project plamiq . tprprd by Priacist skinner o II.. * t_ hit I m_ rVgiafl Iem tspe. Ie I eo c. - bridele rpeet reason (22 rassIa) Naellt t l it Affaiar. ce, l.e. M r_- chreliat_a c t.rrei peeth. ac - r am miasta of (to I9l16I1 Dp 10 U). re-starited to UWMU lb.!. 1U?4 ft h I ta rem ruissin prntelpetiac to de1- irrtia - aceimi orat for bit - ba plaming (SIPIs) to Pr Pr_waictal C o_er Tt.l. 1afft aetviitta. - ra ad t_rc.mat# rgwia (S ra ) omCar after AM baa baa aprcd by are *_ _ _ autat. of ietaa_ (2. 13/4? Utp 12 O). estatar at *t Moelt". Man n - ether pwjte accrdis to tha - each reom's srpt - Prejt Ilqmatttea my ba dam by (uta gM) (hSata) -tety'a med. ateldad lste ta catr._ ter ar mIt-hlp. jc _ ,e_,tat tII r ets t_f a hIAtI1 1. AM U.1 S. spoettle-fttaea - Is farmiatles pej ee f I lo the Ab i. Shigeet hior yea dite taha) sigh 1S ts B fadI t_d sia _m fad thr I h (PAI) _cld met e Xmd t *er. fr readcidge - T fad to "taaaad &I M mceerdis to Iggrenme. tri,s*- the n0 of te ile trof c fiP e. he giv mitm *c. fta ts relea l__ rter yerly to gh irrtgetim iprmn- Preegeaao Ieesah/pr.wimtat hnelegant. mat (beado an -_*t - ed ' the rqct ef Itac/ite. The aep. Per X or *Ge,rr per lt_ehe As *t pgrjets f itl- taeter). sea arcertesa to h le to tlb lma. Is. dIecretlalt thoir. (hema yeeg dAerebba) Atentmive for r_mlder of ant. mU IU?0/71 Sc crmte MA &qvrm Jl.gmm A to emierma ct - had sp1_e Popua1tion - P`ejet Ptl_Ie -Ts pe pared he Ie3mi/ mm dia. It.. gain taw fr tit a1 i _let t_ pelaWli p1cipai - cis tU_atid sf retretere (Re1965/U? Up 1.3t701 2S Otemdya nad hie etat. asset_* inte tli same dcle_met. prejecte perime). - nh Finales to approved bherstesmal plasee hIttn_he to Mt _ prae teCI IrAetrgteore pajce - a oma &ret par let U mrer o ttar iit ie setmed t - -herbh Pahic lbahe eUmad. - ethr pjete Uhic em tipgic It (St 151U Utp 170 a). cter cerme*t dtli io atteasl It.. ilteti af _ewtre_* t eatiy ad eyn- - Ipn letm_im is cUeemltaliw _ati Itteel his I Pret d_IC/t__ .hlecr timi cb ether prejte gima to Bhts I - Projet ipplmacatia my he dem he ias agc_ r_qr_- to the retac. aeerdleg to the atrteyc or "it-hlp. am aebimmt of 1i - lhe rjeta t s reate appeee I_.. 2 af premt to he tart ad caeedleg arc_teti. eare leatr-tetemic watt ti tl_ t r "loo. t* popeletie. tachilaw. taally ptd tcrale some Iae l dac ad _ eetlec ad Pasd leher proet _r (at t l lShr). Rejet 1lmaWiF to dam by tueloe d t the meteer of nae... mb tfad retsed e_rab bheeb t_u. Mt am mUm ad M. go t icd lo badgte to tremitar pat of am0 Th.t.1r 1t lflU Is __w"go c_ _ae_ tes* rop - e", lepect af prjeeta chb a - _e et_ rw eah project proporeft/pr tmteet toc e 5 at ept/iAiheamad U)) heat ci sae Ple _em (Cmt ectriclac) the *AVillg ee p tia of rse *it le If1 _re (to le_ IUala.be leel, his t1 aerpetithi sme ti1 ie dmlapla the iSr cSltagea. _ meitiac la&/$? lUp I".080 nlteries at agUg, toealtas, Si to hat I9?? m pace _ eMtte ad mihetie A.proves by Mpeth/MoUbaIs ht It. Pmcject 0rI 11a*Ia - prettdg *retrject ipllmemtde by **r_-help. t leca/Iierebe S mal idrecctftwer IigTfulinrf am Uto 9c eqes. vowel. * Prjat iag5obetims - ey =l se. mieeUg, bat Uecc M c5 prims. VW. gI g LOM _tsbleld Ibi. Objsctions Cmtrirt_ of Srostd eqs-ditsro All-etisa criteria lq.lm.tative mid. doisil bSportisc ChMols t a_ to Program SIA J 1973/74 t-one bes possibtity of -12 or - NW prtmry acb_l de l_st - aidod Accrdig s - _ Project potss OAs adllcatios *c p r-P r d (- as I Tltt tT) 19?)t WtUMId old ebtIdrs g ttrss priary eduastion - _ elasr_em sdttis copletd C%O _D of eacb Dotl by me" ad Itab PU for so bt.diag "A 3I.. PA06MMK*r bWIW_e - ts r ot adOcatl islitdi. with Isscllila tT. bOW Seo, b*_se (for .ard. b.somtar sd t1979 becer r - etgag _t tflf ill the mee of priary sch_lase - b_ftnr _ess 4,solopst - s r of 7-12 year *14 t.shers). *ry Al* propared by _ tors It.. Joltsr bias. spsctiliy is trsmlgrittes areas. - tot r b_etes dalopasa childros which hs bee" sa d Dti i f s r SdrI b T bttlyab 1i?5 Ssost1_ of early .tespled sa t_Ieotedb4inry - cmoRl Na"r mo dmvw1*_wt as place/ro., In tlb ehicb mr asedsd to he rsom.sted. wrmsb hbtisy Ares. - prlary *bel 1widls rababilt- * ll0tia ID. - Catrally d4os d beildit taties (ioii./alrao) - trasmwelrottes ass ftlsimtles of project plamaiag sad alitassite - ptUie_ tf beb. son Settlement ad _Sall- to dome by Isp ab to aested by the ftoilitiso _ atibr tacUtig hel1idi eststs Aerm. Ias"vs lk.li. faellItis/.qsilota. - Projet iol_amatia my e dies by eastr ctre or sesf-be3p. _ Proolates sad dirti tlhe of beele, book c.q&ard. sart oqISt osd tiher t1-lag fscltlUt (_e1 ls) an cooriated by the Mciit? of ustaetiO. - roJect finasciag Is dese. by P0bltihig IS Of the Nsietor of Fimeras. - lbs t_ei or ID ad hss are relossad thr bbe (sRI. Mrt NW _ %) II.s lb s feds for biks etc. are released t_ g "v. DIrlWEaMNC.mx st o 143 Cel. *UDU11 9 197415 - to Prorwl. asr r ltb er,is eqasly - prwr ii o dofr i - At lsst as. sakee* _ Project pleastia io proep4d by C.p.. Name USA- 3914 Pebis wamft_= bit oeib the priity to rota - 4 _1sst of 1ltb caster far _esb kactai. issbster Satl t free*, aster SSW1, 192 Ono cauSalit =u lw-imi erba Paoo). (Yashema) sea sibb"Itb roster - 30.000 popoletias seed Pteeheome. heess). 3197 Powbogemag - to ises th states of the people (Pffsesa Poubeate) see prtrs. - Sthe eSig of bhettldig ie csatrelly 1319 tct., boomr _pecially by priia Of bitter aster - 1 rie sW ewselas of d*t.erat_d. 1977 Prsoisim of most a_ ly sad attatim for rwal Peehem es P_ ibosms - zyl'tstoft ad approval of projets Sea bibe fort t mil *_meity. Pimssl. mortard by F-retrIiet COr_er. it. - prwoito of bils bieltb tester - Projet topim_totise as he deme by (Pebsbmas lo1Ltis) coattstor or self-telp sad tt 1 - prrisis of bicles for _4ticel mparr4lsd by iU _ Stiu 11. patemiw of Pask*oa - Provolios Of drv& s ta amstad by Sait I hesvd _ pretsto rornl Oster pply - the gwidosc fre the Nisietry of hoith - prorisisa of pablic latris./ - bs ari t is bdgetod AS a trmwitery til of tolit. APO. - TM proolsis of f*_ds to s iee by oisthi MD Of the IOl*r Of Plast , 1t_ erdt a to a n ppro... letter poIhtebad by laisitsr of Vlte, md IAA. W Alb f_ for Psibemss, Psekse P _aet. homms. later espyly. sad pehils trt_ are "elejsd tbrsft bibts (1111. U!! Oad 11110 s_ree the tfed for dras. Proristte Of aediroml i S. staff rtrimtt_. .bile Pedwm_ . ater bib" sa 'or etier eqeIPsot (pipe, ott.) arT re18ead tl br_ gm. -1551 g_n_r t sa lace1 r_aMty rpes siblo for mistaisiag thw sstiati prrojctaffectlltlss. 1PIRIMITO Ctilts. ti 241 poses 0 V- Crest atablisod Hio *Isettiee.m C.t.1sres of a-rSet"d "peeditore Alifottis crotorst Isplenetotin e d.149 details v tit theam'. Cho" io Press (eampee) DmRIS b19/71 - To roeree -a nistarlod the c. l*t_ - Floating so "J. tio of tre Act'disg to the "v." -oenr.l p_ject plannin to pprepard h Toee -tO.- 19.. Tra1isi far fleod Penljosso storel r eorces. ed. forest "d - ther sopprttsj sctt.ittes I. the is ehb Dosi It. Pamper at Dsti I etof . "ter eepsctelly Is crittial are". forestry arosn. Detail planof remsreenig tn es, vtHs to 1..*arose, ddch see. fre hydr- Prepared by I isI rofitor. scolsicalse. of vi.e coo eadn"r - Psnol *olet to sod pro ect appreol To by theets. JMPA nh I and Teo FPnS.T at asti 1. - nhe feT rseeise pmrotit is .plowasted by Ieala fatsprs. 