Fiscal Aspects of Social Protection Programs

Turmoil and uncertainty may be an inseparable part of the lives of the poor. In an earlier article, my colleague, Rema Hanna, reviewed the impact of the Russian-Ukrainian war on the poor and vulnerable. The poor have been particularly hit by the increase in food and energy prices, especially food, because food is a large part of the consumption of the poor.

Furthermore, Hanna wrote, the government would refrain from raising prices and would bear the burden of subsidies — as is the case in the subsidized fuel (BBM) — but the impact must be paid for in the future, for example by increasing taxes, or even cutting the budget for productive investments, such as infrastructure and health spending. Yet we know that infrastructure or health investment is needed to boost future productivity.

What can the government do to address this situation? My colleague, Benjamin Olken, answered that in his recent article. Olken emphasized three principles that should be considered so that the government's policies are effective in coping with this problem. He mentioned the need to focus on social assistance for poor and vulnerable groups. It is important to make sure this program is flexible and has automatic indexation. With this, aid programs are designed to further increase the efficiency of the social protection system.

Program financing

All of Hanna and Olken's policy recommendations require funding. How to finance them? Does our state budget (ABPN) have enough room for this? This article tries to answer that question.

First, rising commodity and energy prices are like two sides of a coin. On the one hand — as mentioned above — it creates a burden for the poor and vulnerable groups. However, on the other hand, with the increase in coal and palm oil prices, the government will have additional revenue (windfall income) from increased taxes and non-tax revenues (PNBP).

The government estimates that the additional revenue will reach Rp 420 trillion (US$28 billion) this year. From this point of view, the increase in energy and commodity prices caused by the Russian-Ukrainian war has a positive impact on government revenues.

Also read:

> Commodity and Energy Boom: Double-Edged Sword

> Russia's Invasion of Ukraine on Global Economy

It means that the government actually has the opportunity to use the additional revenues for productive investments, such as infrastructure, protection for the poor and vulnerable, health and education.

Second, the government can also explore other sources of revenues, such as an export tax on coal, or increasing the export tax on palm oil. Export taxes have less distortionary impact than export bans or domestic market obligations (DMOs).

As the major exporter of palm oil or coal, Indonesia can determine the price (price setter).

In the case of price setting, export taxes can be used to increase state revenue or to lower domestic prices. Yet on the other hand, because Indonesia is a major coal and palm oil producer, export taxes would increase prices in the importing country. As a result, it would cause a decline in Indonesia's exports.

How big would the decline be? It depends on how sensitive the impact of price increases on demand for imports from Indonesia is (price elasticity). Of course, more detailed calculations are needed. However, in general — as a price setter — the government can benefit from this policy from additional state revenue and a decrease in domestic prices.

In addition, it is more transparent. The additional income from this export tax can be used to finance a cooking oil assistance program like the one proposed by my colleague, Olken.

Third, our study (Basri, Felix, Hanna and Olken, 2021) shows that efforts to increase tax revenue can also be carried out through administrative reforms in taxation, namely moving taxpayers from KPP Pratama (main tax office) to KPP Madya (medium-sized tax office). If this policy is realized and expanded — the government has indeed started implementing this policy since the middle of last year — tax revenues could increase significantly without the need to increase rates, which could create additional burdens for taxpayers.

In addition, the government can review the tax incentives provided so far. The ratio of tax expenditure to gross domestic product (tax incentives) has been relatively high at 1.52 percent of GDP in 2020. Why are so many tax incentives given, but their impact on economic growth is relatively limited? Reduce ineffective incentives, especially for sectors that are not environmentally friendly.

Thus, there is an additional source of financing for the poor and vulnerable groups, while at the same time pushing toward a green economy.

Take advantage of windfall income

Fourth, in terms of government spending, it is very important to change the social protection system to make it targeted as proposed by Olken. In this case, improving the quality of spending by reducing fuel subsidies or diverting them into social assistance to the poor and vulnerable group will be a better solution.

This policy also encourages a green economy. Coady et al (2019) estimates that removing oil and gas subsidies alone could reduce global carbon emissions by 5-6 percent by 2015, and by 28 percent if coal subsidies are also removed.

Therefore, we propose utilizing windfall income for productive and targeted expenditure allocation, imposing export taxes, reforming tax administration and reducing tax expenditure for environmentally unfriendly sectors.

Fifth, as discussed by Hanna and Olken in a previous article, the government may indeed choose to use windfall income to maintain fuel prices. However, apart from being inefficient, because they do not reach the targeted recipients, the costs are also very large.

During a meeting with members of the House of Representatives (DPR) a few weeks ago, the government proposed an additional Rp 520 trillion in energy subsidies for the 2023 state budget. One thing to remember is that one day the commodity and energy boom will end, but fuel and electricity subsidies – which are different from unconditional cash transfer (BLT) and temporary in nature— will be politically difficult to remove.

It is true that the burden of subsidies will depend on energy prices. It means that the ups and downs of the subsidy spending will follow the increase or decline in state revenues. Our state budget will be pro-cyclical. In fact, we want a counter-cyclical budget. The implication is that fiscal space remains unchanged, and its ability to stimulate economic growth is limited.

In addition, we know that state revenues are volatile if sourced from natural resources, while government spending tends to be stable or increase. It means that when the natural resources boom ends, there is a risk that the fiscal deficit will increase. In fact, we want to lower the budget deficit back to 3 percent of GDP starting in 2023.

As a consequence, the government must cut spending and carry out a fiscal contraction. At the same time Bank Indonesia may also have to raise interest rates due to inflationary pressures. This will hit economic growth.

Expansion of the social assistance program

If the social assistance program is to be expanded to the lower middle class, which has been hit hard by Covid-19, as proposed by Hanna and Olken, more funds are needed.

For example, the World Bank (2020) estimates that there are 115 million people who fall into the aspiring middle class category. If this group is to be targeted, the required social assistance will have to cover about 30 million households (assuming one family consists of four people).

If the social assistance is worth Rp 1 million per month (bigger than the current BLT) and it is given for 12 months, an additional Rp 360 trillion is needed. Interestingly, this amount is smaller than the Rp 520 trillion budget proposed by the government for energy subsidies in 2023.

The implication is that part of the subsidy budget proposed by the government can be used for productive and inclusive investments, while at the same time protecting the poor and vulnerable groups.

With the help of digital technology, improved data and good narratives, the government can take advantage of the commodity and energy boom, and at the same time protect the vulnerable groups mentioned.

We see that the policy of changing the allocation of fuel subsidies to direct subsidies has three advantages: it is good for vulnerable people, good for fiscal and good for the environment, because it will reduce the consumption of fossil fuels.

Expanding social protection through targeted subsidies such as those proposed by Hanna and Olken would provide fiscal space to promote economic growth. Of course, we understand that a policy does not exist in a vacuum.

There are problems with inaccurate data, problems with interagency coordination, or perhaps political unpopularity.

However, with the help of digital technology, improved data and good narratives, the government can take advantage of the commodity and energy boom, and at the same time protect the vulnerable groups mentioned by Hanna in her article.

KOMPAS/RADITYA HELABUMI

Muhamad Chatib Basri

Muhammad Chatib Basri, lecturer at the School of Economics and Business, the University of Indonesia

This article was translated by Hendarsyah Tarmizi.