THE ASIA PACIFIC JOURNAL OF PUBLIC ADMINISTRATION VOL 26, NO 1 0UNE 2004)- 71-90

Property Tax Reform in Indonesia: Emerging Challenges from Decentralisation

Roy Kelly

Indonesia is in the midst of an exciting decentralisation reform. Expenditure and revenue responsibilities have been rationalised, granting Dati II local governments responsibility for virtually all public services. Although devolved revenues have initially funded the newly devolved local responsibilities, there is increased concern that additional local revenues may be needed to further sustain the decentralisation process. One possibility would be to restructure the property tax from a pure "shared tax" to a more "local oriented tax". This would involve granting local tax rate discretion to promote autonomy and accountability, allocating property tax revenues entirely id local governments based on property location to promote ownership of the property tax, and adjusting the relative co-administrative responsibilities between central and local governments. All three required changes could be implemented immediately, while retaining the benefits of the current legal and institutional shared tax structure pending a more thorough review of the broader revenue allocation decisions.

Introduction Indonesia is experiencing an exciting fiscal decentralisation reform, rationalising expenditure and revenue assignments, and introducing a new intergovernmental grant structure. Dati II local governments are now responsible for virtually all public services with the exception of defence and security, foreign policy, monetary and fiscal policy, the judiciary and religious affairs. The previous Subsidi Daerah Otonom (SDO) salary grant for civil servants and the package of Inpres grants have been replaced by a new Basic Allocation Grant (Dana Alokasi Umum (DAU)), while the central g o v e r n m e n t tax s h a r i n g a r r a n g e m e n t s w i t h p r o v i n c i a l a n d local governments have been expanded to include a portion of the national personal income tax (20 percent), forestry (80 percent), mining (80 percent), fisheries (80 percent), oil (15 percent) and gas taxes (30 percent) (Fane 2003; World Bank 2001,2003). On aggregate, decentralised revenues have sufficiently funded the expanded expenditure responsibilities. In 2001, regional governments were estimated to have received about Rp 21 trillion in "surplus revenues", roughly 1.5 percentage points of GDP (World Bank 2003). However, the emerging new intergovernmental fiscal structure appears to be perpetuating local government dependency on central government transfers and shared
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taxes. Local own revenues (Pendapatan Asli Daerah or PAD) still only contribute 5-15 percent of total local fiscal resources, with large variations among Dati II local governments (Sidik & Karjamiko 2002; World Bank 2003). To support local own revenue mobilisation, the government enacted Law No 34/2000 which provides a list of available taxes and enables local government to introduce new local tax regulations guided by such broad principles as revenue adequacy, efficiency, equity and administrative feasibility. Local governments are now quickly introducing numerous local taxes, which are inhibiting economic development and violating sound taxation principles (Ray 2001; Saad 2001; Lewis 2003; World Bank 2003). To promote greater local autonomy, accountability and efficiency and to avoid this plethora of inappropriate local revenue instruments, government reformers are rethinking the original revenue assignment decisions, trying to identify a more effective package of grants, shared revenues and own revenues. To better capture potential decentralisation gains, local governments in Indonesia need access to and responsibility to mobilise more local own revenues (Ahmad & Krelove 1999; Bird 2000; Mann 2001; World Bank 2002). One prime candidate under consideration is the property tax, which is generally recognised as an ideal "local tax" (Musgrave 1993). This article explores possible options for restructuring the Indonesian property tax to better support these ongoing decentralisation reforms. It examines the property tax reform experience from 1986 to present, outlining the fundamental policy and administrative policies and resulting revenue performance. It then focuses specifically on the revenue performance from 1986 to present, presenting a simple revenue model to illustrate possible opportunities for further policy and administrative reforms to improve revenue yield. It concludes with recommendations for restructuring the Indonesia property tax to better support the decentralisation reforms. Specifically, Indonesia needs to provide local discretion for tax rate setting and to reallocate property tax revenues to Dati II local governments, while maintaining the policy simplicity and administrative benefits from the current shared-tax, "co-administration" property tax structure. Property Tax Reform Experience (1986-2003) In 1986 Indonesia enacted the Land and Building Tax (Law No 12/1985 Pajak Bumi dan Bangunan iPBBl), which significantly rationalised property tax policy, broadening the tax base, reducing exemptions, simplifying the tax rate structure, and introducing a framework for improved administration. Prior to this reform, property taxation had evolved into a complex system of seven different property-related taxes, each with slightly different bases and varying tax rates, and administered by different agencies and levels of government (Booth 1974; Kelly 1989,1992). Average property tax collection
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rates were less than 60 percent of total assessments, with large variation by property type and location. Most property tax information was out of date, largely compiled during the Dutch colonial period, subsequently maintained on an ad hoc basis, creating major discrepancies in data quality. Property valuations were considerably lower than true market value and inconsistent among properties one study estimated the appraised values at about a quarter of market value, while effective tax rates ranged from 0.01 to 0.4 percent of market value (Lerche 1979). The low revenue collection rates, incomplete fiscal cadastre data and inconsistent valuations generated major equity, efficiency and administrative problems, and low revenue yield. The 1986 PBB law dramatically simplified the property tax system, replacing all previous property-related taxes with a single tax levied at 0.5 percent on the capital value of land and buildings. The previous 50 percent tax rate concession for residential property and the progressive rates for rural land were all eliminated. To provide flexibility in phasing-in the tax, an assessment ratio, which can be determined through government regulation, was introduced. This assessment ratio, which can range from 20 to 100 percent, was set for all properties at 20 percent in 1986, yielding an effective uniform statutory tax rate of 0.1 percent. In the light of unclear or incomplete legal titles, the property tax liability under the 1986 PBB law is defined broadly to fall upon either the property owner a n d / o r beneficiary, who are jointly and severally liable for the property tax. The tax base was broadened by reducing exemptions and by shifting from a rental value to a capital value basis. Tax exemptions are narrowly defined limited to non-profit organisations engaged in religious, educational, cultural and social activities, graveyards, protected forests, national p a r k s , social common land (adat), diplomatic offices, and international organisations. Power for granting special exemptions for unique or exceptional properties was shifted from the director of the property tax department to the Minister for Finance. To improve equity, a valuation deduction for buildings is provided for all properties. This valuation deduction amount, which was subtracted from the building value, exempts most rural housing and low value urban structures, essentially making PBB a land tax in rural and low value urban areas. The valuation deduction was set at a fixed unit amount rather than as a percentage of building value to introduce a degree of progressivity to the property tax system. Overall, the legal structure was simplified to facilitate i m p l e m e n t a t i o n a n d e n c o u r a g e e q u i t y a n d t r a n s p a r e n t administration. Strict deadlines and penalties were introduced to ensure timely and accurate property registration and tax payment. Taxpayers and third party institutions, such as notaries, planning and land departments, are required to provide property information to the tax department or else face penalties. Taxpayers are given six months to pay, with a 2 percent per month penalty
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(up to a maximum of 24 months) applied on late payments. Seizure and auction of movable and/or immovable property is permitted to deal with non-compliance. The PBB law introduced several administrative changes related to revenue collection and enforcement, property information, and valuation. The major change was designating the banking sector as responsible for the cashiering components for tax collection. All other tax collection activities related to the estate, forestry and mining sectors is retained by the central government, while the law allows the Minister for Finance to delegate tax collection activities related to rural and urban properties to the provincial and local governments. Fiscal cadastre responsibilities of property tax information and valuation management also remain a central government responsibility. Using a combination of taxpayer-reported information and property data gathering field exercises, the central government is responsible for updating and managing the tax roll property information. In practice, however, the fiscal cadastre field activities are implemented with varying levels of participation from local Dati II governments. The property tax is assessed on the sales value for each property, as determined by the tax department. Property valuations are to be carried out every three years, except in areas of rapid development where the exercise can be carried out annually. With the exception of unique, high value properties, all rural and urban properties are valued through a simple mass appraisal system which relies on a similar land value zone approach for land, and a building classification system based on the replacement cost approach for buildings. The estate, forestry and mining sectors are valued through a combination of income, cost and comparative sales approaches. Although the tax department is responsible for property valuation, the tax department also works closely with local government officials in determining the land value books, which contain the estimated average sales price per square meter of land values within each land value zone. All land value books are discussed with the local governments, and signed off by the regional head, prior to being authorized for property tax valuation purposes. This review process ensures a degree of quality control, ownership and transparency in the land values used for taxation. The PBB law also introduced a new division of revenues between government levels. Ten percent was allocated to the central government. Of the remaining 90 percent, 10 percent was allocated to cover collection costs (9 percent) with the remaining 81 pecent to be allocated 80 percent to the Dati II local governments (64.2 percent) and 20 percent to the Dati I provincial governments (16.2 percent). All property tax revenues are considered discretionary local revenues available for either routine or development expenditures based on local budget priorities. The 1986 PBB law provided a firm enabling foundation for introducing