7_ to of fda t. does h . r Itshig OO of the Moisier of in_st. recerdtng to a. apporal toltter preatd by Moistter of n e..s ,d 3AP'AWS. - Ue ft for reafforeststtie, regrent. An .feld staff are releasd tMrem bo (ml aed am). ehrs_a fed or trss. pet sine Of o"od sad atsistOr5tios are released throwsh Kr". IlWt.MATtIU C.i, i. 140 I QotI. pogel 13S 197910 - To deelop asd rehabilitate, tahpstot - bettest *o rof de - dAcordins to the neds - Projt plosaing to prpredw h project -ida.- jtdsl Notamda r. ts oird is asko - strethsisg the reod ertfce of so*ch itot IT. neosr at titi 11 leftI. tr_pwrtattm _u dtstrihetise of - se hris dele_9se.t - Falatinenod opptresl ef orf et plsi t ole elir rtIelorly is isolated - repca-t of old hri se. do. by Pretocil tonrwer o. os mstatd sod prctte a*rse. hy WPA k. and ties P_T Ik.li -Project isplasnsiteet as he da by coatrstetrs or self-help . -7The tplaoantamt-ei s.prid by ethe0 P >raiseAr oepsO r -11'" 404 474 555 651 762 893 Su_mters Selaten 1,316 1,417 1,527 1,645 1,773 1,910 1,120 1,210 1,307 1,412 1,525 1,646 1 lengkulu 185 261 369 521 736 1,039 167 244 356 519 758 1,107 Lampung 1.039 1,119 1,205 1,297 1,396 1,503 1,027 1,116 1,348 1,544 1,769 2,027 co Java Barat 10,424 12,082 14,005 16,233 18,416 21,809 8,513 9,941 11,609 13,557 15,832 18,4 Jawa Tengah 5,582 6.330 7,179 8,1S1 9,232 10,470 4,993 5.775 6,660 7.726 8,935 10,334 DI Yogyakarta 998 1,142 1,306 1,495 1,710 1,957 969 1,127 1.309 1,522 1.769 2,055 Java Timur 8,641 11,229 14,592 18,964 24,644 32,026 6,186 11,944 17,426 25,424 37,093 54,318 Ball 4,025 4,764 5,639 6,674 7,899 9,349 3,912 4,662 5,556 6,622 7,892 9,406 Russ Tenggara esrat 177 185 192 200 209 218 126 141 158 177 198 22' Nusa Teng_ ra Timur 169 183 197 213 230 248 112 135 163 197 239 288 Kalimantan Bsrat 1,323 1,463 1,618 1,789 1,978 2,187 1,332 1,537 1,773 2,046 2,361 2,724 Kalimentan Selatan 947 1,031 1,122 1,222 1,330 1,448 938 1,079 1,241 1,427 1,641 1,887 Kalimantan Tengab 188 256 348 474 645 878 167 249 370 550 813 1,217 Kalimantan Timur 2,591 3,178 3,897 4,780 5,861 7,188 2,372 3,065 3,960 5,117 6,S11 8,542 Sulawesi Utara 1,811 2,n15 2,243 2,496 2,778 3,092 1,585 2,025 2,568 3,308 4,227 5,402 Sulawesi Tengsh 456 491 528 569 612 65v 361 431 513 612 729 669 Sulavesi Tenggara 245 275 308 344 386 432 131 154 161 213 250 293 Sulawesi Selatan 2,864 2,899 2,934 2,970 3,006 3,n42 2,083 2,407 2,7A2 3,216 3,717 4,296 Maluku 578 624 674 728 787 850 380 405 431 458 481 S59 Irian Jayn 381 416 455 498 545 596 219 241 266 293 324 357 Total 51,687 59,530 68,990 80,448 94,386 111,415 45,275 55.23 67,R78 14.569 106.736 136,411 Note: The projections use the growth rate in real revenues, vith an assumed 5S rate of Inflation. r n s ,uuIC llumm UmMAGIt null Local Governmet nomas" beath of bYSmwe * Ramittra. bg tOYS t Oumet 0,r b el5ta 111 (1971517 to 1913/14) Prewlaca U1 Jkahast 20 loarste Notd a* All Deal IL at (Lemel I a"d 51) Lug. emma! Lvi. a al an. s L A, . enm 1979/30 1903144 a3 C_t. 1979,30 1954104 e9t C. 19,5/0 1431/64 rst C_t. 1979160 IM5UM O1n_t911. 91916 INV9030 _ t t. z e bit 34.30 09,700 - - - - - - / a/l - - 10,700 10S0 - - 43,5 ".41 - - Cetra s, .M0) 45030 1.02%,000 22.0 3.0 30. " 0 ".500 22.0 0.0 24.700 58,200 21.9 9.7 36.U00 452.00 2.S 10.2 U00N0 IU501.3 n.3 9.1 low tom 771,0 17.C00 21.9 0.9 5,000 11.290 21.1 7.2 11.100 23,300 70.4 *.* 21.500 45.200 20.4 0.0 13,1S0 32B.SW 11.0 9.0 Chrges & dtm recepts 34.300 2,100 19.0 S.0 10.700 33.90 33.4 141.1 12.00 29,00 t4.0 9.3 4.*100 10S.tO 23.1 9.0 * 1.33 3 10. 20.0 9.6 Ptaitt of t5g. ooterpriaa 1.100 4.0O 43.0 20. 1.300 4. 00 37.2 21.4 I.500 1.200 2.2 (.) 1.900 3.100 13.0 - 4.30 12. 3.0 15.1 Other rastis loco" 9.303 30.00 37.0 39.5 15.300 0.500 (19.9) (29.0) .0o0 91300 - - 27.000 03,90 20.0 9.6 52,156 127.6 2. 1n.0 lielmiogs beloo b/f S37,900 1,342.90 22.9 4.9 112.700 22.700 19.5 3.6 14.300 120 .00 - - 293.700 065.30 232 . I 2 22. I.* bel-aims helo_ec b/t 553."O 3.293.200 23.7 9.5 112.700 220.700 19.5 S.6 30.300 12.0 - - 20S.000 670,30 23.5 9.7 9007.0 2.1395. 23.2 9.1 Lee are u eiptsre 551.400 1.253,800 22.t 9.8 77.200 123.100 32.5 - s0,000 100.500 20.3 7.0 uo.100 01.700 22.8 8.1 .?7" 23.33O O 1.0 4.3 Tragfere to da. a/e 23.90 09.200 6.3 (4.)l 35.300 10X.000 31.4 50.4 mica 14.000 14.0 0.9 4.600 12 o60 25.7 11.3 7.I3 01 .33 23. 7 7 . bee elt I0 3da - - - - - - S oo 0 0600 - - 1.I0 * - - -L we bit 40.300 60.owo - - 55.300 59,000 - - 8,000 33,000 - - 0,030 12.000 - - ,40 320 - Trnsorm tr rotie &t 3c . 800 *9.200 0.3 (0.04) 3.s30 100.000 31.5 30.4 3/5 a. a - - 4.000 12,000 25.7 35.3 70.500 137.33 21.7 7.6 XOtrnl Brents (Inpres) 112,'00 205.000 23.8 9.5 13.000 253.00 23.0 9.5 11.400 30.900 28.3 13.6 274.4010 13102.00 41.0 23.4 30. 10 36.8 21.1 Transers frm prowltee - - - - - - - - - - 10.200 20, tO.0 3.9 5.3 (eotrnl) (uoers) Ipi 0.300 13.400 (S.5) (56.3) *.Cw 12.500 2. I 33.0 4,0 51,400 29. 14.5 9.900 109.400 21.7 7.7 e 1,500 I o35 13.5 4.0 otsf l _t s i 70,30O 3.700 | (2.9) (14.0) 9,0 4 (47.2) (53.2) I .0JA 50.200 9.4 0.2) 40.300 2370 O 13.2 18.0 58.?rj 30.50 12. othsr Adw,ommat tweeam 5 10900 5 .:400 31 300.700 51 100,1, IWs,m Total Si!Mt Isse". 2_1 O 1 12 75 700 20 700 30.0 55.1 353 0 71 00 - - 36 700 1363 5Joe 31.3 21.5 73" IOD 2j04Sj wcI|s ; | -~~~~~~~~y.. WIN71alo. 'F {7]9 00I wT xr T t44 - 1rmhi-t-ie,et 1 pssirt_ 1090 316.300 1D.9 0.7 5.00C0 127,50 22.3 3.1 30,500 U1,000 21.7 1.0 3#1.800 3356.100 31.1 22.U0 02,709 30.4 3A.S Trmfsva ta 2ad loyal regogI 10.200 20.400 36.9 3.3 - - - - - - - - -- - - (cesrs) (gears) boJ eIt U12.80) 154,300 - - 14.700 77,200 - - *U a/a - - 12.900 27.000 - - 115340 21U85D 261.900 451.000 1 71e700 2041.00 - 30.500 7.000 30.700 1.33.100 -9 - 33.130 2U01U.43 - T.-a f4gr"shows are * at,en., nct_ r,tlpe *" p_ "mte.. 2. Th fiure tor loal tes, charges sa dles romIpts, peelito ot rslaUl oetrprisso, 21 and other ratlasod dc,a1amt twcct, are baed es psbltahad Ws data on reg*amol ae_ o ret amdca C'I "r_r approriato to allaw for ro"ies eitted tra thoe statlttles. 3. TM tirstof cemtral grant. (33 ca Ispre) sad for toal reat cad devolepmest a Items ea esttast of actal raeslpts at" paMnt. had Mn varioty ot data relativg *e *r. t ad s vt ac_ntl racipeu 4. It fiUr1s f or rel_esa, trssfao fn matlm to dteslopmet aces sA loaus arm e*tli_tes. S. Figres do m"t el"" ma esOrtly en grow tots M to rasadias. U. Is follaldo *nhsatlm arm aad: blf * brougt for_ad; a/e * see_ut; oi elf * carried forerd. * -bead _ - _s"rata u klyoe at the 20 larest Kmammds estaid. of MI Jabrts (premoted tm x 1, Tabloe 4). eoran Ctratol Btatttseal Off tea (38). trW of Pimsee. 