Taxes on real property have been identified as a source of income whose potential is currently underused by many countries. Indonesia has recently decentralized the property tax to the local level, but has this led to a better use of the tax potential from this source? A look at revenue figures provided by the Indonesian Ministry of Finance suggests that reforms may have boosted tax collection at an aggregate level. However, closer scrutiny of seven local cases reveals that local governments are far from tapping the full potential of the property tax. Most of them are struggling with deficient data, low public acceptance of the tax and huge amounts of tax liabilities. In addition, local governments shy away from the political costs associated with more active revenue mobilization.
Keywords: Taxation, Indonesia, fiscal decentralization, property tax, political economy
Mobilizing domestic revenue is a key issue on the international financing for development agenda (for instance, see OECD, 2014; United Nations, 2015). In their efforts to tap hitherto underused sources of revenue, some governments have turned their eyes to the taxation of real estate property. Property tax has been labelled "the number one un-exploited potential source of public revenue globally". (2) It is also considered an 'ideal' local tax (Fjeldstad and Heggstad, 2012), since it is relatively difficult to avoid due to the immobile character of assets and collection is based on locally available information. In localities with dynamic changes in the real estate market, for instance due to high urbanization or economic growth rates, granting local authorities the right to tax property should lead to rapidly rising revenues from this source.
Recent contributions to the debate acknowledge the revenue potential of property tax in developing countries while identifying several factors that make collection of this tax a challenging task for local governments (Fjeldstad and Heggstad, 2012; Kelly, 2014; Mikesell, 2007; Monkam and Moore, 2015; Norregaard, 2013; Slack and Bird, 2014): First, property taxation requires administrative capacities (for instance with regard to valuation and enforcement) many local governments do not possess. Second, central government transfers may create powerful disincentives to local revenue generation, leading to moral hazard behavior of local authorities (Weingast, 2014). This means that transfers may enable local governments to shift the costs of local service delivery to the central level rather than levying taxes or user charges on their own constituencies. Third, effective property taxation can be hampered by political settlements where local politics or tax administrations are captured by powerful groups and any decision to tax is taken in the light of the political costs it entails (Di John and Putzel, 2009; Everest-Phillips, 2009; Jagger and Shively, 2014; Slack, 2013).
With all these observations being widely discussed by now, it is fair to say that the underlying microtheoretical mechanisms have hardly been studied so far. How do administrative constraints, incentive structures and political settlements express themselves in everyday tax policy and tax administration? Some studies explore this question with reference to the USA and other OECD member countries (Alm, Buschman, and Sjoquist, 2012; Asatryan, Baskaran, and Heinemann, 2014; Ashworth and Heyndels, 1997; Cabral and Hoxby, 2012; Gill and Haurin, 2001; Makowsky and Sanders, 2013; Presbitero, Sacchi, and Zazzaro, 2014; Slack and Bird, 2014). Several interesting lessons can be drawn from this research, as will be shown in the next section of this paper.
Beyond the world of industrialized countries, however, evidence remains scant (for instance, see Bird and Slack, 2004). Researchers note of course that developing countries rely to a much lesser extent on direct taxation of personal income and property than the industrialized countries (Bird, 2013). While Gordon and Li (2009) seek to solve this puzzle by changing the model to account for higher enforcement costs due to large informal sectors in developing countries, other authors broaden the scope by looking at the strength and stability of political institutions as a key determinant of the tax structure (Besley and Persson, 2014; von Schiller, 2016).