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major administrative reforms. In 1989, for example, the government restructured the property tax department along functional lines, doubling the number of regional field offices, which were renamed from "Property Tax Inspection Offices" to "Property Tax Service Offices" reflecting the government's new priority on taxpayer service. These 106 regional offices are currently staffed by 6,700 central government employees, administering property tax for about 50 million taxpayers and 78 million properties. In 1989, the government also adopted an innovative "collection-led" reform implementation strategy, which introduced the payment point collection system (Sistem Tempat Pembayaran or SISTEP) (Kelly 1993).1 Similar to the payment system used for the national electricity company, the SISTEP system designated specific banks within a predetermined geographic zone to serve as "payment points" for the property tax. Preprinted receipts were deposited at each payment point to reduce administrative and compliance costs, with the receipts, which remain at the payment point after the payment due date, creating a delinquency list for enforcement purposes. The SISTEP system was fully implemented throughout Indonesia by 1992, enabling the banking sector to efficiently receive and properly account for tax revenues. The SISTEP system significantly simplified revenue collection, improved accountability, reduced compliance and administration costs and provided a delinquency list for enforcement purposes. Tax collection efficiency rose from an average of 65 percent to 79 percent of the assessments following SISTEP's first year of implementation, and in 1991 led to a historic property seizure the first property seizure for property tax delinquency since Indonesian independence in 1945. Complementing these successful collection reforms, the Government introduced a computer-based property tax administration management system (Sistem Managemen Informasi Obyek Pajak or SISMIOP) which integrated new, rationalised administrative procedures with information processing technology to comprehensively manage all aspects of the fiscal cadastre, valuation, billing, collection, enforcement, and taxpayer service (Kelly 1996). By 1994, SISMIOP was successfully introduced throughout Indonesia, currently managing over 78 million properties, making Indonesia the largest property tax system in the developing world managed through a single, and uniform computer-assisted tax administration system. This first reform phase from 1986-1994 firmly established the fundamental policy and administrative framework into an effective revenue generating fiscal instrument (Kelly 2004). First, the government successfully mobilised the necessary political, management and operational support, linking the property tax reform to the momentum of the broader tax reform of 1984 that successfully introduced a new income tax in January 1984 and a value added tax in April 1995 (Gillis 1989). Visionary leadership behind the comprehensive tax reform ensured that the property tax was included in the policy and legal reform package and that sufficient, strong and
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sustained support needed for implementing the administration reforms was mobilised. Second, the property tax reform was built on a well-established property tax culture among taxpayers and tax administrators, whose historic roots date back to the early 1600s. Building on this institutional basis, the reform successfully linked policy and administrative components, coupled with a proper set of institutional and personal incentives through a "collection-led strategy" (Kelly 1993). Third, the reform successfully integrated tax policy changes with innovative administration systems and procedures to improve taxpayer service, reduce compliance and administrative costs, improve equity and enhance revenue mobilisation. The SISTEP payment point system established a baseline credibility which stimulated subsequent rationalization of all administrative procedures related to property discovery and information management, valuation and assessment management, collection, enforcement and taxpayer services. All these tax administrative procedures were comprehensively integrated through the SISMIOP computer-assisted property tax management system. In introducing computerisation, the government was forced to rationalise all administrative procedures, establishing a unique parcel identification numbering system (nomor objek pajak), systems development and support, and capacity training on new standard operating procedures and computer use (Kelly 1996). These improved institutionalised SISTEP and SISMIOP systems and related standard operating procedures continue to provide the consistent framework for reform sustainability. Fourth, all innovative administrative procedures and systems were developed and introduced on a pilot basis allowing the government to field test procedures, economize on scarce managerial and field staff and gauge possible reactions to the new procedures (Kelly 1992). Once proven successful, the SISTEP and SISMIOP systems and procedures were replicated throughout Indonesia, providing an enabling framework for subsequent policy adjustments and improved technological innovations. Fifth, all administrative procedures, systems and technology applications were developed cognisant of the available institutional capacity to facilitate implementation. Although capacity development programs were also instituted, all procedures were designed initially to match the existing administrative capacity, with systems that could evolve with improved local capacity. The key concern was to ensure that all systems and procedures could be readily implemented and sustained with existing capacity (Kelly 1992). Building on the foundations established from 1986-1994, the Government subsequently introduced several policy adjustments to the PBB law and further embellished the SISMIOP system.2 In 1994 the PBB law was amended to introduce three policy adjustments.
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First, the government changed the original revenue allocation formula, shifting the 10 percent originally allocated to the central government to the local governments.3 This portion is currently allocated 35 percent uniformly to all local governments as an "equalisation" component, and 65 percent as incentive payment if specific local governments achieve their mandated property tax revenue targets. In 2001, Indonesia introduced the DAU grant that contains an equalization element that now overshadows the 6.5 percent of the property tax allocated for equalization purposes. Second, the assessment ratio was changed from one uniform percentage to one differentiated by property value and sector. Under the 1994 changes, high value urban properties over Rp 1 billion began using an assessment ratio of 40 percent, which raised their statutory tax rate from 0.1 percent to 0.2 percent. Subsequently, in 2000, the 40 percent assessment ratio was applied to all rural and urban high value properties over Rp 1 billion and to all estate and forestry properties. Currently, only mining, urban and rural properties under the Rp 1 billion threshold use the 20 percent assessment ratio. This differentiated assessment ratio now introduces a somewhat progressive rate structure based on individual property values. Third, the valuation deduction was increased in 1994 from Rp 7 million to Rp 8 million and changed from a deduction based only on building value to one based on the total land and building valuation.4 The valuation deduction was also modified from being applied to each property to one applied once for each property owner. In 2001, this valuation deduction was increased up to a maximum of Rp 12 million, and discretion was given to each regional government to set the valuation deduction threshold.5 In addition to these three policy changes, the Government has continued to introduce improvements to the SISMIOP system. The basic SISMIOP system was renamed as i-SISMIOP signifying its change towards a more internet-friendly and automated taxpayer service environment. Mapping and other Geographic Information System (GIS) components have been gradually incorporated into SISMIOP. In Jakarta and Surabaya, the tax department introduced a "Payment On-Line System" (POS) at each property tax payment point in 1999. This POS system, implemented through joint cooperation between the PBB tax department, the local governments and the banking system, is designed to further simplify the collection system providing on-line information on collections to enable more effective cash flow management, compliance enhancement activities and taxpayer service. As part of the POS initiative, taxpayers are, as of July 2003, able to pay their property tax bills through the ATM machines at selected banks (Bank Central Asia 2003). The tax department also instituted a telephone information system in 37 regional offices to further improve taxpayer service and the dissemination of PBBrelated tax information based on the property identification number.