1i*try ot Mses Aftaitr. "otom *sttete. II¢ IIDONESIA PULIC RESOURCI HNAGCaWT STUDY lo1al Governmnt Finance Analysis of Pain Sources of Local evemne in the Larger Rotmedyas for Itewlita Itt (FT79/m3/54) a I79/80 M3/T4 alt. total gat. I of Avf Local Service charge Local Service charg e p olin ati o 190 po. LWM M cl dur Province watmdya taxes and dime Tota taxes and din-e Total 1I79I I for urh tame mi dime Ta1 (itp per bed of cutimated total populations) ('000) - (2) (2) DCI Jakarta 8,617 1,706 10,325 15,716 4583 20,299 6,277 7,395 91 16.2 28.0 16.4 Jatis Isrebays 1,047 46S 1,512 1,S79 2,Wd0 3,879 1,964 2,213 8 10.8 49.1 26.6 Jaber lenu 1,396 1,217 2,613 3,264 2,370 5,634 1,429 1,341 100 23.7 U6.1 21.2 _11nt Nwdan 1,269 1,473 2,742 1,265 2,315 3,560 1,255 1,760 92 -0.1 12.0 4.9 Jateg Semarang 713 1,06 1,79 1,535 1,678 3,213 971 1,14 60 21.1 11i. 15.4 sumet Paleuben 582 709 1,291 764 1,444 2,228 759 8669 9 7.7 19.5 14.0 Bul"l Ujung endaung 1,279 1,566 2,865 1,631 2,222 3,053 86 633 90 4.3 8.8 7.7 Jatim Iblang 461 649 1,110 774 1,250 2,024 300 545 9 13.6 173, 16.2 Smber Padeng 938 1,237 2,175 1,490 2,541 4,031 432 646 62 12.3 19.7 16.7 Jateng Surakarta 607 1,413 2,020 1,413 1,164 4,577 463 490 100 23.5 22.3 22.7 Di Jog Jogjakerta 396 1,482 1,678 1,444 3,608 S,252 391 420 100 38.2 2n.6 29.3 Kalset S nj r_*in 973 652 1,825 1,503 1,332 2,835 367 421 *7 11.5 11.9 11.6 I Kalbar Pontiansk 1,352 1,026 2,378 2,242 1,208 3,450 293 341 91 13.5 4.2 9.7 - Lipung lender Le puog 1,196 1,479 2,675 2,110 3,228 5,338 272 320 100 15.2 21.5 1i.9 oo Kaltie lflikpapen 1,120 966 2,066 3,050 2,090 5,140 257 355 74 26.5 21.3 25.3 Knitia Samerinda 1,347 1,450 2,797 2,248 1,555 3,803 245 326 70 13.7 1.8 6.0 Jaber Dogor 638 2,456 3,094 1,972 4,524 6,496 241 267 100 32.4 16.5 20.4 Jembi Jembt 688 483 1,171 1,094 1,960 3,074 220 261 68 12.3 42.3 27.3 Jabar Cirebon 730 2,002 2,732 1,797 3,671 5,468 218 241 100 25.3 14.4 18.8 Jatla Kediri 186 543 729 326 1,048 1,374 216 238 79 15.1 17.9 17.2 Sulut lhnmdo 1,155 2,123 3,276 2,858 4,175 7,033 211 23S 100 25.4 10.4 21.0 Valuka Anbon 1,450 1,113 2,563 972 1,516 2,486 186 287 54 -9.5 6.0 -0.7 Rian Pekanburu 662 1,013 1,675 1,513 1,979 3,492 181 202 100 23.0 18.2 20.2 Jatin mediun 339 961 1,300 707 1,606 2,313 149 154 100 20.2 13.7 15.5 Sumt Pensteng Sienta 1,118 1,903 3,021 1,274 7,677 8,951 148 156 100 3.3 41.7 31.2 Jateng Pekalongpn 371 !,029 1,400 1,133 2,896 4,029 130 140 Ino 32.2 2.5 30.2 Jeteng Tegal 795 2,532 3,327 1,368 5,522 6,890 126 142 100 I4.s 21.5 26.0 Jeteng Mcgelang 584 1,758 2,342 759 3,510 4,269 122 126 100 6.8 18.9 16.2 Jabar Sukabuni 1,135 3,000 4,135 1,588 6,445 8,033 106 115 100 6.6 21.1 16.1 Total 33,144 39,714 72.858 59.409 83.637 143.04U 18.801 22,263 15.7 20.5 16.4 Sources: WS Regional Governent Financial Statistics; 1971 and 1980 census date; MUDS estimates of urban populatious. INDOIISIA PUU.IC uSOURCI IAUACEIT STUDY Local Covernmnt Finance Loana A4reed for First and Second Level ealIonal Governmnte and Unterprtses Over the Pertod 1976/77 to 1965/66 by Pr7vime (4p illion) RDI Von 1gm aid Inprer Pasar /a tU In" (PDAtl S others) 3PD PDAI Other W " le to to to 198i'4- to 193 - equity equity to equity to t 1982t3 1983/4 1982/3 1985/6 1982/3 1985/6 to date 1985/6 198S/6 (PtMb) Prbea Total Acel ) 409 450 - - - - 250 - - - - 3.10S Sustera Utara 6,916 1,556 203 - - 5,652 400 - - 10,6O 3,600 29,307 Smatera Brat 8,697 5,785 - 732 - - SOO 6,528 1.500 15,680 1,300 40,722 Riau 2,585 - - - - - 400 - - - - 2,"5 J_bi 766 1,811 10 - 1,666 855 282 - - 700 - 6,090 Sumters Selatan 9,843 995 523 - 3,908 - 350 7,309 - 5,700 2,000 30,626 Uengkulu 4,460 4,266 20 - - - 400 - - - - 9,146 Lapung 3,139 1,555 132 307 - - 250 - - - - S,303 OKI Jaklrta 7,869 6,800 - - - 1,358 150 43,731 - 70,300 51,700 101,630 1 Jav Barat 12,083 6,428 1,230 1,820 10,575 2,625 850 12,153 - 11,400 3,000 I4,U P. Java Tenabb 17,858 3,000 241 - 554 536 SOO 11,660 4,696 10,560 17,000 54, § DI Togyakarta 2,598 - - - 235 - 100 2,354 - 3,400 - a,U67 Jas Tlur 9,811 125 2,U8" 2,112 1,134 650/b 800 3,546 - 4,500 27,000 52,066 Kalimatan brat 1,972 - - - - - 300 - - - 1,900 4,172 Kallmntan Tengh 1,538 659 79 - - 250 - - - - 2,526 Kali_mtan Selatan 7,553 - 70 - - 250 1,S60 - 1,600 11,0S3 alimmatan Timr 1,SS7 3,107 - - 1,210 772 300 1,768 - 1,100 1,100 10,934 Sulawemi Selatan 12,602 1,275 2,194 1,009 IS8 250 1,205 - 740 8,300 27,733 Sulawesi Teaggara 2,045 - - - - 300 - - - - 2;34S SUlaiei Tengah 6,841 - - - - 400 - - - - 7,241 Sulasi Utara 2,816 1,042 - 150 - - 250 - - - - 4.256 s1.1 4,714 1,135 40 - - - 400 - - - 600 7,1 Iuse Tenggara brat 3,619 170 - - - - 250 - - - - 4,0" Msu Tennerc Timr 1,945 - - 37 - - 350 - - 1,120 - 3,452 tlluku 1,072 400 - - 506 - 350 - - - _ 3,772 Irian Jays 2,287 - 230 - - - 150 - - - - 2,67 Timor Tlur - - - - - - 250 - - - - Total 139,595 40,559/c 7,360 6.167 19,046 12,650 9.282 93,296 6.198 155.790 119.300 610.145 /a No Inpree Pamar program for 1984/5 and 1985/6. 7ii HaIf of working capttal loan of Pp 1,300 *illion to Joint Venture slaughterhouse between Surabaya and DKI. 7F Realiation to end 1985/6 was only Rp 14,932 million (372 on average). C,X Appendix 5 -189 - Page 1 THE ECONOMICS OF OPERATIONS AND MAINTENANCE 1. The (OWM) problem emerges from the simy)e fact that the government is engaged in the production of public services._ In some cases, these services are provided relatively passively, through roads, drainage canals, or sewage systems, where the physical condition of the capital infrastructure effectively determines the quality of the services. In other sectors (health, education, irrigation services), the provision of services requires the use of staff and intermediate inputs, and where the role of the associated capital infrastructure is more variable in its significance. Ultimately, the impor- tance of OEM derives from its role in the process of producing public output. Failure to provide adequate O&M has real economic consequences for the level of public output, for the capital entowment of the economy and the implied rate of return associated with public investments. These cv'zsequences must be weighed against the cost of outlays on OWM. 2. In the past, the O&M issue has typically been viewed as a problem of planring and budgeting--to ensure that the O&M implications of a new invest- ment are considered when a project is evaluated and when the operations phese of a project is to commence. In Indonesia, after two decades of a massive investment program, the O&M problem is rather the problem of remedying the inadequacy of spending on O&M on existing programs and infrastructure and the legacy of a deteriorating capital stock. Specifically, this includes insuffi- cient outlays for the maintenance of infrastructure and equipment, and for the operation of programs at a reasonably efficient level. 3. In developing a policy toward O&M, several obvious questions arise. Should one pursue a strategy of routine and periodic maintenance of infrastructure or should one deliberately defer maintenance outlays, accepting the implications of frequent, and perhaps more costly rehabilitation effortc in the future? What is the appropriate level of operational outlays for a program or project? What should be the relative priority attached to outlays on operations relative to maintenance? How do the costs and benefits asso- ciated with operations or maintenance compare with the return to new invest- ment or to a program of rehabilitation? What are the OEM implications of new investments? Despite their significance, there are no simple answers to any of these questions, and what answers there are will probably differ both within and across sectors. The objective of this Appendix is to clarify the underlying analytical issues that must be addressed in developing sector- specific strategies for O&M. 1/ Tables A5.1 and A5.2 provide an overview of the types of common public services, their associated public capital assets requiring O&M and the types of required O&M. Appendix 5 - 190 - Page 2 Issues in the Formulation of an O&M Strategy 4. Many O&M issues begin with simple technical questions, such as how rapidly will an asset deteriorate with or without maintenance. Such technical relationships are of obvious importance in assessing the economic consequences of alternative strategies. The influence of design standards, or of the impact of usage on the rate of deterioration is equally important. However, the choice of strategy will ultimately reflect economic considerations, as technical relationships are assessed in terms of their economic consequences (e.g., as monetary values are attached to the inputs and outputs involved). 