VAT Rate to Increase to 12% Starting in 2025, Lower-Middle Class to be Most Affected

The Indonesian government has confirmed a Value Added Tax (VAT) increase to 12%, effective from the beginning of 2025.

This VAT increase is stipulated in Law Number 7 of 2021 concerning Harmonization of Tax Regulations (UU HPP). Article 7, Chapter IV of the law states that the VAT rate will increase by 1% to 12%, effective no later than January 1, 2025.

Coordinating Minister for Economic Affairs, Airlangga Hartarto, stated that various regulations have been formulated and issued during the presidency of Joko Widodo (Jokowi), including the VAT rate adjustment, which will be continued by the next administration.

Airlangga argued that the Indonesian public's choice of presidential candidate favors the continuation of Jokowi's government programs. "Certainly, if various government programs are continued, they will be continued, including the VAT policy," said Airlangga, as reported by *Katadata* on Friday (March 8, 2024).

After the General Elections Commission (KPU) announces the winning president of the 2024 election on March 20, 2024, the government will formulate the 2025 State Budget (APBN) in accordance with the new president's programs.

"Programs that need to be included in the APBN are those that will be implemented by the future government. That's the key point," said Airlangga.

Previously, Indonesia's VAT rate was increased from 10% to 11% on April 1, 2022. This increase was based on the UU HPP signed in October 2021.

Indonesia first implemented a 10% VAT through Law Number 8 of 1983 concerning Value Added Tax on Goods and Services and Sales Tax on Luxury Goods, better known as the VAT Law. However, through Government Regulation in Lieu of Law Number 1 of 1984 (Perppu), the government decided to postpone the implementation of Law Number 8 of 1983 until no later than January 1, 1986.

Groups Most Affected

Bank Permata's Chief Economist, Josua Pardede, believes that the lower-middle class will be most affected by the VAT increase to 12%.

"This will affect the lower-middle class; the upper-middle class will not be affected at all," said Josua, as reported by *CNNIndonesia.com* on Tuesday (March 12, 2024).

According to Josua, the VAT increase will lead to a surge in inflation. Although not significant, the price increase will add pressure on the middle and lower classes.

Furthermore, he continued, the middle class does not receive government assistance, unlike the lower class or the poor. The middle class is considered ineligible for assistance, but their income cannot keep pace with rising basic commodity prices.

"The middle class does not receive social assistance (bansos), as only the bottom 40% receive bansos. Deciles 1-4 are the government's responsibility to support through bansos. Now, deciles 5-6 need consideration. They don't receive bansos, but the cost of living, the impact of inflation, affects them, and their income isn't increasing much," said Josua.

However, Josua stated that if the VAT increase is not accompanied by an increase in basic commodities and electricity prices, the pressure on the lower-middle class may not be too great.

"It might only slightly affect the vulnerable middle class," he said.

Meanwhile, Senior Analyst at the Indonesia Strategic and Economic Action Institution (ISEAI), Ronny P Sasmita, believes that the VAT increase is not a problem as long as it is used for social spending aimed at increasing public purchasing power and reducing inequality. Because, according to him, it will economically strengthen purchasing power and increase consumption.

"So, even though the VAT increases, the opportunity to improve and expand businesses is also significant due to increased purchasing power and consumption. This means that the opportunity for businesses to increase the production of goods and services is also increasing because their customer base is expanding," said Ronny.

However, he continued, if the VAT increase aims to finance policies unrelated to increasing purchasing power and public welfare, the economic situation will become more difficult.

Because, according to Ronny, the VAT increase will burden businesses because public purchasing power will not improve. "In this condition, businesses and the public lose, only the government benefits," he said.