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Table 1 Property Tax Revenue Collection by Sector, 1969-2002 (in Rp billion) Year 1969/70 1972/73 1975/76 1979/80 1981/82 1983/84 1985/86 1987/88 1989/90 1991/92 1993/94 1995/96 1997/98 1999/00 2000* 2001 2002 Rural 5.9 10.5 22.7 311 36.2 45.8 44.1 76.8 96.1 118.3 153.7 146.3 240.3 267.0 356.0 322.0 397.6 Urban 0.8 1.9 5.9 12.7 20.6 37.9 34.1 951 128.8 208.2 381.5 595.3 837.8 1,040.0 1,445.0 1,712.0 2,002.9 Estate 0.7 1.0 3.7 8.0 11.2 12.9 20.8 32.3 43.5 38.0 33.4 75.5 96.5 201.2 265.0 245.0 261.1 Forestry 0.0 0.1 1.6 13.4 12.5 17.0 10.5 7.0 348 617 128.6 170.7 204.6 174.8 176.0 170.0 173.1 Mining 0.5 1.6 2.0 9.1 15.1 24.1 45.3 104.8 311.8 515.0 766.6 921.3 1,264.0 1,584.3 2,505.0 2,838.0 3,541.8 Total 7.9 15.1 35.8 74.3 95.6 137.6 154.8 316.0 615.0 941.3 1,485.9 1,909.1 2,643.0 3,267.3 4,749.0 5,287.0 6,376.5