5. In principle, given a thorough understanding of the underlying production function relationships, the guiding economic framework is that of cost-benefit analysis. One is forced to consider the cost and benefits of the alternative options--the present cost of providing operations or maintenance, relative to the benefits derived in the present (in the forms of initially higher output), and in the future (both in terms of deferring the time when expensive rehabilitation is necessary and of realizing higher future output from a given capital asset). The treatment of intertemporal time preference and of uncertainty obviously becomes extremely important in assessing an optimal strategy, given that one is comparing present and future benefits and costs. With a high rate of time preference, a deferred maintenance strategy might prove optimal. 6. Yet valuation of the benefits associated with increased operational or maintenance inputs may be extremely difficult, and give rise to a sense of despair. Each sector has its own specific set of issues. Separate studies could be written on the problems of estimating the benefits of health or education services, or of improved irrigation services or road quality. Often sectoral specialists abandon efforts to attach a monetary value to the bene- fits of specific services, and this obviously complicates the problem of evaluating the appropriate level of outlays on operations and maintenance. In examining the altervative O&M policy issues, it is recognized that sectoral policymakers are perforce working with limited information, and that very approximate answers are available to many important questions, but this does not render the exercise irrelevant or insignificant. How much should be spent on Operational Outlays? 7. Outlays on operations reflect the purchase of goods and services (labor, materials, and supplies) to facilitate the contemporaneous production of public output. The physical relationship between the inputs and current output, in the context of given capital stock, effectively defines a signifi- cant part of the payoff to increasing or decreasing the funding for opera- tions. This relationship is normally expressed by economists in a production function relationship. The emphasis on "contemporaneous" output reflects the fact that much of operational outlays do relate to the current production of goods and services, although it is obviously recognized that much of the economic value associated with the output may arise far in the future (e.g., the example of primary education is obvious). Operational outlays may also have an impact on future output. The rate of utilization of a capital asset - 191 - Appendix 5 -191- ~~~~~~Page 3 may affect yis rate of depreciation, and thus its potential for subsequent production.- 8. At best, such production function relationships can be roughly understood and approximated for any program within a sector. For example, in the health sector, one can provide a primary health center with a well stocked pharmaceuticai dispensary, ample supplies of petrol, and a full complement of medical and paramedical staffing, and the associated output should be reason- ably high, whether measured by indirect output measures (number of patient visits) or ultimate output measures (magnitude of illness p5vention, reduc- tion in the effects of morbidity, reduced mortality rates).- In principle, reducing the quality of staffing, cutting back on the capacity to provide mobile clinics, and decreasing the supply of drugs will decrease tˇie output level, depending on the form of the production function and the efficiency with which production occurs. Output is likely to be particularly sensitive to the provision of particular inputs. The absence of drugs presumably limits the potential impact of a physician or a paramedic. Absence of petrol may limit the amount of mobile outpatient visits by the physician. 9. Such production function relationships in any sector are contingent on the quality of the inputs, including the human capital provided. For erample, in the irrigation sector, a poorly trained or absent gatekeeper for an irrigation network will not provide the appropriate quantities of water to farmers at the relevant times, with resulting losses in agricultural output. 10. In principle, the optimal level of operational inputs would reflect a consideration of the benefits and costs associated with additional inputs. In actual practice, sectoral poiicymakers operate with limited information and considerable uncertainty and may not be able to quantify benefits in financial terms. However, they may establish that a given norm yields acceptable results or has a high payoff in terms of measurable objectives. Country- specific economic and policy considerations play an important role in estab- lishing the "norm" level of operational inputs associated with a project or program, since a given type of infrastructure may be fairly elastic in terms of the quantity and quality of the services that it supports. For example, 2/ The production function of public sector output of a project can be simply expressed in normal economic terms: Qt F(°lt, 02t' MRt, Mpt, .... Kpt, Ket) whereby the level of the different operational inputs 0., and possibly some maintenance inputs (routine, MRt, and periodic, Mpt) determine the level of output produced in the short run, in the context of the level of the effective capital stock in the form of plant, Kp, and equipment, Ke. 3/ Obviously, the precise relationship between inputs and outputs is not strictly technical and is influenced by the role of demand factors, and by the numerous other factors influencing health status within a community. - 192 - Appendix 5 Page 4 one can assert that a given level of staffing and operational inputs is necessary for the minimal functioning or a particular type of infrastruc- ture. It would be hard tu justify the construction of a primary school if there were no teachers, or of a health center, if there were no doctors and paramedics. Equally, one would suspect that the marginal productivity of textbooks and of a reasonable drug supply would be sufficientiy high as to warrant inclusion of 4n adequate amount of such supplies in one's norm for operational inputs. - 11. Beyond this, the choice of the "norm" level of operational inputs becomes an important policy issue, and is influenced by the prevailing budget constraints faced by public sector agencies in the funding of programs, the price of inputs, the perceived potential of nonbudgetary sources of financing (e.g., user charges), sectoral policy objectives, and the nature of the production function relationships. The range of options is clearly illus- trated for the case of the health center, where a given health facility can be used to support the provision of basic curative services, or may also serve as the center for a number of preventive health, family planning, and communi- cable disease control programs (as in the case of Indonesia). To determine the norm level of services, and the implied normative operational input mix, one would need to evaluate the direct payoff to the additional preventive health service inputs. If the output in terms of increased immunizations, improved treatments and reduction in the caseload of particular communicable diseases is significant, this might argue for providing such additional operational inputs. In the context of budget constraints, the implicit shadow price of the additional resource cost may be such as to preclude the addi- tional outlays. 