Comparative study on Corporate Income Taxes of Japan and Indonesia

Based on Tax Misery Index and Index of Economic Freedom

Abstract

This paper examines corporate income tax rate as a main source of tax
burden causality in Japan and Indonesia from fiscal policy and
macroeconomic perspective. It employs data from the Tax Misery Index
and the Index of Economic Freedom to compare the tax burden between
Japan and Indonesia. It then creates a mixture index comparison, which
provides more representative look at relative tax burdens from investors’
and policy maker viewpoint.

I. Introduction

1. Corporate income tax by definition

According to A Dictionary of Economics (Black, 2002) definition of corporate

income tax is:

“A tax on the profits of firms, as distinct from taxation of the incomes of

their owners. There are strong arguments for having separate income tax
schemes for firms and individuals: the system of allowances and progressive
tax rates appropriate for a tax on individual incomes is quite different from a
sensible scheme for taxing firms.”1.

However, in terms of application, the definition of corporate income tax may slightly
differ regarding the prevailing circumstances in each country.

2. Overview of corporate income tax rate in Japan

In Japan, corporate income tax is levied on the taxable income of corporations

which taxable income itself defined as the excess of gross revenue over the total of its
costs and business expenses for each accounting period 2.
Corporate tax rates in Japan from April 1 1999 are shown below.

Table 1,
Tax Rates for Ordinary Corporate Income in Japan
Ordinary corporations Annual Income Tax Rate
Corporations with capital of 30%
more than 100 million yen
Corporations with capital of For annual income of more 30%
no more than 100 million than 8 million yen
yen For annual income of no 22%
more than 8 million yen
Cooperative associations and public service corporations 22%

1
A definition of "corporate income tax" from A Dictionary of Economics.
2
MOF of Japan, Comprehensive Handbook of Japanese Taxes 2006 [Electronic version] pp. 76-89

1
 For additional information, company not only responsible for corporation tax rate
however they also have obligation for enterprise tax and inhabitants tax which attributes
as local tax refer to where they are domicile 3.

3. Overview of corporate income tax rate in Indonesia

In Indonesia, a corporation for tax purposes is classified as “resident” or “non-

resident”. Residency is determined on the basis of place of incorporation 4 . Resident
corporations are taxed on their worldwide income. Tax credits are allowed for income
that was taxed outside the country. Non-residents are taxed only on income derived from
Indonesian sources, subject to any relief available under double taxation agreements
Taxable income is defined as any increase in economic prosperity received or
accrued by taxpayer, whether originating from within or outside Indonesia, which may
used for consumption or to increase the recipient’s wealth in whatever name and form 5.
Tax Rate
Income tax in Indonesia is progressive and a self-assessment method is used to
compute the tax. Since January 1, 2001 corporate tax rate are shown below 6:

Table 2
Tax Rates for General Corporate Income in Indonesia
Taxable Annual Income Tax Rate
Up to 50 million rupiah 10%
Over 50 million rupiah to 100 million rupiah 15%

Over 100 million rupiah 30%

II. Analysis

1. Pre Analysis

International comparisons of corporate income tax rates are potentially difficult to

perform, for several reasons7:
a. effective tax rates may be measured in a variety of ways, the differences
among countries tax rates may distort aspects of economic behavior,
b. characteristics of countries’ economies may differ and interact in ways that
affect how those nations’ tax systems should be compared.
c. further complicating such analyses are the existence of sub national
corporate income taxes, differences between the ways that returns to
3
Rates of enterprise tax and inhabitants’ tax varied among cities in Japan local tax with average rates of
7.56%.
4
A corporation is therefore considered “resident” if incorporated in Indonesia and non-resident if otherwise
5
It includes any remuneration in connection with work or services, business profits (with no distinction
between operating and capital income), dividends, interest, rent, royalties and other income related to the
use of property.
6
Republic of Indonesia, Law Number 17 Year 2000 on Income Tax Article 17
7
See The Congress of the United States O Congressional Budget Office - Corporate income tax:
International comparisons (November 2005) The Congress of the United States O Congressional Budget
Office Retrieved at http://www.cbo.gov/ftpdoc.cfm?index=6902&type=1

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 investments financed by debt and by equity are taxed, and the various ways
in which taxable income may be defined and calculated.

Therefore, comparisons that do not fully account for such differences and
intricacies must be interpreted with full-care. Since the exact comparison is difficult to be
accomplished, then the analysis is conducted in another perspective. The analysis here
take a micro approach to public finance by examining certain aspects of taxation and
public finance from the perspective of taxpayer and policy maker, using the Forbes Tax
Misery Index and Index of Economic Freedom.

2. Tax Misery Index

Each year, Forbes magazine releases a study on tax misery. The Forbes Global
Misery & Reform Index is a proxy for evaluating whether tax policy attracts or repels
capital and talent. It is computed by adding the top marginal tax rate for the corporate
income tax, individual income tax, wealth tax, employers’ and employee’s social security
tax and value added tax. The higher number of the total, the more the misery, because tax
burden which carried out by taxpayers become higher 8.
The 2005 tax misery index was used for this comparative study. Several countries
are ranked. Table 3 contains selected countries that were included in the Index from
selected developed and developing countries in term of comparison purposes.