Source: Government of Indonesia, Directorate of Property Taxation 2003. + In 2000, GOI changed the fiscal year to the calendar year. These FY 2000 figures have been adjusted to provide a 12-month equivalent to maintain comparability over time. Property Tax Revenue Progress (1986-2002) Since the enactment of the Land and Building Tax, property tax revenues have grown from Rp 154.8 billion in 1985-86 to over Rp 6.3 trillion in 2002, representing an average annual increase of over 26 percent. During the first phase of the reform (1985/86 to 1993/94), property tax revenues increased
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Table 2 Regional Government Revenue Structure, 1987/1988 and 1999/2000

1987/1988 Rp billion Provincial Government Central Grants Property Tax Level I Taxes User Charges Government Enterprises Other Revenues Loans
i

1999/2000

%
100 75.7 2.1 16.4 2.1 0.7 2.7 04

Rp billion 11,871 6,041 1,277 3,632 268 102 336 215

%
100 50.9 10.8 30.6 2.3 0.9 2.8 1.8

2,791 2,112 58 459 58 19 75 11

Property Tax as % of total revenues Property Tax as % of non-grant revenues Property Tax as % of total tax revenues

2.1 85 11.2

10.8 21.9 26.0

Rp billion Local Government Central Grants Property Tax Level II Taxes User Charges Government Enterprises Other Revenues Loans 1,414 911 146 74 152 7 71 54

%
100 644 10.3 52 10 8 0.5 5.0 38

Rp billion 26,935 21,176 2,893 1,416 971 75 301 103

%
100 78.6 10.7 5.3 3.6 0.3 1.1 0.4

Property Tax as % of total revenues Property Tax as % of non-grant revenues Property Tax as % of total tax revenues

10.3 28.9 66.3

10.7 50.2 671

Source: National and Regional Government Budget Database (Ministry of Finance) 2001. annually by over 33 percent. As Table 1 indicates, the major revenue increase comes from the mining and urban sectors, which together account for 87 percent of total property tax collections in 2002. As a central government shared tax, the property tax plays an important role in provincial and local government finance. As Table 2 indicates, the
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property tax provided about 11 percent of total local revenue, 50 percent of non-grant revenue and two-thirds of all local government tax revenues (67 percent) in 1999/2000. At the provincial level, the property tax provides 11 percent of total revenues, 22 percent of non-grant revenue and 26 percent of tax revenue. For the provincial governments, due to the relative decline in grant funds, the property tax increased in relative importance from 2.1 percent of total revenue in 1987/88 to 10.8 percent in 1999/2000. As a percent of GDP, property tax revenues increased from 0.16 percent to 0.45 percent from 1985/86 to 1993/94. In general, the rural, estates and forestry property tax revenues remained virtually unchanged as a percent of GDP, while urban property tax revenues and mining sector revenues more than quadrupled from 0.03 to 0.12 percent and 0.05 to 0.23 percent of GDP, respectively. Urban revenues increased due largely to the policy and administration improvements introduced by the 1986 reform, while the dramatic increase in mining sector revenues can be largely attributed to how the government allocates its national oil-related revenues. Since 1993/ 94, in contrast to the earlier reform period, overall property tax revenues have not been very impressive, all sectors essentially stagnating with respect to GDP. In 2002, property tax revenues declined to 0.40 percent of GDP from its peak of 0.45 percent of GDP in 1994/95. By international standards, the absolute level of property tax revenues in Indonesia remains low. In 2002, the property taxes represented only 0.40 percent of GDP, about 2.9 percent of total government tax revenues and roughly 11 percent of local government revenues. Although comparative data is scarce, property taxes throughout the world account for about 0.53.0 percent of GDP, 2-4 percent of total government taxes and between 4080 percent of local government finance. In developing countries, the property tax tends to generate significantly less property tax revenue typically generating about 0.5 percent of GDP, 2 percent of total government revenue and a maximum of 40 percent of local government revenue (Youngman & Malme 1994; Bird & Slack 2004). These aggregate statistics suggest that the property tax system in Indonesia should be able to generate a substantial increase in revenues. For example, if Indonesia was to improve property taxes to at least the average of most developing countries (0.5 percent of GDP), property tax revenues could increase by about 43 percent thus, potentially generating an additional Rp 2.7 trillion per year. These increases could come from a combination of increased effective tax rates and administrative improvements in expanding the tax base coverage, improving the valuation level and enhancing collection efficiency. A simple tax revenue model provides an estimate of the potential impact from administrative improvements alone (Kelly 2000, 2002,2003):

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Tax Revenue = [Tax Base * TR] (Policy-related Variables)

* [CVR * VR * CLR] (Administrationrelated Variables)

Definitions used in this model are as follows: Tax Base Tax Base is defined according to the government policy in terms of what is and what is not taxed. In the case of Indonesia, it is the value of the urban and rural land and buildings and the value of mining, estate and forestry property, minus the value of those specific properties exempted by law. Within this definition, the absolute tax base level then depends on market dynamics of supply and demand of properties. Tax Rate is defined as the statutory tax rate. In the case of Indonesia, it is the tax rate of 0.5 percent multiplied by the assessment ratio. Currently the assessment ratio is differentiated by property value and sector, 20 percent for low value properties and 40 percent for higher value properties. The statutory tax rate thus ranges from 0.10 to 0.20 percent. Coverage Ratio is defined as the amount of taxable property captured in the fiscal cadastre, divided by the total taxable property in a jurisdiction, measuring the accuracy and completeness of the property tax roll information. Valua tion Ratio is defined as the property value as recorded on the valuation rolls divided by the real market value of properties on the tax roll. This measures the accuracy of the overall property valuation level (i.e., what percentage of market value is being captured through the valuation process).6 Collection Ratio is defined as the tax revenue collected over the total tax liability billed for that year, which measures collection efficiency. The CLR is affected by the collection of both current liability and tax arrears.

