The effects of the 1983 Indonesian tax reform on the effective tax rates on capital

This dissertation analyzes the effect of the Indonesian tax reform of 1983 upon the effective tax rates (ETR) on capital in Indonesia. The model is based on the cost of capital model originally developed by Hall and Jorgenson (1967). Unlike their model, however, this study extends the analysis to account for the provisions of tax holidays. In addition, this study also incorporates the provision of direct government subsidies which have been ignored in previous studies of ETRs.;The results suggest that, under the basic rules, the Indonesian tax reform lowered the overall ETRs on capital. However, when we incorporate tax incentives into the model, especially the tax holidays, the results indicate that the reform generally increased the ETRs on capital across categories. Three main factors of the reform that affect the ETR calculation are the elimination of the tax incentives, the adoption of new method of depreciation, and the elimination of exemption on interest income.;The new tax rules produce more neutral ETRs across different sectors, regions, types of assets, and different sizes of firm. The variation of ETRs across categories is mainly due to the different debt/equity ratios, especially for debts channelled through financial institutions. The inclusion of direct government subsidies into the model does not significantly alter the ETRs on capital since the subsidies have mostly been given to the agricultural sector which has a relatively small share of capital formation in Indonesia.;Sensitivity analysis indicate that the ETRs under the old and new tax rules are increasing with the rate of inflation. The elimination of exemption on interest income caused the new tax rules to be slightly more sensitive on inflation rates and different types of ownership relative to the old tax rules. On the other hand, such elimination led to a less sensitive ETR of the new tax system on the debt/equity ratio. Under the current tax rules, therefore, it is important for the government to eliminate the preferential treatment on interest income and keep the rate of inflation at a very low level.