Have Diminishing Returns Set in? The Efficiency of ...

Bisnis & Birokrasi: Jurnal Ilmu Administrasi dan OrganisasiInternational Journal of Administrative Science & Organization, September 2019 Volume 26, Number 3

INTRODUCTION

One of the main functions of a tax administration is to collect revenues for the government to finance its provision of public services. In this sense, a tax administration could be seen as managing revenue production process, in which multiple inputs are utilized to produce a single output, i.e., tax revenue. Therefore, the capacity of a tax administration to efficiently utilize its available physical and human resources in collecting revenues to finance government programs may affect the ability of the state to perform its function as the provider of public goods and services. The efficiency of a tax administration may affect the allocation and distribution of production factors in an economy and may consequently influence the rate of economic growth.

Indonesian tax administration (Directorate General of Taxes, DGT) has been expanding its resources to improve its revenue collection capacity. Empirical evidence, however, suggests that tax revenue as a share of the economy is actually decreasing. The increase in factor inputs (or resources), which is not followed by an increase in the output (in this case the

tax revenue) suggests that DGT might operate at diminishing returns to scale. The available resources are possibly ineffi-ciently used, leading to decline in tax collection performance.

With this background, this study examines the efficiency of DGT in using its resources to collect revenues. This sub-ject may be deemed important because inefficient use of tax administration’s resources may imply some future limits to tax revenue expansions. Inefficiency constraint may become a serious source of concern when, on one side, a significant underground economy that is largely outside the tax net exists; on the other side, when the government faces mounting pres-sure to increase its level of public expenditures, whereas political supports for raises in tax rates are not available. In this study, neoclassical growth theory is employed to measure the efficiency with which the DGT uses factor inputs (i.e., capital stock and labor) to produce outputs (i.e., tax revenue).

Figure 1 shows the performance DGT in collecting two of its major sources of revenue: income taxes and value-added taxes as a percentage of Gross Domestic Product (GDP) for the period of 2001–2017.

One of the prominent features in Figure 1 is the declining

Have Diminishing Returns Set in? The Efficiency of Indonesian Tax Administration

Heru IswahyudiMinistry of Finance, Republic of Indonesia

[email protected]

Abstract. This article aims to determine whether Indonesia’s tax administration operates at diminishing returns to scale. The neoclassical growth model was employed to measure the tax administration’s Total Factor Productivity (TFP), which may represent the level of efficiency. A low level of TFP could indicate that an organization may be inefficient and thus may operate at diminishing returns to scale. Results show that the TFP of Indonesia’s tax administration is basically nonexistent, and the diminishing returns to scale might have set in its operations. Left unchanged, these conditions may imply some future limits to tax revenue expansions. Simplifying the tax system, changing tax officials’ attitudes toward taxpayers, and improving the information system management and the business practices could be considered to increase the efficiency of tax administration. Maintaining the stability of tax legislations and overcoming organizational path dependencies could also be considered.

Keywords: Total Factor Productivity, Tax Administration, Diminishing Returns, Efficiency JEL Classification: H20, H83, M10, O33

Abstrak. Artikel ini bertujuan untuk menentukan apakah administrasi pajak di Indonesia beroperasi pada tingkat imbal hasil yang menurun. Model pertumbuhan neoklasik digunakan untuk mengestimasi Total Factor Productivity (TFP), yang menunjukkan tingkat efisiensi. TFP yang rendah mengindikasikan bahwa suatu organisasi tidak efisien dan oleh karena itu mungkin beroperasi pada tingkat imbal hasil yang menurun. Hasil penelitian menunjukkan bahwa administrasi pajak di Indonesia memiliki TFP yang sangat rendah dan beroperasi pada tingkat imbal hasil yang menurun. Jika tidak ada perubahan, kondisi ini dapat membatasi peningkatan penerimaan pajak di masa depan. Penyederhanaan sistem perpajakan, perubahan sikap fiskus terhadap Wajib Pajak, dan perbaikan dalam manajemen sistem informasi dan proses bisnis mungkin dapat dipertimbangkan untuk meningkatkan efisiensi. Selain itu, mengurangi frekuensi perubahan peraturan dan mengatasi masalah kelembaman organisasi mungkin juga dapat dipertimbangkan untuk dilakukan.

Kata kunci: Total Factor Productivity, Administrasi Pajak, Tingkat Imbal Hasil, Efficiency JEL Classification: H20, H83, M10, O33

DOI: 10.20476/jbb.v26i3.10931

ISWAHYUDI, HAVE DIMINISHING RETURNS SET IN? 123

trend of collection after 2008. For 2001–2008, the average ratio of collection was at 9.9% of GDP; for 2009–2017, this ratio was down to 8.9%. With this background, one of the approaches that could be considered to investigate the proxi-mate causes for this fall in revenue collection is by assessing the efficiency of DGT’s operation.

For a tax administration, efficiency measurement is an essential tool because it enables policy makers to determine how well the tax administration utilizes resources in achiev-ing its objectives. Two possible implications for future output expansions could be drawn from efficiency measurement exercises. First, efficiency assessment may be used as base for reallocation of resources from units or business processes that have low marginal returns to those that have relatively high marginal returns. Second, inefficiencies may imply that the available resources have not been utilized in the most produc-tive manner; hence, further explorations on ways to improve productive efficiency are warranted (Yaisawarng, 2002).

However, quantitative measurement on the efficiency with which the Indonesian tax administration uses its resources to accomplish its mission of collecting tax revenues has scarcely been studied; hence, this study aims to fill this gap. To the best of the author’s knowledge, this study is the first to employ neoclassical growth theory in assessing the efficiency of a tax administration, particularly in the context of developing countries, such as Indonesia.

The research question proposed in this article is as follows: Does DGT operate at diminishing returns to scale? This ques-tion can be answered by estimating the DGT’s Total Factor Productivity (TFP). According to neoclassical growth theory, a low level of TFP indicates that organization’s operations are inefficient. When the operations are inefficient, the law of diminishing returns to scale would set in, that is, marginal increases in the input of resources would result in reductions in the marginal output.