TR

CVR

VR

CLR

As this model indicates, tax revenues are equal to the tax base multiplied by the statutory tax rate adjusted by three administrative variables related to coverage, valuation and collection. The tax base is essentially a variable determined by market dynamics of property supply and demand and the legal definition as to what is and what is not included in the tax base. The tax rate is also a policy-related variable legally determined by central government decision.
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Once these basic policy decisions are determined, the tax revenues, which will be received, are affected by three administrative variables, namely the level of the coverage ratio, the valuation ratio and the collection ratio. These three administrative ratios ultimately affect the effective tax rate and tax burden for each property, which in turn affect the overall revenue yield, economic efficiency and equity of the property tax system. Unlike the tax base definition and tax rate, which are determined politically by the central government, the coverage, valuation and collection ratios are affected by administrative capacity and political will continuously throughout the year. Using this model, it is possible to estimate the potential revenue yield from improved tax administration. For example, Indonesia is estimated to have, on average, a coverage ratio of about 80 percent, a valuation ratio of about 60 percent, and a collection ratio of about 80 percent.7 If each ratio could be improved by 10 percentage points, that is up to about a coverage ratio of 90 percent, a valuation of 70 percent, and as collection ratio of 90 percent, revenues could be improved by 24 percent overall, without any change to the actual tax rate.8 International experience suggests that Indonesia should be able to improve its property tax revenues up to at least equal to 0.5 percent of GDP, which implies a possible 43 percent increase in property tax revenues. The revenue model above suggests that property tax revenues could be increased by 24 percent solely by improving the tax administration-related variables of coverage, valuation and collection. The difference of 19 percent could come from increases in the effective statutory tax rate. In fact, if the effective statutory tax rate could be gradually increased up to the full statutory tax rate of 0.5 percent, along with improvements in administration, the Indonesian property tax could generate over Rp 9.3 trillion, or about 0.62 percent of GDP.9 Property tax revenues are a function of the property tax base, the statutory tax rate and the quality of tax administration. The property tax base in Indonesia is a function of property market dynamics of supply and demand and central government policy decisions on tax base definitions. The tax rate determination and administration quality are also directly under central government responsibility, severely limiting the ability of local governments to substantially improve property tax revenue performance. The statutory tax rate is a policy variable that is fixed in law by parliament, while the assessment ratio is fixed by central government regulation. There is currently no discretion, responsibility or control by the local governments. Similarly, the administrative variables related to coverage, valuation and collection are also under central government responsibility but in practice are "co-administered" between the central and local governments, giving some, but quite limited, local government influence on tax administration quality. In light of the ongoing decentralisation reforms, there is now
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consideration being given to making the property tax more of a "local tax", possibly establishing some local discretion over the tax rate and allowing more local influence over tax administration functions. These various options will be explored in the following section. Restructuring the Property Tax to Further Support Decentralisation The property tax policy and administrative systems introduced under the 1986 Indonesian property tax reform follow international best practices. Indonesia's property tax is levied on the capital value of land and buildings, with minimal exemptions provided to the tax base. The tax rate structure is simple, initially designed as a uniform tax rate, but subsequently changed to a two-tier rate system differentiated by property value. The various administrative policies linked to property identification, valuation, assessment, collection and enforcement are also consistent with international best practice. In fact, the Indonesian property tax reform of 1986 both the policy framework and the innovative administrative procedures and systems is considered an international best practice, serving as a model for other developing countries embarking on a comprehensive property tax reform (Youngman & Malme 1994; Kelly 1993,1995,1996; Rosengard 1998; Bird & Slack 2004). In the early 1980s, Indonesia was faced with the challenge of restructuring the property tax system into a more effective revenue instrument. Through a process of policy simplification and innovative administrative reforms, the government established a firm foundation for sustainable, efficient and equitable property tax revenue mobilisation. The SISTEP payment point system introduced in 1989 continues to facilitate tax collection, while the SISMIOP administrative system introduced in 1991 continues to successfully integrate data collection, data management, valuation, assessment, billing and collection, enforcement and taxpayer service. Since 1999, the Indonesian property tax system has come under renewed scrutiny, raising key questions as to how best to restructure the property tax in order to better support decentralisation.10 First, Indonesia should ideally eliminate the property tax portion currently being allocated to the Dati I provincial level and reassign all property tax revenues entirely to Dati II local governments, to create a stronger link between property tax revenues and locally-provided location-specific services. Any resulting provincial revenue loss could be compensated through either an increase in central transfers or through increasing revenues from such provincial taxes as the motor vehicle and fuel taxes. In fact, similar to the Philippines, Indonesia should consider formally granting a portion of property tax revenues to village level governments under the Dati II governments (Guevara 2004).
