With a gross domestic product (GDP) representing 2.8% of the global amount, Indonesia has become the largest economy in Southeast Asia and the seventh-largest in the world. In the aftermath of the pandemic, its economy managed to rebound stronger by growing 5.31% in 2022, reaching a staggering GDP value of Rp19,588 trillion, which is equivalent to Rp71 million (US$4,783.9) per capita. However, on the other hand, Statistics Indonesia reported that 9.57% of the population, equaling 26.36 million people, still live below the poverty line of Rp535,547 a month. How is it possible for such a stark contrast between prosperity and impoverishment to occur simultaneously within the same economy?
The national economy, which has proven to be resilient, is projected to grow continuously to become the fourth-largest in the world by 2045. The Organization for Economic Co-operation and Development (OECD) and the World Bank predict that the growth rate over the next three years could reach an annual high of up to five percent. Nevertheless, poverty remains a serious issue looming over the economy, with over 1.5 million people remain trapped in the abyss of poverty despite the effects of the pandemic have gradually subsided.
Why Inequality Persists While the Economy Flourishes
The poverty rate, which seems to have never fallen below 8% amid the economy that continuously growing, implies an eminent issue affecting not only Indonesia but also many other countries in the world: economic disparity. Credit Suisse in their 2018 Global Wealth Report stated that in Indonesia, 46.6% of wealth is concentrated among only 1% of the richest population. This utterly distressing evidence shows the reality that all the economic growth that occurred unfortunately still can only be benefited by a small portion of the population, sacrificing the well-being of a large number of people living in the lower level of the economy.
There are many reasons to why economic inequality continues to persist. One of the most fundamental causes, as also highlighted by the OECD, is a significant disparity in opportunities to obtain quality education for children from different socio-economic backgrounds. According to a publication by the American Psychological Association (APA), the education system in communities with less favorable socio-economic conditions tends to be overstretched and under-resourced, which will eventually hinder the ability of children to fully develop their potential. This will eventually limit their opportunities to obtain better employment in the future, thus creating a cycle of persistent inequality, as also emphasized by the United Nations Children's Fund (UNICEF).
Furthermore, those who grow up in poverty-stricken communities also tend to have limited access to adequate nutrition, sanitation, and healthcare facilities, which essentially are the basic necessities of life. UNICEF estimates that 48.7 percent of children in Indonesia still live in poverty, with 14.5 percent of them even living in extreme poverty. As the fourth-best country in terms of the Global Health Security Index in Southeast Asia, the prevalence of stunting among toddlers remains at a chronic level of 21.6%, with infant mortality rates being the fifth worst in Southeast Asia.
This alarming reality suggests a tremendous lack of opportunity for low-income households to improve their economic situations. Eurostat found that low standards of living during pre-adolescence impose a high risk of unemployment and socioeconomic marginalization in adulthood, which once again will create a new generation trapped within poverty. As a result, this will further widen the gap in the economy, with the lower end of society continuing to live in a never-ending cycle of poverty while the higher counterpart continues to live through the ever-increasing living standards; despite the fact that they both live within the same growing economy. Therefore, what measures can be taken to address this issue of disparity?
Adjusting the Economy by Redistributing the Wealth via Taxation
One prominent or perhaps even the most prominent instrument in the efforts to address welfare inequality within the economy is tax policy intervention. Taxation has remained to be the clearest way to redistribute wealth, as stated in a 2018 paper published by the International Monetary Fund (IMF).
Implementing progressive taxes, such as graduated income taxes and luxury taxes, imposes a higher tax burden on the upper echelons of society while maintaining a much smaller or even nil tax burden on those at the bottom. Under this arrangement, financial resources that had previously been concentrated in a few portions of the population can be diverted into the state budget, which will then be used to fund the basic needs of all citizens. This will enable households with limited economic resources to obtain the same quality of life without having to be restricted by cost constraints. According to a report published in 2019, this progressive taxation scheme has proven to be effective in reducing inequality across OECD countries.
In Sweden, for example, the imposition of progressive income taxes combined with social assistance spending policy has reduced the level of inequality among the productive age population by 28%. The Indonesian government itself has budgeted social protection spending in the 2023 State Budget worth Rp241 trillion (US$16.3 billion), equivalent to 10.73% of total central government spending. Strengthening the social protection system can provide low-income households with better access to resources needed to fulfill their necessities, thus improving the quality of life and human resources, which, together with the imposition of progressive taxes, will narrow the existing gap in the economy.
Taxation has also enabled children from low-income households to obtain a quality education, with funding indirectly provided by the taxpayers. In 2021, around 6.37% of tax revenue was allocated to education spending, making it the fourth-largest central government expenditure that year. The provision of quality education, as stated by former UNESCO Director-General Koichiro Matsuura, provides everyone the opportunity to fully develop their potential, thus enabling them to benefit from development. This will eventually allow impoverished families to improve their economic conditions, lessening the inequality within the economy.
Summary
Addressing the welfare disparities is crucial so that everyone, regardless of their socioeconomic background, can benefit from economic development. Poverty remains a major issue threatening the rapidly growing national economy. Inequality has led to a division in the quality of life, with wealth concentrated within a small group at the top of the hierarchy while the majority at the bottom have limited access to even fulfill their basic necessities.
Tax policy interventions, both theoretically and empirically, have proven to be effective in reducing inequality within the economy. Progressive taxation has the ability to create a more equal economy by shifting the concentration of wealth from the top layers to fund the development needed to improve the quality of life for every citizen; thus benefiting the low-income and marginalized groups more. Therefore, the existence of taxation undoubtedly creates a better equal economy by allowing everyone to reap the same benefits from the continuing development.
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