Administrative dimension is one of the important factors in the tax system because how a tax administration imple-ments existing tax policies may affect, among others, how

much revenue can be collected (Bird, 2004). In a broader term, the level of tax revenue in a country may reflect the capacity of state institutions, including the tax administra-tion, in collecting taxes (Levi, 1989; Slemrod, Blumenthal, & W. Christian, 2001; Tilly, 1990). Further, the capacity of a tax administration in generating revenues from a given set of tax systems and policies may depend on its ability to utilize available resources toward insuring citizens’ compliance with tax laws (Klun, 2004).

One strand of literature argues that tax compliance is rarely the result of pure altruistic behavior; instead, it is the result of policies aimed at enforcing tax laws and deterring citizens’ nonconformity with such laws (Allingham & Sandmo, 1972; Bergman, 2003; Clotfelter, 1983; Cowell, 1990). Thus, the relation between tax administration and taxpayers could be described as antagonistic (Braithwaite, 2003a). In this antago-nistic relation environment, the tax administration holds the view that taxpayers need to be constantly held in check since they would always attempt to evade paying taxes whenever they can (Cialdini, 1996; Frey, 2003). On the other hand, tax-payers hold the view that they are being persecuted and thus feel that they have the right to engage in rational weighing on the risks and benefits of evading taxes (Orviska & Hudson, 2003; Trivedi, Shehata, & Mestelman, 2004; Wenzel, 2005).

The other strand of literature maintains that tax compliance is the outcome of the willingness of citizens to voluntarily pay taxes because they hold the view that paying taxes is their obligation as members of community. In this environment, a synergistic relation exists between tax administration and taxpayers (Kirchler, Hoelzl, & Wahl, 2008). The tax adminis-tration’s attitudes reflect respectful and supportive treatments toward taxpayers (Feld & Frey, 2004). Taxpayers have faith in the underlying objectives of the government and hence pay their fair share of taxes without even considering the costs and benefits of evading taxes (Feld & Frey, 2002; Fjeldstad, 2004; Rawlings, 2003).

These two lines of arguments imply that to improve tax collection, a tax administration could focus its resources

Source: Badan Pusat Statistik (2003, 2006, 2010, 2014, 2018); Direktorat Jenderal Pajak (2009, 2018)

Figure 1. Revenue from Income Taxes and Value-added Taxes as a Percentage of GDP


toward improving the power of tax administration and the trust of taxpayers (Kirchler, 2007; Tyler, 2006). Efforts to improve the power of tax administration may be directed toward influencing public perceptions on the capability of tax officers in detecting and punishing noncompliance behav-ior, for example by increasing the probability and quality of tax audits as well as by imposing sufficiently high fines (Andreoni, Erard, & Feinstein, 1998; Park & Hyun, 2003; Wärneryd & Walerud, 1982). Efforts to improve trust in tax administration could be directed toward influencing public perception toward the view that the tax administration works for the common goods of the society and will treat taxpayers fairly and respectfully (Braithwaite, 2003b; Wenzel, 2003).

One of the crucial premises in collecting taxes requires the tax administration to utilize its available resources efficiently. Nevertheless, a general, agreed upon model for assessing tax administration’s performance has not been established (Klun, 2004). Given this lack of a unified model, literature provides various methods to measure the performance of tax administration. For example, Baer and Silvani (1997) suggested that tax administration’s performance may best be measured based on the tax collection process and the mag-nitude of the tax gap, i.e., the difference between the amount of tax supposedly owed to the government and the actual tax collected. The World Bank (2011) proposed a measurement that includes various elements encompassing three broad categories: legal and regulatory, institutional set up, and core business functions. Crandall (2010) argued that assessment of tax administration’s performance should be based on key performance indicators, such as tax revenue collected com-pared with projections and the ratio of costs to collection.

The performance of a tax administration may be assessed by the efficiency with which it uses its available resources. In this respect, how efficient the tax administration uses its resources may be assessed under the framework of neoclas-sical growth theory. According to this theory, the main reason why the output of an economic entity (e.g., a country, a busi-ness, or an organization) changes is because of changes in capital stock, labor force, and/or productivity. Capital stock represents a set of physical tools (e.g., offices and computers) used to generate output. Labor force represents the number of workers participating in production. Productivity is the ability of the economic entity in harnessing available physi-cal and human resources to generate output (Hahn, 2010; Horowitz, 2017).

The essence of neoclassical growth theory is the prop-osition that sustaining positive, long-run growth in output requires perpetual increase in technological progress. This increase could manifest in the form of new markets, goods, or processes (Aghion, Howitt, Brant-Collett, & García-Peñalosa, 1998). In their seminal papers, Solow (1956) and Swan (1956) demonstrated that the output of an economic entity would cease to grow when technological progress did not exist. This cessation of output growth occurred because according to the law of diminishing returns, marginal increase in factor inputs would not result in proportional increase in marginal output.

According to neoclassical growth theory, the level of tech-nological progress (proxied by the level of TFP) indicates the efficiency of an organization in utilizing all of its production factors to produce output. A higher level of TFP indicates that an organization operates at relatively more efficient level and that its productivity is higher as well. This efficiency is

needed to stem the law of diminishing returns from setting in organization’s operations. The word “technology” in TFP is a broad, all-inclusive definition, which depends on many things including but not limited to research and develop-ment, education, infrastructure, protection of property rights, political stability, and management skills of producers and entrepreneurs (Krugman & Wells, 2006; Van den Berg, 2012). There is a large body of literature on the neoclassical growth theory. The works of Dimand and Spencer (2009); Hahn (2010); Solow (1999) could be chosen as starting points for those interested to elaborate more.

However, assessment on the efficiency of public sector institution within the framework of growth theory is scarce in literature. Examples in this limited line of research can be found in the works of Bartel and Harrison (2005); Dombi and Dedák (2018); Ehrlich, Gallais-Hamonno, Liu, and Lutter (1994). This scarcity might relate to conceptual problems typically encountered in measuring public sector efficiency, particularly difficulties in quantifying the appropriate measure of output. Market prices for some areas of government, such as defense, public education, and public roads, simply do not exist (Madden, Savage, & Kemp, 1997).