12. Thus, for any sector, the guiding question in judging the desir- ability of the level and mix of operational inputs should be the impact on the output of the project or program within the sector. Obviously, the sensiti- vity of output to the provision of particular operational inputs will vary enormously across different types of public services. 13. While the use of norms becomes an acceptable compromise for decision making, it does make it extremely difficult to judge the relative benefit of shifting resources within or across sectors. At best, one can strictly be aware of what spending on different programs is likely to yield in specific programs outputs. How Much on Maintenance? 14. Maintenance outlays are normally intended to influence the physical condition of the capital stock, by retarding its rate of depreciation (or to arrive at a normal or "predicted" rate of depreciation) and by enhancing, in the case of equipment, its current productivity. Assessing the economic 4/ Some investments require a fixed ratio between inputs in order to operate at an adequate level, others will allow tradeoffs between inputs and will still operate at an acceptable level. Appendix 5 - 193 - Page 5 impact of maintenance requires an understanding both of the technical effects of maintenance activities on the condition of the capital infrastructure and of the role that the capital stock plays in the production of public goods and services. 15. Often, the effects of adequate maintenance are realized in the future, either in the form of maintaining the potential services that an infrastructure may facilitate or in saving on the costs associated with rehabilitation of prematurely deteriorated infrastructure. The sensitivity of current output to the quality and quantity of the associated capital stock is likely to vary widely. In some sectors, the quality of the capital stock may have only limited effect on the output; the quality of construction (or the state of disrepair) of a school building or the primary health clinic is not likely to seriously affect the quality of the educational process or of the medical care provided to a patient. 16. In other cases, it may matter more directly. If a health center vehicle is in disrepair, mobile medical clinics cannot take place, and many patients will not receive care. The condition of a road or a bridge will determine the magnitude of vehicle user costs, and the amount of time required by drivers to go a given distance. Irrigation canals or gates in disrepair will constrain the potential level of agricultural production. 17. In developing a strategy for maintenance, one must distinguish between "routine" and "periodic" maintenance. Routine maintenance influences the susceptibility of infrastructure and equipment to premature deterioration in the context of a given level of usage, pattern of operations, or climatic conditions. While not attempting to redress the normal physical depreciation, it seeks to ameliorate the potential for such depreciation to impede seriously the effective functioning of the infrastructure. In the case of roads, it might include clearance of drains, maintenance of road shoulders, vegetation control, patching of crocks, etc. In case of equipment, this would include lubrication and replacement of commonly worn parts. 18. Periodic maintenance is necessary to address specific breakdowns, malfunctioning equipment, and specific instances of easily repaired deterio- ration (e.g., potholes); it may attempt to provide some restorative effort to the infrastructure without an attempt at extensive rehabilitation. In some cases, in the absence of periodic maintenance or limited rehabilitation, the capital stock may prove nonfunctioning, as in the case of a vehicle with a flat tire or an impassable road. 19. An alternative distinction is often made between preventive and corrective maintenance. Preventive maintenance is defined as systematic, prescheduled programs of inspections and relatively low-cost maintenance activities aimed at early detection of beginning defects and interruption of the deterioration cycle. Corrective maintenance relates to activities in response to breakdowns or detected defects (e.g., fixing something when it breaks down). Rehabilitation is defined as an activity carried out to correct major defects and wear and tear in order to restore a facility to a good working condition without significantly expanding it beyond its originally planned or designed function or extent. Appendix 5 - 194 - Page 6 20. Several general "rules of thumb" on maintenance should be noted. First, in principle, these alternative forms of maintenance should be comple- menta:y, mutually reinforcing each other. The productivity of either type of maintenance will be significantly lower in the absence of the other. Figure A5.1 notes the effects of deferring routine maintenance on the amount of periodic maintenance that is required. In the case of roads, most commenta- ries suggest that a policy of simply providing periodic maintenance is likely to be more costly and yield a lower average quality of infrastructure than a policy of routine maintenance coupled with periodic maintenance (e.g., more than offsetting the marginal cost of the additional routine maintenance). Whether this is true in the case of maintenance on buildings or other types of infrastructure would need to be evaluated on a case-by-case basis. 21. Second, maintenance deferred to a later period is likely to be less productive than maiatenance that promptly addresses emerging difficulties. As noted in a study on the Consequences of Deferred Maintenance, Pavement and bridge structures may undergo accelerating rates of deterioration as defects go uncorrected, with the accumulated cost of repair increasing geometrically over time. Where such conditions exist, the deferment decision represents an added cost rather than a savings to the highway agency. This impact is compounded by the added 5uer costs and inflationary effects of delay on repair costs.- 22. Third, there are situations in which maintenance outlays can prove relatively unproductive. Once a piece of infrastructure has been allowed to deteriorate beyond a certain point, application of routine and possibly periodic maintenance may be of little value. As the asset is again used, it quickly deteriorates, undoing whatever short-term benefits were associated with the earlier maintenance. Once an asset reaches this point, the only relevant policy choices may be to rehabilitate the asset fully or to provide only the minimal maintenance or support necessary to ensure that the effective value of the capital stock is not zero (e.g., to ensure a road is not totally impassable). 23. This gives rise to the ironic conclusion that past failures to maintain may render current maintenance less productive and of lower prio- rity. Conversely, consistent attention to maintenance implies that a greater share of the capital stock will be in "maintainable" condition, increasing the overall demand for maintenance. 