Eradicating tax evasion in Indonesia through financial sector development

Sugiharso Safuan, Muzafar Shah Habibullah, Eric Alexander Sugandi

Research output: Contribution to journalArticlepeer-review

Abstract

Many poor countries, like Indonesia, struggle with tax evasion. It reduces government revenues, impeding government activities and a country’s economic development. In this study, we look at the topic of tax evasion in Indonesia from 1980 to 2019. Using the “modified-cash-deposit-ratio” technique, we estimate the scale of tax evasion in Indonesia. We specifically calculate the loss in tax revenue caused by Indonesia’s shadow economy. Using a variety of estimators, we then evaluate whether financial development can eliminate tax evasion. To estimate the long-run model for Indonesian tax evasion, we used Ordinary Least Squares with robust standard error (OLS-robust), Autoregressive Distributed Lag (ARDL), Dynamic OLS (DOLS), and Robust Least Squares-M-Estimation (RLE-ME). Our findings reveal that there is a non-linear long-run link between tax evasion and financial development in Indonesia, with an inverted U-shape curve indicating that a lower (higher) level of financial development corresponds to a higher (lower) level of tax evasion. An important policy implication is that the Indonesian government and the Central Bank of Indonesia should embark on programmes to increase financial inclusion, provide easy access to credit arrangements and financial facilities, and implement information technology-based financial systems capable of transmitting data to tax authorities.

Original languageEnglish
Article number2114167
JournalCogent Economics and Finance
Volume10
Issue number1
DOIs
Publication statusPublished - 2022

Keywords

  • financial sector development
  • Indonesia
  • modified-cash-deposit-ratio
  • tax evasion

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