For a tax administration, its output may be relatively less difficult to quantify. The monetary value of the output of a tax administration in terms of tax revenue is available from official publications. Although the level of taxes may not indicate a market price in its pure sense; however, the amount of taxes collected by the tax administration may be assumed to reflect the prices that citizens are willing to pay for govern-ment services, regardless of their motives. Citizens may pay their taxes out of voluntary obligation to society or because of the risks of punishment associated with noncompliance.

This study aims to fill the gap in literature on the assess-ment of tax administration’s performance under the conceptual framework of neoclassical growth theory. Considering that Indonesia is a developing country, this study would shed insights on the underexplored area of the dynamics of dimin-ishing returns to scale in tax administration’s operations, particularly in the settings of a developing economy.

The neoclassical growth model was employed to answer the research question: does DGT operate at diminishing returns to scale? This model is employed because it can cal-culate the level of efficiency of DGT in utilizing its physical and human resources (as proxied by the level of TFP). A low level of TFP may indicate that the law of diminishing returns to scale may have set in DGT’s operations

RESEARCH METHOD

Empirical data were analyzed using the framework of the neoclassical growth model with the tax administration was seen as doing revenue production process, which involved the utilization of multiple inputs to produce output, that is tax revenue. According to neoclassical growth theory, long-run output growth can only be sustained by perpetual increase in technological progress, and the state of technological progress is captured by TFP. The level of TFP indicates the efficiency with which an organization can utilize all of its factors of production (classified into capital stock and labor) to gener-ate output. The higher the level of TFP is, the higher would be the organization’s productive efficiency; thus, the law of diminishing returns to scale would be unlikely to set in its


ResultTable 3 presents the results of TFP growth calculations for

DGT, as specified by Equation (3). For the period under study, the average growth of TFP was −0.07 per year. The very low level of TFP may indicate that the productive efficiency in DGT’s operations virtually did not exist. Growth in tax rev-enue could be the result of the accumulation of factor inputs (i.e., capital stock and labor) and not due to the efficiency in utilizing these resources.

As shown in Table 3, for the entire period under study, the growth in tax revenue was mainly the result of adding resources in the form of physical assets and employees, not from the efficient use of these resources. On average, 48% of any increase in tax revenue could be explained by increases in capital stock, and 36% could be explained by increases in labor hiring while TFP only explained 16%.

operations, vice versa.One of the crucial predictions suggested by neoclassical

growth theory is that in the absence of TFP, output growth would cease to exist once the law of diminishing returns sets in. This proposition might best be explained using the model developed by Solow (1956) and Swan (1956), as follows:

where Y denotes the output, A indicates the TFP, K is the capital stock, and L represents labor. α represents the share of capital input in the production process, and 1-α represents the share of labor input in the production process.

According to this model, additional growth in output could be spurred by increases in the inputs of capital stock and labor. However, merely increasing the inputs of capital (K) and labor (L), without increasing the efficiency with which these inputs are utilized (A), would only sustain output growth for a time. In the long run, however, output growth would “hit the wall”; that is, input utilization would run into diminishing returns. Hence, when the level of TFP is sufficiently low, at some point, diminishing returns would set in. At this point, increas-ing the capital and labor would result in lower incremental per-unit returns, thereby limiting further output expansions.

Equation (1) can be restated in a logarithmic differential form, (·), with respect to time, t, as follows:

Once an estimate of the share of capital input (α̂) has been provided, TFP (ât) can be calculated using the follow-ing equation:

Here, α̂ was estimated using the proxy of the share of capital input in the output of the aggregate economy. The available data for calculating the capital’s share in the aggre-gate economy are from the Social Accounting Matrix (SAM) published by Indonesia’s Bureau of Statistics (Badan Pusat Statistik, BPS). Table 1 reports the calculations of α̂ for years when data on SAM were available; on average, α ̂ was found to be 0.56.

The period under study covered the years from 2008 through 2017 due to data availability, particularly data on DGT’s capital stock. The year 2008 was chosen as a starting point because in this year, the DGT started to compile and publicly report data on the value of its fixed assets. Further, 2017 was chosen as the end or the latest when such data were publicly available.

Data on the output of DGT (i.e., tax revenues) were derived mainly from the publications of the annual report of DGT (Table 1 in the Appendix of this article). Data on tax revenue comprised taxes that are administered and collected by DGT: income taxes, value-added taxes, property taxes, and stamp-duty.

Data on capital stock consist of physical assets, such as office buildings, information systems (both hardware and software), and vehicles, under DGT’s management. These

data cover all fixed assets, including assets that have useful life span of more than one year, and were compiled from the financial reports and annual reports of DGT. From 2008 to 2012, the fixed assets were reported at gross value, i.e., the value before depreciation. Data on the net value of fixed assets and the value of depreciation were only available for 2013–2017. Hence, the average rate of depreciation for 2013–2017 was employed to estimate the depreciation of fixed asset for 2008–2012. These data on the net book value of fixed asset for the entire period under study are reported in Table 2 in the Appendix.

Data on the number of workers (labor) were collected from DGT’s annual reports and shown in Table 3 in the Appendix. Current monetary values were restated to the fix the 2010 prices by using GDP deflator provided by the World Bank’s World Development Indicators (World Bank, 2019).Table 1. Capital’s Share of Output in Aggregate Economy (2005=100)

Source: Badan Pusat Statistik (2011).

Table 2. the descriptive statistics of the data employed in the analysis.

Source: Direktorat Jenderal Pajak (2009, 2010a, 2011, 2012, 2013, 2016, 2017).


Note: N.A. = Not Available, this is because data for previ-ous year (2007) are not available; hence, the rate of growth for 2008 cannot be calculated.

According to neoclassical growth theory, without con-tinuous improvement in productive efficiency, output growth would cease to exist because the law of diminishing returns would set in. When an organization operates at diminishing returns to scale, putting more resources into production would result in a decreasing output per unit of resource committed into production. In other words, the marginal output gained from adding more inputs would decrease when the produc-tion is inefficient.