Against this background, the present article discusses the influence of administrative capacities and political costs on the local collection of the 'land and building tax' (pajak bumi dan bangunan, PBB) in Indonesia. (3) Despite the recent character of reforms--the tax was decentralized in a gradual process between 2011 and 2013--Indonesia is a case that offers several interesting insights into the political economy of tax decentralization. After more than three decades of autocratic rule under General Suharto, the country embarked in 1998 on a political transition towards democracy that included several bold decentralization measures (Horowitz, 2013). This so-called 'big bang decentralization' (Hofman and Kaiser, 2004) became effective in 2001 and has led to the transfer of many new responsibilities to the nearly 500 cities and districts (kota and kabupaten). Both the transfer system and the local revenue system were changed several times, with the decentralization of the land and building transfer tax in 2011 and the land and building tax in 2011-2013 being two major reforms.
Based on empirical fieldwork carried out in 2014 (reference hidden), this paper observes that local governments appear to collect more land and building tax after decentralization. A detailed look into seven cases located in different parts of the country reveals, however, that local governments are far from using the new taxing abilities to their fullest potential. The article argues that capacity constraints are but one determinant of this finding. In addition, results appear to be driven by political considerations. Of the seven tax policy and administration functions at their disposal, local governments rely to a lesser degree on those with high requirements in terms of administrative capacity, but also on those associated with a higher risk of causing taxpayers' protests and losing electoral support, i.e. higher 'political cost'. This finding might be associated with the recent character of the reform, but it may also be related to political considerations, as will be discussed below.
The next section builds the case of the political economy of property tax reform. By looking at the available literature it introduces the concept of 'political costs' and identifies the variables and their assumed causal relationships that guide the empirical inquiry. Section 3 introduces our empirical case, Indonesia. Section 4 describes the research design while section 5 presents the main research findings. Section 6 concludes.
THE POLITICAL ECONOMY OF PROPERTY TAX REFORM--BUILDING THE CASE
Paying taxes is never popular. Every tax reform--and for that matter, taxation in general--comes at a political cost. (4) The definition of political costs used in this paper is based on the political economy literature, in which decision-makers are assumed to be rational actors aiming to secure political support in order to stay in power (Bueno de Mesquita, et al., 2003). In a democratic setting where politicians depend on political (usually electoral) support, a 'political cost' is thus represented by an expected loss in political reputation or votes (Hettich and Winer, 1988, 1999). Public protests against specific policy measures could be considered indicative of losing support. In that sense, politicians weigh the expected political benefits and costs before enacting public policy reforms, and their perception of public opinion and possible opposition restricts their choices on tax policy and administration (Ahmad, Brosio, and Poschl, 2014).
Several studies provide empirical evidence for the responsiveness of elected authorities to their constituencies with regard to taxation. Most of them focus on OECD member countries. Based on a survey among local politicians in Belgium, Ashworth and Heyndels (1997) observe that vote-maximizing political actors choose reform paths that minimize political costs. Tax levels are chosen so as to reduce the opposition of popular vote. Perceptions of political costs are shaped by tax policies in neighboring jurisdictions.
The revenue effect of tax reforms (property tax in particular) is often more visible and immediate than the benefits arising from spending that revenue. Voter discontent can be triggered by a direct loss of disposable income, which stands against an indirect and less transparent improvement in the provision of services through increased public expenditure (Kenny and Winer, 2006). In such a setting, property tax is more likely to meet resistance due to its salience and broad tax base (Cabral and Hoxby, 2012; Poschl, 2015; Rosengard, 2013). The salience of property tax seems to be particularly relevant at the local level: Presbitero et al. (2014) observe that in a sample of 22 OECD member states a higher recourse to property taxes at the subnational level is associated with higher primary fiscal surpluses (i.e., more fiscal discipline), while a larger share of property taxes in the overall government tax take does not have any statistically significant effect on the fiscal balance.
Even when the overall tax take is not the main issue, political conflict and opposition may arise with regard to the composition of the tax structure. This is shown, for instance, by Asatryan et al. (2014) who observe that greater reliance on direct democracy at the local level in the German federal state of Bavaria leads to higher taxes in general, but to a relative shift from the broad-based property tax to the narrow-based business tax. To deal with pressure from specific groups, politicians may have an interest in diversifying the tax...