24. Fourth, the average cost curve for maintenance in a sector is likely to rise. A sectoral cost curve for maintenance is likely to have several dimensions. in the short to medium term, one would expect a rising average cost curve associated with an increase in the amount of infrastructure to be 5/ Transportation Research Board, Consequences of Deferred Maintenance, National Cooperative Highway Research Program, Synthesis of Highway Practice, No. 58, Washington, D.C., May 1979. APPENDIX 5 - 195 - lFiRure A3.l Routine Maintenance vs. Periodic Maintenance and Total MAintenance Cost e The precise relationship betveen- a; " ~~~~~~~~R + P in usually not known, except * a ~~~~~~~~~that it is inverse; iGeq, if R is , ~~~P will be high and vice versa Routine (Preventive) Maintenance Cost, R Appendix 5 - 196 - Page 8 maintained, or in the level of maintenance activity to be undertaken. As the institutional and technical capacity is developed to maintain a greater network, or to provide more frequent routine and periodic maintenance, one might expect that the cost curve would flatten in the longer run, and conceiv- ably even decline if there are economies of scale associated with the procure- went of capital equipment and supplies for maintenance. The cost of mainte- nance is also likely to rise with the age of the infrastructure to be main- tained. 25. Fifth, spending on maintenance is not sufficient to ensure that the desired effect on the capital stock is realized. Are there significant sources of inefficiency in the use of maintenance funds (e.g., due to administrative leakages or an inappropriate choice of maintenance technolo- gies)? The same issue applies in the case of operational expenditures. Productivity in the use of O&M funds may be as important as the &ount spent. Comparing Alternative Maintenance Strategies 26. Evaluating the discounted stream of costs for a given strategy of keeping an infrastructural unit viable, one can compare alternative maintenance strategies. One common comparison involves a strategy of building infrastructure, providing only the most essential maintenance, and rehabilitating it at a later point in time. The alternative strategy is to establish a program of routine and periodic maintenance of the infrastructure, prolonging the time at which the facility would have to be rebuilt. 27. Such comparisons have been made in a number of instances for roads (e.g., a strategy of construction cum rehabilitation with no maintenance, relative to a strategy of construction cum maintenance, with rehabilitation occurring at less frequent intervals and at lower required costs, e.g., every 11 years rather than 6). Comparisons are made simply of the financial savings associated with the frequent maintenance strategy, with most studies suggest- ing savings on the order of 5 to 20 percent of the cost of the road in the case of certain types of Indonesian roads (depending on the discount rate involved). 28. The results of those studies are further reinforced by the fact that such studies do not account for the higher output to users associated with infrastructure in good condition. Estimates made in the case of urban roads in Indonesia suggest that the reduction in vehicle operating costs from a program of maintenance yields an 6nnual payoff of more than several times the cost of the maintenance program.6 6/ This study examined the cost of maintenance program to reduce the road roughness factor, and evaluated the resulting savings in vehicle operating costs. - 197 - Appendix S Page 9 The Balance between Operations and Maintenance 29. It is difficult to judge the relative benefits of operations vs. maintenance. In part this reflects their obvious interdependence. The greater the usage of infrastructure, the more rapid its depreciation, and the greater the need for maintenance. The quality of operations will also influence the functioning of the infrastructure and its susceptibi - to breakdown or premature wear and tear (e.g. poor operation of irrigaLion gates). While one can evaluate the impact of a given level of operations on the likely wear and tear of infrastructure, and make an assessment of the implications for maintenance, judging the relative rate of return of increas- ing the one at the expense of the other is difficult. One suspects that a balanced approach to the provision of operations dnd maintenance is the more cost-effective strategy for producing a given .evel of output over the medium term. In the short run, failure to maintain w.ay not reduce the productivity of operational inputs, but in the medium term deterioration in plant and equipment will more seriously impinge on overall productivity. 30. There may be factors which give rise to a bias toward maintenance. Skimping on operational inputs to a sector may have less visible consequences than the obvious signs of deterioration in capital stock. An impassable road or one filed with potholes, or a silted-up irrigation canal obviously attract attention. Reduced output in the education and health sectors are likely to be manifested more subtly or more privately, in the form of limited education, higher levels of morbidity and mortality, and lower agricultural productivity. At some later time, statistics may emerge suggesting that services have operated at low effectiveness, though these results may not be directly traceable to inadequate provision of operational funding. The fact that lost output is not visible or immediately obvious does not mean that it is not real and of importance. This accentuates the importance of sectoral efforts to identify concrete measures of output and performance which can be related to the operation of programs and to the maintenance of infrastructure. New Investments vs Rehabilitation 31. Is it important to distinguish between investments in new infra- structure and investments to rehabilitate existing infrastructure? Both have the same nominal effect in terms of increasing the aggregate capital stock. Rehabilitation may take the form of a simple reconstituting of the original plant or equipment, or may involve upgrading the quality of the original infrastructure (e.g., an upgraded road or higher quality building may involve greater maintenance requirements than were required on the previous infra- structure). In the latter case, there is a blurring of the extent to which it is rehabilitation or new investment. 