Figure 2 shows the diminishing returns to scale which might have set in DGT’s operations. The growth of tax rev-enue is compared with that of factor inputs which are capital stock and labor. From 2008 to 2011, the pace of growth of tax revenue was slower than that of capital stock and labor. This finding might show the period when the DGT accu-mulated factor inputs to maintain growth in tax revenue. In 2012–2014, the factor inputs accumulated in the previous period seemed to show their results. In this period, the growth in tax revenue was higher than the growth in capital stock and labor. However, in 2015–2017, diminishing returns seemed to set in possibly due to the lack of productive efficiency. In this period, significant growth in capital stock and labor resulted in only modest growth in tax revenue. In 2015–2017, the average growth of capital input was 63.5%, the average growth of labor input was 7.7%, and the average growth of

Table 3. Growth Accounting of DGT (%)

Source: Processed by author.

tax revenue was only 1.7%.Overall, Figure 2 shows that the DGT needed bigger

growth in inputs to produce smaller growth in output, indi-cating that diminishing returns might have set in. When this condition is left untreated, it might limit the capacity of the DGT to increase tax revenues in the future (assuming there would be no increases in tax rates).

One of the consequences of the lack of productive effi-ciency in tax administration could be described by comparing the growth rate of the economy vis-à-vis the growth rate of tax revenue, as presented in Figure 3.

As shown in Figure 3, after a significant drop in 2009, the growth in tax revenue bounced and reached the highest level in 2011. In this year, tax collection grew at 10.01%, while the economy only grew at 6.17%. After 2011, the growth in tax revenue declined; since 2014, the growth rate was below the growth rate of the aggregate economy. Overall, for 2008–2017, the average growth of tax revenue was only 3.16%, whereas the average growth of the economy was 5.46%.

The lower rate of growth in tax collection relative to the growth rate of the economy could be linked to the absence of efficiency in the tax administration’s operations. The lack of productive efficiency might pose a potential limit to DGT in sustaining long-term growth in tax revenue. According to neoclassical growth theory, in the long run, the only thing that matters for output expansions is the level of TFP; in the words of Krugman (1990). “Productivity isn't everything, but in the long run it is almost everything.”

Should this lack of TFP growth continue, it might drive the DGT to add more factor inputs to maintain the growth in tax revenues. However, basing the output growth merely on the expansions of inputs would unavoidably subject to diminishing returns. This limited potential to future growth in tax revenue might be a major concern because a significant

Source: Direktorat Jenderal Pajak (2009, 2010a, 2011, 2012, 2013, 2014, 2015, 2016, 2017).

Figure 2. Growth of Tax Revenue and Factor Inputs

Figure 3. Growth in Tax Revenue and Economy (2010=100)

Source: Direktorat Jenderal Pajak (2009, 2012, 2013, 2016, 2017); World Bank (2019).

underground economy that is generally difficult to tax exists in Indonesia. Studies regarding the magnitude of underground economy in Indonesia were varied: 25 % of GDP in Wibowo (2001), around 20 % of GDP in Tatariyanto (2014), and 18 % of GDP in Schneider, Buehn, and Montenegro (2010).

The absence of TFP may imply that the tax administration has a limited capacity in utilizing its resources efficiently to detect, deter, and punish noncompliance in the underground economy. In other words, difficulties in producing more output per unit of input arising from the lack of productive


efficiency could restrict the ability to increase the level of tax collection from the underground economy.

Moreover, the notion of diminishing returns could imply limits to the future ability of the DGT to maintain adequate control over taxpayers who were already registered in the tax net. This control is necessary to ensure the highest possible levels of compliance with the tax laws. In this regard, one of the consequences of the nonexistence of TFP is that the tax administration would have to rely on mobilizations of capital and labor inputs to increase the tax collection from the improved compliance of the registered taxpayers. However, as discussed previously, relying output growth merely on input mobilizations cannot continue indefinitely because dimin-ishing returns would decrease the ratio of taxes collected to the amount of inputs required to monitor taxpayers. Without improvements in the level of TFP, long-term output growth in tax collection may cease to exist.

Policy ImplicationsOne of the avenues of approach that can be chosen to

improve efficiency is through reforming the managerial aspects of the organization because this is one of the determinants that could explain productivity growth at microeconomic levels [for example, the studies of Bloom, Mahajan, McKenzie, and Roberts (2018); Karlan, Knight, and Udry (2015); McKenzie and Woodruff (2013)]. In relation to tax administration, some measures (Bird, 2010) could be implemented to improve the DGT’s efficiency in collecting taxes. First, the tax system may need to be simplified so that the system can be applied in a low-compliance environment. For example, terminating requirements for unnecessary information in tax returns as well as designing a consolidated form for return and payment could be considered. Once the system is simplified, the tax administration would focus its limited resources toward its main tasks, namely, facilitating and monitoring compliance as well as handling noncompliance.

Further, the tax administration may need to change its attitudes toward viewing taxpayers as clients rather than treating them as potential criminals. When the tax admin-istration views taxpayers as potential criminals, significant resources would be diverted toward identifying, controlling, and catching those who cheat. Studies show, however, that these measures rarely provide optimum results (Kirchler et al. (2008)). More could be gained from treating taxpayers as client, relative to the resources committed. In this respect, one of the measures that could be considered by the DGT may involve improving taxpayers’ services by reducing uncertainty; for example, by clarifying ambiguities in legal aspects. Giving clarifications to taxpayers regarding simple issues, such as the tax rate for certain business transaction, improving communications to taxpayers to convey about what the law is and refraining from changing the regulations too often that no one quite knows what they are could also be considered. These efforts may reduce the compliance cost for taxpayers and the administrative cost for the DGT, thereby improving efficiency.

In theory, TFP could closely be associated with techno-logical changes (Aghion & Howitt, 1990; Romer, 1990). One of the examples of technological changes is advances in Information Technology (IT); proper management on this aspect was argued to have large potential effects on improving the productivity of organizations (Stiroh, 2016). Appropriate

management of IT may reduce the costs of coordination, communications, and information processing; thus, they may spur efficient utilizations of resources (Brynjolfsson & Hitt, 2000). However, to optimally realize the potential benefits of the IT systems, they need to be managed and designed in such a way as to facilitate the automation of business pro-cesses. Without these automations, productivity gains from IT adoption might not materialize for organizations (Dedrick, Gurbaxani, & Kraemer, 2003).