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Second, to increase the available property tax revenues and to improve the efficiency in managing administrative costs, Indonesia should review, reduce and reallocate the 9 percent portion of property tax revenues currently allocated for covering collection related costs. Although the original 9 percent established in 1986 may have generated an appropriate amount to cover marginal administrative costs, property tax revenues have since increased 40 fold without a commensurate increase in administrative costs. International experience suggests that a total property tax administrative costs structure of about 2-5 percent of total collection may be a reasonable target for Indonesia (Almy 2001; Bird & Slack 2004). Reducing and reallocating this 9 percent collection fee based on the relative cost structure for central and local tax administration responsibilities would provide proper incentives for central and local level tax administrators and increase the available property tax revenues for local governments. Third, Indonesia should allocate all property tax revenues based purely on property location to increase local tax ownership and better correlate property-related services with property taxation. The 6.5 percent currently being allocated across the country for "equalisation" purposes could be eliminated in light of the large equalization component contained in the new Basic Allocation Grant (DAU). Fourth, and perhaps most importantly, Indonesia should grant local governments some discretion over effective tax rates that can directly influence the level of collected revenues. The power to set tax rates is arguably the most critical policy variable which would enable local governments to raise additional revenues in line with local citizen preferences (Bird 2000). Being responsible for setting the tax rate increases the local government leaders' accountability to citizen taxpayers. Local governments in Indonesia currently have no tax rate discretion; the tax rate is set in national law at 0.5 percent, while the assessment rate is determined through central government regulation. As is common internationally, Indonesia should allow local governments to set tax rates within a range, with the possibility of a citizen override option in the future. Immediate discretion over effective statutory tax rates could be given to local governments through rewriting the government regulation on assessment ratios.11 For example, the new government regulation could provide local government discretion to increase the current assessment ratio uniformly up to 100 percent, ultimately moving the effective legal tax rate up to the legal maximum of 0.5 percent. Initially local governments could be given the discretion to set the assessment ratio on rural and urban property, while the central government could retain the power to set the assessment ratio on mining, forestry and estate properties to minimise possible economic distortions and equity concerns. Using the newly chosen assessment ratios, the tax department could continue to levy the tax liability, potentially generating more property tax revenues for local governments.
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There is little debate that these suggested changes would enable the Indonesian property tax to better support the decentralisation reforms. The more questionable b u t often suggested change w o u l d be to immediately shift the property tax from a central government administered "shared tax" to a locally-administered "local tax". Although perhaps tempting, in light of the "Big Bang" decentralisation fever, there are strong theoretical reasons and international experience that would question the wisdom of this approach. Consistent with international experience, central level policy and administrative oversight is imperative to ensure uniform and equitable implementation of the law, while central level involvement can also be important to ensure cost effectiveness, consistency and standardization in fiscal cadastre maintenance, property valuation, revenue collection and enforcement, a l t h o u g h p e r h a p s w i t h increased local g o v e r n m e n t involvement. Revenue collection, on the other hand, has and should continue to be largely a local government responsibility, although banks should continue to be effectively used for the cashiering function. Enforcement, which is currently a central level responsibility, should be broadened to include a more direct local government involvement. The key for Indonesia, as with all countries, is how to maintain a proper balance between central and local involvement in tax administration not how to make property tax administration either a central or local government responsibility. At least in the short to medium term, the property tax should remain a shared tax under central government administration, although adjustments should be made to the relative division of administrative responsibilities between the central and local government levels. Although the central government should continue being overall responsible for tax administration, local governments should gradually become more involved in the various tax administrative components affecting tax base coverage, property valuation, revenue collection, enforcement and taxpayer service. In the light of the extreme diversity in local level leadership, management, and operational capacity across Indonesia, some local governments will no doubt continue depending primarily on central government administration, while others will increasingly be able to play a more expanded and direct administration role. To ensure that each government level has proper incentives and are compensated for actual administrative costs, Indonesia should undertake a thorough administrative cost analysis and review, reduce and reallocate the 9 percent revenue component currently being allocated to cover collection costs. The basic SISTEP collection system and the SISMIOP property tax administration management system continue to effectively function through the 106 regional PBB offices. The challenge facing Indonesia is to strengthen these administrative systems, while gradually introducing incremental policy and administrative changes needed to better enable the property tax
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to support decentralisation. Any newly proposed property tax reforms to support the decentralisation process should be structured to retain the advantages of the current standardised and uniform administrative reforms initially introduced through the 1986 property tax reforms. Allowing the proliferation of over 300 different property tax administrative systems, standards and procedures, unique for each local government, would be a terrible step in the wrong direction. Any immediate, wanton wholesale transfer of administrative responsibility from the central to the local government could prove disastrous. The basic Indonesian "coadministration'' approach should be maintained. However, the government should carefully review the responsibility mix across the central and local governments to ensure that the relative comparative advantages and institutional incentives are tailored appropriately. Over time, local governments should be able to assume a larger role in fiscal cadastre maintenance and enforcement against noncompliance, while the central government should begin shifting its primary focus to providing policy and administrative guidance, technical support, p r o p e r t y valuation, monitoring and oversight to ensure that the property tax is uniformly administered throughout Indonesia in a cost effective and equitable manner. The major challenge for property tax reform in Indonesia will be finding ways to more effectively support the country's decentralisation goals, without forfeiting the simplicity of the existing property tax policy and the major progress made to date in the property tax administration system.