32. The key difference is that a new investment in aew infrastructure extends the network of existing infrastructure, while adding to the overall - 198 - ~~~~Appendix 5 - 198 - Page 10 stock of infrastructure in need of maintenance.7/ In contrast, rehabilitation strengthens the quality of the existing infrastructure, restoring it to a fully functioning level, often without increasing the overall need for mainte- nance. Indeed rehabilitation may lower the need for maintenance. In effect, one may characterize the former as an extensive" (or quantitative) increase in the capital stock, while the former constitutes an "intensive" (or qualitative) increase. Comparing the two options involves evaluating the net present value of additional infrastructure (e.g., additional schools or roads) at the expense of the lost output and potential nonfunctioning (at some point in time) associated with the deterioration of the existing infrastructure. Design Standards and Re4uired Maintenance 33. Over time, rehabilitation is necessary on any asset. Most assets will depreciate even with the best of attention to maintenance, $iven the physical life span of any piece of equipment or infrastructure.e The only exception would be if one envisioned a program of periodic maintenance, say on a road, that would continue to provide overlay on the existing roadbed, postponing rehabilitation indefinitely. A critical investment issue is the design standard 0 construction. Accepting a lower quality of design, for whatever reason,- will imply a higher intrinsic rate of depreciation, accelerating the time period when the infrastructure will need rehabilita- tion. The poorer the actual standard to which a road or irrigation network has been constructed, the shorter its lifespan and the more rapid the depre- ciation that will occur, even in the presence of maintenance. Equally impor- tant, the lower the design standards, the greater the consequences of a failure to provide routine and periodic maintenance in terms of the rate of depreciation. Borrowing for Maintenance and Rehabilitation? 34. What considerations should guide the Government in deciding whether to borrow to finance rehabilitation? Are there any differences from the normal considerations of project evaluation on a new investment? In princi- ple, one would want to consider such borrowing on the same terms as any other potential investment project, evaluating both the discounted stream of costs and benefits. The rate of return should presumably exceed the cost of borrowing. In both cases, one is effectively evaluating the return associated with the provision of an upgraded infrastructure--in one case relative, 7/ Obviously, if the new investment occurs simultaneously with the total deterioration of a deteriorating section of infrastructure, this would not be the case. 8/ In fact, sometimes projects are "overbuilt" and very expensive because of the mistaken belief that they will last forever. 9/ This may derive from an objective of maximizing the pace and quantity of infrastructural elaboration, or may arise from inadequate supervision of the standards of construction by contractors. - 199 - Appendix 5 Page 11 perhaps, to no infrastructure, in the other case relative to nonfunctioning or deteriorated infrastructure. In, principle, the stream of benefits should be similar, though not identical.'°/ 35. In both cases, one would need to make realistic assumptions concern- ing the design standard likely to be put into place, as opposed to the intended design standard, and the level of maintenance that is likely to occur. In the past, such considerations did not apparently enter in the appraisal of project rates of return. One cannot say that a given rehabilita- tion project or new investment will inevitably be unprofitable in the absence of maintenance or with construction at a lower design standard. One can say that the rate of return will be significantly lower if a road or building is built to last only 5 years before beginning to deteriorate seriously rather than 10, or if the rate of deterioration is accelerated as a consequence of inadequate maintenance. Obviously, borrowing for rehabilitation is likely to be more acceptable if there is assurance that adequate maintenance will be provided. 36. An additional implication of borrowing for rehabilitation or new investment needs to be considered. Let us consider the case of two comparable projects, with equal social rates of return (e.g., comparable reductions in vehicle operating costs and passenger time saved). Assume one is a toll road, with a direct mechanism for capturing some of the rate of return through tolls on users. Assume the other is a nontoll highway. In this case, one can make the assumption, perhaps optimistic, that the flow of additional taxes earned from the higher output rising from the road generates some additional tax revenues, though these may or may not be sufficient to cover the debt servicing costs of the project. 37. The obvious difference between the projects is that the former has an assured financial flow to absorb the cost of maintenance and possibly debt service (if it is permitted to keep the revenues); the latter is dependent on general budgetary resources for financing these costs. Obviously, the latter project is more susceptible to the possibility of inadequate maintenance, and thus a lower rate of return than intended. The illustration raises the issue of the types of mechanisms the Government might seek to design to ensure that maintenance occurs or to realize a flow of fiscal revenues to cover some of the attendant costs of the project. Alternatively, it raises the question of whether future costs associated with maintenance should receive a shadow price of more than one to reflect the possibility of budgetary constraints. 10/ In the case of a rehabilitation investment, one would be able to subtract from the stream of costs the foregone stream of maintenance that would have occurred on the existing infrastructure. One would also need to appraise the net increase in benefits associated with the improved quality of infrastructure, rather than the total stream of benefits associated with putting new infrastructure in place. PUBLIC inSmUCu HMIAGUS? B?UV Overvie of the llot Common Public ervices i LDC Cities and the Pertinent Nlei Types of Publlc Capital Asnete Mhich Bere 4 eretlon ad Halitesae Hela tree of physical fecilities which roestr* o*ratioe esa Mdintenace Basic tarreetructure, veutlcles. pleait. Service sectors civil work,. usdergreund utilities Buidindg,. tructures mechesie l sad electrical equipment Basit l.fr tructure *d Utiit Srvies need. petbi. ussor re and erldp Prvemata. curb.. shoulders, slo"s. Bridge substrueteres. superatructures and Roed stia. traffte *tpuls. other stroet embnkentst, retaisiug sells. roadside docks fursiture dreim . pauamni markings L%treet lighting Poles fistares. tubes sA bulbs, switchgar. treseforurs tlettreity distributlio /a Umdergrounil distrtibtlon Itmes Poles Trassfermars, etreut bhrekrs. ceedacters mtsrs Metor supply Itnkte faelities. treotmisslon sad disttr- Bsaless othrt treatment plant structures. P"S deepeIs. mac_eaicaeleotriel bstios miss water tours, pumping stations listallstieme to trst_ t plasto. "twos. fire hydrsnts. public fecste heuw cen- mectioe. Mt'__ lmna dricgasa *d flood protection works Drti caenals. culverts. dikes. retention puwing stetbons Pcs. coatral equipnt besims Semre system. low-cost esmitation Pipes, manholes. oxidation ponds sInas, other tretm_nt plant structures. Pumps. neh_te callectrical tstsltsttio public Ictiess, puuping stations is troot_et pleats. vehicles far sptle i;** 5etyl5g Solid wets collection ad disposal Du ip Otes 5tata - commnal etorap units, transfer Collcettem wvhicles bescarts. oeotasirs, *tattoon stamdrdtid dat hime. eqsuiet at _ sitee. compostisef planst sildip amd Bosisz ith fertinent Srvice buildinw Building site area, access, utility connec- Schools, cliniec, hospitals. etc. INcteaIcl/*lectrical Installatl_s, Sb 0 tiona teeces Utility buildingp Buitding sIte area, access, utility conme- Public markets, slaughterhous*es police Nschm Ical/electricel is"tell,tinn sec- tions stations, court houses. prisose, fire sta- vics vehicles, Police cars, fire trucks. tions, cestral mtor ptola workshops sad relisg stock sod ltmd plft sod euipFset stores for esttsesce of reeo sao ewr Moets Public buildings buildias site