Efforts to reform Indonesia’s tax administration were prompted by macroeconomic and fiscal shocks following the Asian financial crisis of 1997/1998. One of the reformed areas involved updating IT hardware and software to better support the core business processes of DGT. Changes occurred in the information systems, which initially aimed to automate the processes of taxpayer services and data utilization. Some positive outcomes are evident, for example the majority of tax returns are now filled electronically and tax payments are processed through electronic systems that directly links data from the banking sector to the DGT (Direktorat Jenderal Pajak, 2017).

After more than two decades of reform; however, no uni-fied information system has been established at the DGT. This condition complicates the utilization of data, which are generated from tax returns and third-party information for audit purposes. Under the current information systems, a tax officer must manually browse through various computer applications and then through various menus in each applica-tion to monitor taxpayers’ reports and to cross-check the data provided by these reports with third-party information. This procedure further complicates the risk management strategies set by the DGT because these strategies rely on the ability to identify, in accurate and timely manners, inconsistencies between data from tax returns and third-party information. Given that this identification is on a large part conducted manually (although this process may be paperless because it may be done on computer spreadsheets), involving 39 million registered taxpayers (Direktorat Jenderal Pajak, 2017), the process is significantly inefficient. Moreover, the informa-tion systems cannot produce accurate amount of arrears that have to be collected from taxpayers, thereby adding to the complexity and inefficiencies in collection efforts.

Further, the inadequacy of information provided by the available systems prompts tax administrators to devise their own information systems. As a result, local offices may have different information systems as additions to the systems already provided by the DGT head office. These “in-house” information systems may cause information fragmentation because the information they produce may only be available for the local tax office that developed the systems. As a result, this fragmentation of information may hamper the sharing of data and information between local offices as well as between the head office and local offices. This condition may further impede efficient monitoring of taxpayers’ compliance because the fragmented information could not support nationwide, credible, and data-driven enforcement efforts.

Nevertheless, the suboptimal gains from IT adoption in improving the efficiency of tax administration may not be exclusively experienced by Indonesia. Efforts to reform tax administrations in developing countries generally involved changes in IT; however, their payoffs often unable to reach expectations [Jenkins (1996); Kumar, Nagar, and Samanta


tasks of servicing and monitoring taxpayers.Further, the lack of efficiency in the DGT might be the

result of the problem with the consistency of the tax regime. Surveys by Deloitte (2014, 2017) indicated that one of the issues pointed out by respondents was the inconsistency of the Indonesian tax regime. Specifically, this problem was related to the frequent changes in tax legislations. Moreover, the publicly available guidance from the tax authority was often ambiguous (Deloitte, 2014, 2017). Hence, the problem with the stability of the tax legislations may partially explain the lack of efficiency in DGT operations because even the most sophisticated tax administration in the world would be overwhelmed with complicated tasks that hamper its effi-ciency when the tax structure becomes overly complex due to frequent changes in legislations (Bird, 2004).

The limited role of education in supporting the efficiency of DGT remains puzzling. In theory, education is argued to play a significant role in TFP growth through three mecha-nisms. First, education could promote labor productivity through increases in human capital inherent in the labor force (Mankiw, Romer, & Weil, 1992). Second, education could promote growth by increasing the innovative capac-ity in product, process, and technology (Aghion, Howitt, & Garcia-Penalosa, 1998; Lucas, 1988; Romer, 1990). Third, education could promote growth by facilitating the diffu-sion and transmission of knowledge and new technologies (Benhabib & Spiegel, 1994; Nelson & Phelps, 1966).

The educational attainments of DGT staffs through formal education or through training programs have been increasing. In 2008, the number of DGT staffs with bachelor, master, and doctoral degrees was 13,060 or 42% of the entire employees (Direktorat Jenderal Pajak, 2008). In 2017, 21,500 staffs or 50% of the total employees had the same academic degrees (Direktorat Jenderal Pajak, 2017). For employee training, 328 training programs involving 28,008 staffs were conducted in 2010 (Direktorat Jenderal Pajak, 2010b). In 2017, 501 training programs involving 20,652 staffs were conducted.

One of the possible explanations for this lack of efficiency growth amid increases in labors’ educational attainment may be the inadequate quality of information systems. Increases in human capital from educational attainment have not been able to translate into improvement in labor productivity because the available information systems could not support staffs’ productive activities. As discussed previously, tax officers have to manually sort through various computer applica-tions to check taxpayers’ compliance; under this condition, even staff with a master’s degree in accounting could be overwhelmed to manually monitor thousands of taxpayers under his/her responsibility. Data for 2017 showed that the number of staff directly responsible for monitoring compli-ance (or Account Representative) was 9,725 whereas the number of registered taxpayers was 39,151,603. Thus, on average, one Account Representative had to monitor 4,025 taxpayers (Direktorat Jenderal Pajak, 2017). This condition might impede the DGT from fully exploiting increases in the education of its human capital to improve productivity.

Another possible explanation for this lack of efficiency gains from education may relate to organizational path depen-dency. The theory of path dependency basically demonstrates how particular laws, rules, and institutions may cause heavy disincentives for change because large resources are already invested in the current ways of doing things (Pierson, 2011).

(2007); Manglik (2008)]. Therefore, lessons learned from the successes and failures of these countries may provide some guidance on the appropriate avenues of approach to improve the efficiency gains from the utilization of IT systems in Indonesia’s tax administration.

From countries’ experiences, Bird and Zolt (2008) identi-fied several key factors for successful exploitation of IT in tax administration: appropriate strategy for overcoming rigidities related to civil service organizations and procedures in hiring capable expertise, hardware, and software; centralized inno-vation strategy to facilitate standardized training, business process, networking, and maintenance; acquisition of off-the-self software to minimize cost and accommodate future developments; and provision of training and skill improve-ment for people who will operate the technology and thorough reengineering of the tax administration toward automated business processes. Overall, solving the problems related to the management of the information systems may be an impor-tant step toward improving the productive efficiency of DGT.

