46. **The tax effort in Indonesia is significantly smaller than regional comparators or even EMDEs.** Over the decade preceding the pandemic, general government revenue averaged around 14 percent of GDP in Indonesia in the past 10 years before the pandemic. This is well below the median in EAP (and EMDEs) by 13.5 percentage points of GDP (9.4 percentage points of GDP) (figure 18). About half of this gap was due to weaker tax revenues. Indeed, revenues from income taxes, general services taxes, and trade taxes were all lower in Indonesia than EAP and EMDEs median. The weak tax effort can be attributed to multiple factors. This includes tax policy considerations, such as the prevalence of tax exemptions and high tax thresholds, or inefficiencies in tax administration that lead to low compliance rate. Nevertheless, pervasive informality also plays a role in such outcomes since informal employment and informal firms typically fall outside the taxation net (for income and general sales taxes). Formalizing firms outside of the tax net while lowering the threshold and improving compliance is likely to increase revenue in the medium term.

# **Figure 18. Fiscal indicators in Indonesia**

<!-- Start of picture text --> A. Government revenues B. Government spending<br>Percent of GDP Percent of GDP / expenses<br>30 Indonesia EAP EMDEs 35 Indonesia EAP EMDEs<br>25 30<br>25<br>20<br>20<br>15<br>15<br>10 10<br>5 5<br>0<br>0<br>Total Tax Income GST Trade tax Total Education Health Gov. emp<br>tax compensation<br>(% expenses)<br><!-- End of picture text --> Sources: IMF GFS (2023), WEO (2022 Oct), World Bank WDI, and World Bank Staff calculation. Notes: EAP=East Asia Pacific region; EMDEs=emerging market and developing economies. Medians over the period 2011-2019.

47. **Low tax effort constrains Indonesia’s growth-related public spending, a feature also observed in countries with high pervasive informality.** Primary expenditure in Indonesia averaged around 16 percent of GDP over the period 2011-2019, which was only three-fifths of the median in EAP and EMDEs. The limited fiscal resources led to lower public spending on education, health, social protection, and public investment relative to peers. Those programs all have implications for the country’s future growth potential. Nevertheless, unlike other countries with high informality, Indonesia has had an adequate response to recent economic downturns. This was evident by the successful support package put in place during the COVID-19 pandemic. A package that was made possible given the country’s prudent fiscal policy stance and adherence to the 3 percent fiscal deficit target, which enabled the gradual build-up of fiscal buffers.

48. **The informal sector is excluded from financial markets, hence limiting the reach of banking credit in the economy** (Alberola and Urrutia 2020). About one-third of firms in EMDEs with above-median informality identified access to finance as a major constraint—8 percentage points higher than EMDEs with below-median informality (Ohnsorge and Yu 2021). By weakening the banking sector's performance (figure 19), the informal sector further dampens the transmission channel of monetary policy and makes it less effective in stabilizing inflation 20