Notes 1. The initial 1988-1991 phase of administrative reform was funded with assistance from the World Bank. The project was originally designed as a "valuation-pushed" reform strategy that placed priorities on valuing the top 50,000 properties in the largest cities. Immediately after project commencement, however, the Government recognised that improved valuations, in the absence of an effectively functioning comprehensive tax administrative system, would not achieve its equity, efficiency and revenue goals. The government therefore shifted to a "collection-led" reform strategy (Kelly 1992,1993). 2. In addition to the revisions to the Land and Building Tax law (Law No 12/98), the Government in 1997 enacted a Land and Building Acquisition Tax (Law No 21 / 97) which is a tax of 5 percent applied to the "acquisition value" of the property minus a valuation deduction of up to Rp 60 million, a threshold that is determined by the regional government. The Land and Building Acquisition Tax is a central level shared tax where the central government retains 20 percent of the revenues while distributing 16 percent to the provinces and 64 percent to the local governments. 3. The property tax revenue allocation was a point of contention immediately following the enactment of the Land and Building Tax in 1986. In 1986, policymakers decided to allocate 10 percent to the central government largely to replace the central 86

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government revenues that were lost through the abolishment of the National Wealth Tax (Pajak Kekayaan Negara). The inclusion of the 10 percent to the central government was heavily criticized at the time as a "centralisation" of the property tax, since the central government had not received any property tax revenue under the previous property tax system known as luran Pendapatan Daerah (IPEDA). 4. The original valuation deduction was only on buildings because policymakers in 1985 felt that everyone who owned land should "participate in development" by paying at least a token amount through the property tax. Given uncertainty in land titles, citizens preferred to pay the property tax in order to have a property tax receipt that provided evidence of "indicative ownership", especially for low value property under customary ownership (Hak Gink). The policy change in 1994 for the first time exempted low value land from property tax. 5. The valuation deduction was originally set at Rp 2 million in 1986, then increased to Rp 3.5 million in 1990, Rp 7 million in 1992, Rp 8 million in 1994 and Rp 12 million in 2001. In 2001, local governments were given discretion for the first time in setting this deduction up to a maximum of Rp 12 million. In 2001,210 (61 percent) local authorities used Rp 8 million, 17 (6 percent) increased the deduction, while 114 (33 percent) decreased the deduction. 6. In tax policy, property valuation is to determine the relative tax burdens of properties, not necessarily the absolute tax burden per property. The absolute tax burden is determined largely through the tax rate. However, in a country like Indonesia, where the tax rate is fixed in law, the valuation ratio level does affect total revenue level. However, if property tax rate discretion is given to the local governments, the importance of the absolute valuation ratio level will diminish with priority correctly given to the accuracy of relative property valuations measured by the coefficient of dispersion that affects property tax equity (Eckert, et al 1990). 7. These estimated administrative ratios for Indonesia are consistent with other developing countries (Youngman & Malme 1994; Bird & Slack 2004) and with separate recent estimates for Indonesia (Lewis 2003). 8. This improvement estimate is calculated as the change between the existing administrative efficiency of the coverage ratio (0.8) * valuation ratio (0.6) * collection ratio (0.80) = 0.38 and the improved administrative ratios of 0.9 * 0.7 * 0.9 = 0.57). The percentage change from 0.38 to 0.57 is 48 percent However, the improvement estimate should only apply to the rural, urban, estate and forestry sectors, which are those sectors that directly rely on Directorate of Property Taxation administration. The mining sector revenues are administered outside the tax department, thus the tax department cannot directly influence the coverage, valuation, or collection ratios. Excluding the mining sector revenues, which account for about 50 percent of the total revenues, the possible administrative improvements would be equal to 24 percent. 9. A property tax to GDP ratio of 0.62 percent for Indonesia would be consistent with Chile (0.61 percent) and South Africa (0.65 percent) (Bird & Slack 2004) and with Spain (0.68 percent) and Lithuania (0.57 percent) (Almy 2001). 10. See Asher (2003), Lewis (2003) and World Bank (2003) for alternative conclusions on how to restructure the property tax to support decentralisation. 11. A more radical approach to granting discretion to local governments would be subjecting the PBB law to a broader parliamentary review, changing the tax rate structure itself along with introducing other possible major policy and administrative changes related to tax base definitions and exemptions, among others. The proposed
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approach of modifying the assessment ratio structure is suggested as an immediate, less instrusive and less risky approach, preserving the fundamental simplicity of the PBB policy and administrative structure. In the medium to long term, however, it may be necessary and desirable to initiate the more radical approach, fundamentally subjecting the property tax law to a broader, more open debate as part of the current decentralisation reforms.