Other domain that could be considered for improvement in the effort to boost TFP is in the area of business process. A large body of literature focuses on the consequences of busi-ness process management on productivity at firm and national levels. Recent studies include the works of Adhvaryu, Kala, and Nyshadham (2016); Bertrand and Schoar (2003); Bruhn, Karlan, and Schoar (2018); Gancia, Mueller, and Zilibotti (2013). Bloom and Van Reenen (2007) found that the qual-ity of implementation of managerial practices was strongly correlated with firm’s productivity. This finding suggests that once an organization decides to adopt a good managerial practice, improvement in productivity would materialize after that practice has deeply embedded within the organization. In other words, the better a managerial practice is adopted, the more embedded its implementation, the higher would be the performance of the organization.

Hence, managers should identify whether practices adopted by their organizations are better than other alter-natives, have been fully utilized to their full potential, and ensure that the organization has been reaping benefits through increases in productivity (Büchel, 2016). Simply adopting additional management practices in excess of existing pro-cesses would only put burdens on employees and on physical resources without significant marginal increases in productiv-ity. By the same token, too frequent changes in managerial policies without thorough qualitative and quantitative evalua-tions on the benefits and drawbacks of the existing procedures to be replaced as well as of the new ones to be adopted would only result in confusion, disruption in organization’s focus, and diversions of resources toward introducing the new pro-cedures away from the real missions of organization; all of these may adversely affect productivity.

This problem might have dragged the productive effi-ciency of DGT. For example, despite various information systems that have been adopted, existing regulations still required that tax officers submit routine reports in which the required data have to be collected and written manu-ally. Moreover, local offices should supply information on an ad-hoc basis by manually sorting through various documents because the available information systems could not produce specific or accurate information. These activities are time consuming, prone to errors, may cause redundancies, and potentially distract the attention of tax officers from their main


Path dependency may drag the DGT’s productive efficiency amid increases in educational attainment. For example, some operational procedures still require that certain reports must be regularly submitted to the head office. Although computer information systems are available, these procedures have not been annulled; as such, even with better educated staffs, these tasks are still time consuming and cause lags in information availability. Another example for the possibility of path depen-dency may relate to the quality of the information systems, which even with their drawbacks, as discussed previously, are still being used for decades.

Research Limitations and Directions for Future ResearchOne of the limitations of the neoclassical growth model

is that it treats TFP growth exogenously. Therefore, the model employed in this study does not conduct empirical tests regarding the sources of TFP growth. Future research should conduct empirical tests to determine factors that affect the growth of TFP in Indonesian tax administration.

Other limitations may involve the period of the study. This study only covers the period of 2008–2017 due to limitations in data availability. Neoclassical growth theory is concerned with the sources of output growth of an eco-nomic entity in the long run. Therefore, when more data are available, future studies could measure the efficiency of Indonesian tax administration over a longer time period. This endeavor might provide better insights into the possible determinants of efficiency and propose more comprehensive policy recommendations.

CONCLUSION

Employing the framework of neoclassical growth theory, this study found that the productive efficiency, which was measured by growth in TFP, of the Indonesia’s tax administra-tion (DGT) was basically nonexistent. Moreover, diminishing returns to scale were found to have set in DGT operations due to the lack of TFP. This condition may imply some future limits to tax revenue expansions from the tax administration.

Areas that could be considered for improving the effi-ciency of the DGT may involve simplifying the tax system and changing the attitudes of the tax administration toward viewing taxpayers as clients, not as potential criminals. Once procedures were simplified and services to taxpayers as clients improved, the tax administration would be able to focus its limited resources toward its main tasks, namely, facilitating and monitoring compliance and handling noncompliance. With a more focus in carrying its main tasks, the tax admin-istration might be able to improve its efficiency.

Other areas that could be considered to boost efficiency may involve improvements in the management of the infor-mation system. Renovations in IT should include efforts to automate the process of cross-checking data from tax returns against data from third-parties. Improving the accuracy of data may also spur efficient operations. Further, a single and centralized information system could avoid information frag-mentation. These improvements in the management of the information system might increase the efficiency through their effects on easing the burden of the tax officials and reducing the compliance costs borne by taxpayers.

Efforts to raise efficiency could be directed toward improv-ing the tax administration’s business process. Regular and

irregular reports, which have to be prepared manually, should be discontinued. As replacements, the information system should be designed to provide the needed information. In this way, resources could be freed and be focused on servicing and monitoring taxpayers. Further, maintaining the stability of tax legislations and overcoming organizational path dependen-cies might enable the DGT to improve efficiency gains from human resources’ educational attainment.

ACKNOWLEDGEMENT

This article was prepared in author’s personal capacity. The opinions expressed in this article are the author’s own and do not reflect the view of the organization with which the author affiliated.

REFERENCES

Adhvaryu, A., Kala, N., & Nyshadham, A. (2016). Management and shocks to worker productivity. Mimeograph, University of Michigan Working Paper.

Aghion, P., & Howitt, P. (1990). A model of growth through creative destruction: National Bureau of Economic Research.

Aghion, P., Howitt, P., Brant-Collett, M., & García-Peñalosa, C. (1998). Endogenous Growth Theory: MIT press.

Aghion, P., Howitt, P., & Garcia-Penalosa, C. (1998). Endogenous Growth Theory. Cambridge, Mass: MIT press.

Allingham, M. G., & Sandmo, A. (1972). Income tax evasion: A theoretical analysis. Journal of Public Economics, Vol. 1, No. 3-4, pp. 323-338.

Andreoni, J., Erard, B., & Feinstein, J. (1998). Tax compli-ance. Journal of Economic Literature, Vol. 36, No. 2, pp .818-860.

Badan Pusat Statistik. (2003). Statistik Indonesia, Statistical Yearbook of Indonesia 2003. Jakarta: BPS.



Badan Pusat Statistik. (2011). Sistem Neraca Sosial Ekonomi Indonesia Tahun 1975-2008. Jakarta: BPS.



Baer, K., & Silvani, C. (1997). Designing a tax administration reform strategy: Experiences and guidelines: International Monetary Fund.

Bartel, A. P., & Harrison, A. E. (2005). Ownership versus environment: Disentangling the sources of public-sector inefficiency. Review of Economics and Statistics, Vol. 87, No. 1, pp. 135-147.

Benhabib, J., & Spiegel, M. M. (1994). The Role of Human Capital in Economic Development Evidence from Aggregate Cross-country Data. Journal of monetary economics, Vol. 34, No. 2, pp. 143-173.