area, access, stility coemmc- City hell. librariaes, wasem. cultural sad C lectrical sed mehanical isstallsttes tie"s religious centers Roseisg schm On-site Isf rstructure and utilities LOt-coat houslig units sad eommunl tlectrical sad mch_lcal l_stialAttesu buildigsp Bacreetiesa Facilities Parks, playgrounds. cemeteries sports cam- Spectator staeda is sports couplea. mo_- Lightln. hkeche slaygrlsad e"1spuet. Plexsm gmets etc. Othor Services ad rPeciltti* =ettreport *ptu_ ports u snd ailways. tramways. runways, quoys herd- Stattons. terals. edslmistratioe build- _;s traimd tram, mechkeicl sad *lec- airpects 1± ~~~~~~~staindisg. etc. insg trical eqeipest Public tol p sytm_ /a Underground cables Aduinistration buildiep Bachaess overhsd dires. etc. telephose Bost he Ptblic gas surly / pip"e Storep tanks, buildtop P_ s. valves, reqletoeq uip_eit etc. Facilities for provisilo of materials for Cravwl Pits. qescries MlIng plants. reek cruashrs, bult ceevey- Mites*aaam ore Vacest lead easd by local authority Vacant lewd /a Loes frteqetly tbh respossability of the arche local goverm_nt. tS- f-fI IBDUOMSIA PUBLIC BICURCE MISOtI?t STUDY Overview of Comn Types of OD rattO and aaintenance Work Activities in bDC Citie" L Service sectors and functioal aras Operations aintenance /b Roads, paths, ainor drains and Traffic emangement: Operation of traffic signals; boads and paths: pothole patching; deep patchtng; single- or *ultip1-s_urface treatmats; o_vr- bridps control of road use (special lvae, vehicld ls; beaa and subbase repair, crack sealing; slurry seaI; fot .a-l aed aud ost veighing scal*es rain gates, etc.) Surface bladinX of gravel roads; spot retr_alling; gravel ra"rfactag; det coetrol; drag- Operation of toll tee collection tfeclities ging of gravel surfaces Openiagiclosing of brtidge Cemnt concrete surface repair; slab joint cleaning sa filling; usdraealn Replenishing earth and gravel shoulders; resbaping shoulders; sLope pretectits ead repair; tree and bush clearing; weeding; xress cutting; pot-aceidest ea_up and repairs; reir of road mrkin g; utility trench raimtatseats; debris eceuttig sa r_svl; repair and replaceaent of senhole covers Street furniture: Stret sign cieaning and repair; repainting of bue sope sd other street tur- niture; repair of guard rails and other safety devices Stall drains: Cleaning of linwd ditches, dram adn cetch basins; scructurel repir bf Istng; cleaning and dnior reshaping of unliled ditehe, drins sad catch besie_ Brtdges: Cleaning and clearing; protective p4inting; conerete brite structural nastesas; tisber bridge matntenance Street lighting Operation of street light control system Beplacement of bulbs and tubes; welnten.ace of transformers ead swtchger; structural reair; protective pa-ting and other _intenance of poles and fixtures Blectricity distribution Operation of transfor_r facilities; bulk and consu_r Line inspect ons and repair; eter sointenance; structural repair. protective paisting and other meter readi-g; conneetion and disconnection of consus- caintenance of poles maintenance of transfort.,-s arm Water supply Operation of pups; operation and control of treatmnt leak detection and repair; repair of vale and fi. kdreats; ple cle aing; structural tsits- processes; bulk sn conso or mter reading; crnnection nanee of water towers. tanks and other structures; Protective peistita of * teral "rfaces and disconnection of cons umers nsin drains and flood protec- opc,-atl of pumping stations; operation of warning Desiting of ain drain channels; cleantng of lined drains sad catchst basit; structural tlim works and .otrol equipmet mintenance of drain lining; cleaning and minor reshaping of unled draiss; cleening/clearing of culverts Sewerage systom and low cost Operation and control of treatment processes; con- Clesning of sewer lines; structural eAlntenance of sewers; replacemsnt of sewer pipes; aeptytag aanitation nection and dieconnection of houses; operation of of septic tanks; vegetation cutting and sludge removs fin maat, stabilov,tion pods commnal latvrine; night enil collection Solid waste collection and Door-to-door collectlon; street sweeping; store Structural maintenance of communl storage units, transfer stations. etc.: asistenace of draie dispoesl cleanup; gully pit soptying; transfer and haul to and other installtiones and disposal sites; naeitenasce of mchalceal plants; vehicle maintenance disposal sttes; sanitary ladfill operatton; operation of comoating planta Bulldingp Operdtion of: ventilation, air conditiontngX heating; Washing and cleening of floors and hardstandinge; window clessing; nelstesance of gr_nd and *levators and otbhr sachenicatlJ-lctrical equip- envtron_snt (used control, horticulture, grass nwiag); emptying of septic tanks, grJae, traps. mnt; utility installations such as water, etc.; internal painting and redecoration; structurdt repairs; protective patiting of estersal electricity, gas, telepbone, solid vaste collec- surfaces; msintenance of nechanical/alectricsl tistallattios tion Periodic operation/testing of fire protaction and fire-fighting Installations; operation of securtty wasures and access control Workshop facilittes for roil- Oetion of worksp and service facilitiast fuel Operator' daily nintenance; washing; lubrication; tire repair; body repair; engine sad ing stock for all service filling; stores operation; plant hire operstionse transmiasion repair sectors Facilities for provisio of Quarrying; screening. gtrading and stockpiling; Nfainten nce of plant and wchanic.l/electrical Installations mtrerials crushing plant operation; blade mining and storage of cold sines; hotela plant operation Signs mnufacturing Recreational facilities, cent- Operation of sports coplexes swissing pools, Cutttng trees and bushes; grass soving; horticulture; weeding; saintenance of mchanieal/ terte. vacant land playgrounds, etc. electrical equIpsent: structural mintenence of buildings and sonuwnts; protective painting of fences, benches, etc. Burials at cemeteries Fire and ambulance service Operatton of fire trucks, fire hvdrants and asbulances Vehicle sainternce la Purely addinistrative tasks not Included. Services like gas, telephone, ports and airports are left out of this overview as chey are less frequently a local government retponqlbility. D : 7F Inspections and Inventory updating included in alt service areas In addition to the tasks stated. I CA .4 le RD THAILAND 'Or 1r Hr 24 00 1W PHILIPPINES ,- I N DON E SI A MALAYSIA CiNERUNI / T (, ~~~~~~~~~~*dox \ 9 / \ ~~~~~~~~~~~~~~~~~~~~~~~~~~~~Rim"r PwimnoBouwkI I vooKmn8I' netoi16ordre L2 ( N MALAYSIA c> SINGAPORE \ A g / _t 10n^0; 0 ; A 23 < \ GoromolO Ols ~~~~~~~~~~~~~~~~~~HALM4HFRA *23 C GA'nnJ 5S 4 26 KA /V4 A IV r ALLn-,do r_ b@ _ o ,.f \20 / 6 n414o 5 b-b ˇGKA 25 / - 1 o2n-TI ) AogkRIomnog / y 2 D O 7 n- " Lo.AO500LTBLT / 24 5 11 A W EslI-> KEPVIAUAN SUA1F 1011410 PRUVIN( ES 6 QBELITUNG / 22 21 17E.-I.I. -Es L. L. IRI /fIAN JAVA -Al_AE 'n-n... AHSIl K-".- 4 -IAU - G7 SFMAHAIA 8FAA Hi/ nb o.,eoUAol al 9 Awl JASART 9 I3 4AWA L R00 oCmARn Y DUR |5 NUOjNGR bAA S--0 ( 11 _( tw* 12 LI TOHHAAA / ADUR 4 WAL Tb I1 =Z2AWL T5NGGARA SOLOS A 1- 1GO 300 GO 22 SULATESI SLAST 5IO-\AWA 3 16 ,, I - 23 --A - O TI- U W-9- R 27 MILES 24 KAL,MOTAA SA I ALA s no-- 22 KALLOWAAA HIT OS AlLANLsn,LL.. ,a ,b tRxe 00 200 300 400 500 27TIAVA TInL- -fT-, *, IA Hs 'LI &L,n--,na-sn-n-. SILMLOLBAS OH0' HAo' 112- lL' 04' 130' 377'