References Ahmad, Ehtsham & Krelove, Russell 2000, "Tax Assignments: Options for Indonesia" paper presented at the Indonesia Sequencing Agenda, IMF, LPEM-FEUI, World Bank, 20-21 March. Almy, Richard 2001, "A Survey of Property Tax Systems in Europe" Report prepared for the Department of Taxes and Customs, Ministry of Finance, Slovakia Republic, <imvw.agjd.com/EuropeanPropertyTaxS\/stems.pdf> [10 October 2003] Asher, Mukul 2003, "The Role of Property Tax in Decentralisation of Fiscal System in Indonesia", Paper presented at Seminar on Indonesia's Decentralisation Policy: Policy and Programme Directions, Hitotsubashi University, Tokyo, 31 January to 1 February. <wzvw.icds.co.jp/sympo/pdf/S6(l).pdf> [5 June 2003] Bank Central Asia 2003, "PBB Payment Via ATM BCA", 24 July <www.klikbca.com/website/enghsh/bca_news/news.html?Id_news=149> [8 August 2003] Bird, Richard 2000, "Subnational Taxes: Realities and Prospects", Washington, D.C.: World Bank. <www.worldbank.org/wbi/publicfinance/documents/sntax.PDF> [6 May 2003] & Slack, Enid (eds) 2004, International Handbook of Land and Property Taxation, North Hampton, MA: Edward Elgar. Booth, Anne 1974, "Ipeda-Indonesia's Land Tax", Bulletin of Indonesian Economic Studies, X (1). Eckert, Joseph, et al (eds) 1990, Property Appraisal and Assessment Administration (Chicago: Illinois: IAAO Fane, George 2003, "Change and Continuity in Indonesia's New Fiscal Decentralisation Arrangements" Bidlettn of Indonesian Economic Studies, 39(2). Gillis, Malcolm 1989, "Comprehensive Tax Reform: The Indonesian Experience, 19811988" in M. Gillis, ed., Tax Reform in Developing Countries, Durham, NC: Duke University Press. Government of Indonesia 1986, 1994, "Law Number 12/1986: Land and Building Tax" and subsequent 1994 amendments. 1997, "Law Number 21/1997: Land and Building Acquisition Tax" as amended by Law Number 20/2000.
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2000, "Law Number 34/2000: Regional Government Taxes and Charges". Guevara, Milwida 2004, "Property Taxation in the Philippines", in Richard Bird & Enid Slack (eds), International Handbook of Land and Property Taxation, Northhampton, MA: Edward Elgar. Kelly, Roy 1989, "Property Taxation in Indonesia", in Nick Devas (ed) Financing Local Government in Indonesia, Athens, Ohio. Ohio University Center for International Studies. 1992, "Implementing Tax Reform in Developing Countries: Lessons from the Property Tax in Indonesia", Review of Urban and Development Studies, 4 1993, "Property Tax Reform in Indonesia: Applying a Collection-Led Strategy", Bulletin of Indonesian Economic Studies, 29(1). 1995, "Property Tax Reform in Southeast Asia: A Comparative Analysis of Indonesia, the Philippines and Thailand", Journal of Property Tax Assessment and Administration, 1. 1996, "The Evolution of a Property Tax Information Management System in Indonesia", in Glenn Jenkins (ed), Information Technology and Innovation in Tax Administration, Cambridge, MA: Kluwer. 2000, "Designing a Property Tax Reform for Sub-Saharan Africa: An Analytical Framework applied to Kenya", Public Finance and Budgeting, 20(4). 2002, "Practical Revenue Mobilisation", Presentation at the World Bank Seminar on Intergovernmental Fiscal Relations in East Asia, Bali, Indonesia, 10-11 January. <www.worldbank.org/wbi/publicfinance/documents/ASEM/presentations/ kelly_localrevenue.ppt> [5 March 2003] 2003, "Successful Property Tax Reforms: Lessons Learned", Presentation at the World Bank Workshop on Innovations in Local Revenue Mobilization, 23-24 June, Washington, D.C. <ivwwl.worldbank.org/. ../June20Q3SetninarPresentaUons/ PropertyTaxReforRoyKelly.ppt> [4 September 2003] 2004, "Property Taxation in Indonesia", in Richard Bird and Enid Slack (eds), International Handbook of Land and Property Taxation, Northhampton, MA: Edward Elgar. Lerche, Detrich 1979, "The Revenue Potential of the Land Tax for Urban Finance in Indonesia", in J Wong (ed), Cities ofAsia: A Study of Urban Solutions and Urban Finance, Singapore: Singapore University Press. Lewis, Blane 2003, "Property Taxation in Indonesia: Measuring and Explaining Administrative (Under-) Performance", Public Administration and Development, 23(3). Lane, Blane 2003, "Tax and Charge Creation by Regional Governments under Fiscal 89

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Decentralisation: Estimates and Explanations", Bulletin of Indonesian Economic Studies, 39(2). Mann, Arthur 2001, "Local Government Taxation: Standard International Practices", P a p e r p r e s e n t e d at the P E G / U S A I D Conference on D o m e s t i c T r a d e , Decentralisation, and Globalization, Jakarta, Indonesia, 3 April. Musgrave, Richard A1993, "Who Should Tax, Where, And What?" in Charles McLure Jr (ed), Tax Assignment in Federal Countries, Canberra: Centre for Research on Federal Financial Relations, Australian National University. Ray, David 2001, "Inventory of Trade-Distorting Local Regulations", USAID-PEG Project, Ministry of Trade and Industry, Jakarta. Rosengard, Jay 1998, Property Tax in Developing Countries, Boston: Kluwer Academic Publishers. Saad, Ilyas 2001, "Indonesia's Decentralisation Policy: The Budget Allocation and Its Implications for the Business Environment" Paper presented at Third EUROSEAS Conference Panel on Decentralisation and Democratization in Southeast Asia, London, September, <www.smeru.or.id/report/workpaper/euroseasdecentral/ euroseasbudgetalloc.pdf> [5 January 2003] Sidik, Machfud & Katjamiko 2002, "Indonesia's Fiscal Decentralisation: Combining Expenditures Assignment and Revenue Assignment", Paper presented at "Can Decentralisation Help Rebuild Indonesia?" Georgia State University, 1-3 May. World Bank 2001, Indonesia: The Imperative for Reform, Jakarta: World Bank. 2002, "Observations on Indonesia's Fiscal Decentralisation from a Panel of International Experts". <www.lnwebl8.worldbank.org/eap/eap.nsf/Attachments/DecentKeyReadings/$File/Panel+thoughts++on+IndonesiaII.pdf> [10 October 2002] 2003, Decentralizing Indonesia: A Regional Expenditure Review Overview Report Jakarta: World Bank. Report Number 26191-IND, <wbln0018.worldbank.org/eap/eap.nsf/Attachments/RPR-DecInd/$Fde/RPR-DecIndJune03.pdf> [14 November 2003] Youngman, Joan & Malme, Jane 1994, An International Survey of Taxes on Land and Buildings, Amsterdam: Kluwer.

Roy Kelly is Professor in the Duke Center for International Development, Terry Sanford Institute of Public Policy, Duke University. He thanks the Lincoln Institute of Land Policy for funding assistance to make the research for this article possible. He also acknowledges the assistance of Dr Suharno (Director of Property Taxation, Ministry of Finance) and his staff for the updated information and data on the property tax reform from 1994-2003 and ofDr Sidik (Director General, Central-Local Fiscal Balance, Ministry of Finance) and his stafffor updated information on the current decentralisation reforms. 90