Bergman, M. S. (2003). Tax reforms and tax compliance: The divergent paths of Chile and Argentina. Journal of Latin American Studies, Vol. 35, No. 03, pp. 593-624.

Bertrand, M., & Schoar, A. (2003). Managing with style: The


effect of managers on firm policies. The Quarterly Journal of Economics, Vol.118, No. 4, pp. 1169-1208.

Bird, R. M. (2004). Administrative Dimensions of Tax Reform. Asia-Pacific Tax Bulletin, Vol. 10, No. 3, pp. 134-150.

Bird, R. M. (2010). Smart Tax Administration Poverty Reduction and Economic Management Network: World Bank.

Bird, R. M., & Zolt, E. M. (2008). Technology and taxation in developing countries: from hand to mouse. National Tax Journal, pp. 791-821.

Bloom, N., Mahajan, A., McKenzie, D., & Roberts, J. (2018). Do management interventions last? evidence from India: The World Bank.

Bloom, N., & Van Reenen, J. (2007). Measuring and explain-ing management practices across firms and countries. The Quarterly Journal of Economics, Vol. 122, No. 4, pp. 1351-1408.

Braithwaite, V. (2003a). Dancing with tax authorities: Motivational postures and non-compliant actions. In V. Braithwaite (Ed.), Taxing democracy. Understanding tax avoidance and tax evasion, pp 15-39. Aldershot: Ashgate.

Braithwaite, V. (2003b). Perceptions of Who's Not Paying Their Fair Share Vol. 38.

Bruhn, M., Karlan, D., & Schoar, A. (2018). The impact of consulting services on small and medium enterprises: Evidence from a randomized trial in mexico. Journal of political Economy, Vol. 126, No. 2, pp. 635-687.

Brynjolfsson, E., & Hitt, L. M. (2000). Beyond computation: Information technology, organizational transformation and business performance. Journal of Economic Perspectives, Vol. 14, No. 4, pp. 23-48.

Büchel, B. (2016). When less is more at your organization - Companies should think twice before adding more and more procedures. https://www.imd.org/research-knowledge/articles/when-less-is-more-at-your-organization/

Cialdini, R. (1996). The triple tumor structure of organi-zational behavior. In M. DM & T. AE (Eds.), Codes of conduct, pp. 44-58. New York: Sage.

Clotfelter, C. T. (1983). Tax evasion and tax rates: An analy-sis of individual returns. The Review of Economics and Statistics, pp. 363-373.

Cowell, F. A. (1990). Cheating the government: The econom-ics of evasion. MIT Press Books, 1.

Crandall, W. J. (2010). Revenue administration: perfor-mance measurement in tax administration: International Monetary Fund.

Dedrick, J., Gurbaxani, V., & Kraemer, K. L. (2003). Information technology and economic performance: A critical review of the empirical evidence. ACM Computing Surveys (CSUR), Vol. 35, No. 1, pp 1-28.

Deloitte. (2014). Risk, uncertainty and opportunity in a chang-ing tax landscape - 2014 Asia Pacific Tax Complexity Survey: Deloitte Touche Tohmatsu Ltd.

Deloitte. (2017). Shifting sands: risk and reform in uncertain times - 2017 Asia Pacific Tax Complexity Survey: Deloitte Touche Tohmatsu Ltd.

Dimand, R. W., & Spencer, B. J. (2009). Trevor Swan and the Neoclassical Growth Model. History of Political Economy, Vol. 41, No. 1), pp. 107-126. doi: 10.1215/00182702-2009-019

Direktorat Jenderal Pajak. (2008). Laporan Tahunan

Direktorat Jenderal Pajak 2008. Jakarta: Direktorat Jenderal Pajak.

Direktorat Jenderal Pajak. (2009). Laporan Tahunan Direktorat Jenderal Pajak 2009. Jakarta: Direktorat Jenderal Pajak.

Direktorat Jenderal Pajak. (2010a). Laporan Keuangan Direktorat Jenderal Pajak 2010. Jakarta: Direktorat Jenderal Pajak.

Direktorat Jenderal Pajak. (2010b). Laporan Tahunan Direktorat Jenderal Pajak 2010. Jakarta: Direktorat Jenderal Pajak.

Direktorat Jenderal Pajak. (2011). Laporan Keuangan Direktorat Jenderal Pajak 2011. Jakarta: Direktorat Jenderal Pajak.







Direktorat Jenderal Pajak. (2018). Buku Saku Pajak Dalam Angka. Jakarta: Direktorat Jenderal Pajak.

Dombi, Á., & Dedák, I. (2018). Public debt and eco-nomic growth: what do neoclassical growth models teach us? Applied Economics,pp 1-18. doi: 10.1080/00036846.2018.1508869

Ehrlich, I., Gallais-Hamonno, G., Liu, Z., & Lutter, R. (1994). Productivity growth and firm ownership: An analytical and empirical investigation. Journal of political Economy, Vol. 102, No. 5, pp. 1006-1038.

Feld, L. P., & Frey, B. (2002). Trust breeds trust: How taxpayers are treated. Centre for Tax System Integrity Working Paper No. 32 Australian National University and Australian Taxation Office.

Feld, L. P., & Frey, B. S. (2004). Illegal, Immoral, Fattening or What?: How Deterrence and Responsive Regulation Shape Tax Morale.

Fjeldstad, O.-H. (2004). What's Trust Got to Do With It? Non-Payment of Service Charges in Local Authorities in South Africa Vol. 42.

Frey, B. S. (2003). Deterrence and tax morale in the European Union, Vol. 11.

Gancia, G., Mueller, A., & Zilibotti, F. (2013). Structural Development Accounting. In D. Acemoglu, M. Arellano & E. Dekel (Eds.), Advances in Economics and Econometrics: Theory and Applications. Cambridge: Cambridge University Press.

Hahn, F. H. (2010). Neoclassical Growth Theory. In S. N. Durlauf & L. E. Blume (Eds.), Economic Growth, pp. 172-192. London: Palgrave MacMillan.


Horowitz, J. (2017). Economic Growth, Conflicting Visions Of The American Middle Class: An Economic Encyclopedia of Progress and Poverty [2 volumes], pp. 116.

Jenkins, G. (1996). Information Technology and Innovation in Tax Administration Vol. 2: Kluwer Law International BV.

Karlan, D., Knight, R., & Udry, C. (2015). Consulting and capital experiments with microenterprise tailors in Ghana. Journal of Economic Behavior & Organization, Vol. 118, pp. 281-302.

Kirchler, E. (2007). The Economic Psychology of Tax Behaviour.

Kirchler, E., Hoelzl, E., & Wahl, I. (2008). Enforced versus voluntary tax compliance: The “slippery slope” frame-work. Journal of Economic Psychology, Vol. 29, No. 2, pp 210-225.

Klun, M. (2004). Performance measurement for tax admin-istrations: the case of Slovenia. International Review of Administrative Sciences, Vol. 70, No. 3, pp 567-574.

Krugman, P. (1990). The Age of Diminished Expectation. Cambridge, MA: MIT Press.

Krugman, P., & Wells, R. (2006). Economics. New York: Worth Publishers.

Kumar, S., Nagar, A., & Samanta, S. (2007). Indexing the effectiveness of tax administration. Economic and Political Weekly, pp. 104-110.

Levi, M. (1989). Of rule and revenue Vol. 13: Univ of California Press.

Lucas, R. E. (1988). On the mechanics of economic develop-ment. Journal of monetary economics, Vol. 22, no. 1, 3-42.

Madden, G., Savage, S., & Kemp, S. (1997). Measuring public sector efficiency: A study of economics depart-ments at Australian universities. Education Economics, Vol. 5, No. 2, pp. 153-168.

Manglik, G. (2008). Using Technology to Reduce Income Tax Evasion in India. Tax Notes International, Vol. 50, No. 8, pp. 705.

Mankiw, N. G., Romer, D., & Weil, D. N. (1992). A contribu-tion to the empirics of economic growth. The Quarterly Journal of Economics, Vol. 107, No. 2, pp. 407-437.

McKenzie, D., & Woodruff, C. (2013). What are we learning from business training and entrepreneurship evaluations around the developing world? The World Bank Research Observer, Vol. 29, No. 1, pp. 48-82.

Nelson, R. R., & Phelps, E. S. (1966). Investment in humans, technological diffusion, and economic growth. The American Economic Review, Vol. 56, No. 1/2, pp. 69-75.

Orviska, M., & Hudson, J. (2003). Tax evasion, civic duty and the law abiding citizen. European Journal of Political Economy, Vol. 19. No. 1, pp. 83-102.

Park, C.-G., & Hyun, J. K. (2003). Examining the determi-nants of tax compliance by experimental data: A case of Korea, Vol. 25.

Pierson, P. (2011). Politics in time: History, institutions, and social analysis: Princeton University Press.

Rawlings, G. (2003). Cultural narratives of taxation and citizenship: Fairness, groups and globalisation (Vol. 38).

Romer, P. M. (1990). Endogenous technological change.

Journal of political Economy, Vol. 98, No. 5 Part2, pp. S71-S102.

Schneider, F., Buehn, A., & Montenegro, C. E. (2010). New Estimates for the Shadow Economies all over the World. International Economic Journal, Vol. 24, No. 4, pp. 443-461. doi: 10.1080/10168737.2010.525974

Slemrod, J., Blumenthal, M., & W. Christian, C. (2001). Taxpayer Response to an Increased Probability of Audit: Evidence from a Controlled Experiment in Minnesota Vol. 79.

Solow, R. M. (1956). A Contribution to the Theory of Economic Growth. The Quarterly Journal of Economics, Vol. 70, No. 1, pp. 65-94. doi: 10.2307/1884513

Solow, R. M. (1999). Neoclassical growth theory. Handbook of macroeconomics, Vol. 1, pp. 637-667.

Stiroh, K. J. (2016). 2001: Information Technology and the US Productivity Revival: a Review of the Evidence The Best of Business Economics, pp. 279-290: Springer.

Swan, T. W. (1956). Economic Growth and Capital Accumulation. Economic Record, Vol. 32, No.2, pp. 334-361. doi: 10.1111/j.1475-4932.1956.tb00434.x

Tatariyanto, F. (2014). Taxing the Underground Economy: The Case of Indonesia. Journal of Economics and Sustainable Development, Vol. 5, pp. 27.

Tilly, C. (1990). Coercion, capital, and European states, AD 990: Cambridge: Basil Blackwell.

Trivedi, V. U., Shehata, M., & Mestelman, S. (2004). Attitudes, incentives, and tax compliance: Department of Economics, McMaster University.

Tyler, T. (2006). Psychological Perspectives on Legitimacy and Legitimation, Vol. 57.

Van den Berg, H. (2012). Economic Growth and Development (2 ed.). Singapore: World Scientific.

Wärneryd, K.-E., & Walerud, B. (1982). Taxes and Economic Behavior: Some Interview Data on Tax Evasion in Sweden , Vol. 2.

Wenzel, M. (2003). Tax Compliance and the Psychology of Justice: Mapping the Field. In V. Braithwaite (Ed.), Taxing Democracy. Understanding tax avoidance and tax eva-sion, pp. 41-69. Aldershot: Ashgate.

Wenzel, M. (2005). Motivation or rationalisation? Causal rela-tions between ethics, norms and tax compliance. Journal of Economic Psychology, Vol. 26, No. 4, pp. 491-508.

Wibowo, S. H. (2001). Growth convergence in Southeast Asia and underground economy in Indonesia: Southern Illinois University at Carbondale.

World Bank. (2011). An Integrated Assessment Model for Tax Administration - The Diagnostic Tool: Poverty Reduction and Economic Management Public Sector and Governance Group.

World Bank. (2019). World Development Indicators. Retrieved from: https://databank.worldbank.org/data/reports.aspx?source=world-development-indicators#

Yaisawarng, S. (2002). Performance Measurement and Resource Allocation. In K. J. Fox (Ed.), Efficiency in the Public Sector, pp. 61-81. New York: Kluwer Academic Publishers.

Have Diminishing Returns Set in? The Efficiency of ...

Documents

Transcript of Have Diminishing Returns Set in? The Efficiency of ...