Table 3
Tax Misery for 2005, selected countries9
Rank Country Corp. Indiv. Wealth Employer Employee VAT Misery
Inc. Inc. tax Soc. Sec Soc. Sec. 2005
tax tax tax tax
1 France 34.4 59 1.8 45 15 19.6 174.8
2 China 33 45 0 44.5 20.5 17 160.0
3 Belgium 34 53.5 0 34.5 13.1 21 156.1
..
18 Japan 39.5 50 0 14.9 13.9 5 123.3
..
43 Indonesia 30 35 0 12 2 10 89.0
…
56 UAE 0 0 0 5 13 0 18.0

During years, the tax misery index had fluctuations related to changes and
situation in each respected countries. For comparison necessities, from 2002 to 2005 the
table presented the changes below.

8
Some taxes are omitted, such as the real and personal property tax and excise taxes
9
Complete list attached in the end of this paper

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 Table 4
Changes in Tax Misery in Asian Countries
From 2002 -2005 (selected countries)
Rank Tax Misery Increased
Country 2005 2004 2003 2002 (Decreased)
2002 to
2005
2 China 160.0 160.0 160.0 154.5 4.0
18 Japan 123.3 121.5 124.9 117.3 (0.3)
43 Indonesia 89.0 89.0 80.7 80.7 8.3
53 Hong 43.5 43.0 43.0 41.0 2.5
Kong

The information on the table shows that during 2002 to 2005, tax misery index in
Japan has decreased by 0.3 point compared with Indonesia which has increased by 8.3
point. However, from Table 4 it shows that tax misery grade for Japan is still higher with
123.3 point compared with Indonesia with 89.0 point.

3. Index of Economic Freedom

Another way to compare the public finance systems of various countries is by

comparing their top marginal individual and corporate income tax rates and their year-to-
year change in government expenditures as a percentage of GDP. These are the variables
used to compute the fiscal burden scores for 161 countries in the Index to Economic
Freedom (2006), an annual study that is commissioned by the Wall Street Journal and the
Heritage Foundation. Each variable in this study was assigned a grade of 1 to 5, where 1
was the lightest burden and 5 was the heaviest burden. The scores for each of the three
individual variables were then weighted to arrive at the final score.

Table 5
Fiscal Burden of Government 10
Country Final Income Corporate Change in Income Corporate Year
Name Fiscal Taxation Taxation Government Tax Tax Rate on
Burden Score Score Expenditure Rate Year
Score score Change
…
Japan 3.6 3.5 4 3 37 30 -0.3
…
Indonesia 4.1 3.5 4 5 35 30 3.3

The information on the table 5 above indicate that according to the result of
Heritage foundation and Wall Street Journal research, for year 2006, Indonesia has higher
burden score compared to Japan. The differences of burden score between Indonesia and
Japan here is 0.5 point.

10
Fiscal Burden is only one factor in determining composition of Index to Economic Freedom. The other
factors include corruption in government, non-tariff barriers to trade, rule of law, regulatory burdens on
business, and restrictions on banks, labor market regulations and informal market activities.

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 4. Comparison of Index and analysis

Which index is provides better measurement of competitiveness especially from

the investors’ point of view? When speaking of competitiveness, one usually thinks of
the attractiveness of investing or setting up a business in a particular country. Thus, the
corporate income tax is an essential component of getting that decision. However, the
corporate income tax is not the only measure that investors considers when deciding
where to invest. They consider other costs of doing business, such as employee payroll
taxes or property taxes. These taxes are including in Tax Misery Index variables
assumptions, whereas the Index of Economic Freedom did not. Nevertheless, Tax Misery
Index also includes some taxes that probably do not affect directly a corporation’s cost of
doing business, such as the wealth tax and the individual income tax. These differences in
assumption and construction variable of terms as a consequence will lead to different
result.
A better index to use probably should including the corporate income tax, the
employer portion of social security taxes and the Value Added Taxes (VAT) or
consumption tax. Those taxes are the most affecting consideration of cost of performing
business. Therefore, if the aim is to determine which countries are the best to set up
business, perhaps only the taxes that affect the cost of doing business should be included
in the index. For the side of policy making Tax Misery Index perhaps provides better
information, otherwise for outside investors, perhaps Index of Economic Freedom
provides better overview.
For the case of Japan and Indonesia, during period of year 2002 until 2005 there
is increasing tax misery for Indonesia (8.3 point) and on the other hand there is
decreasing tax misery for Japan (-0.3 point). It seems in these periods, Indonesia
government seeks to generate more taxes. As a consequence, as the escalation of tax
misery is continuous, it will drive for higher tax burden.
One thing is unambiguous, higher tax burden or tax misery will have deep
implication to the government. There is little evidence to suggest that higher taxation
increases GDP growth rates and much more evidence to suggest the opposite is true11.
Some of empirical studies on taxation and economic growth based upon theory of supply
side economics are supporting previous statement12.
Despite of enormous reliance of government with taxes as fund sources to
ascertain excellent public services provided, government should rethinking over decision
to raise tax rates especially corporate tax rate to finance daily government operation13.
Improvement of tax policy is significant especially forming proper tax structure within a
country to support economic growth14.

11
See Nicholson (2005). For various kinds of taxes which creates generally accumulates burden,
economists generically refer to unexploited gains from trade as deadweight loss of taxes
12
See Marsden (1983), Skinner (1987) and Reynolds (1985). In general, their research found that higher
(aggregate) tax rate led to slower economic growth.
13
See Lee & Gordon (2004). They found that there are strong relationship between cutting corporate taxes
and increase of economic growth. They estimates by cutting 10 percentage points of corporate tax rates
will raise annual growth rate by 1.1 percentage points.
14
See Schumpeter (1942). Raising tax rates for corporate tax has larger deteriorating effect than raising
other kind of taxes estimably. Furthermore, higher corporate tax rate will discourage entrepreneurial
activity.

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III. Concluding remarks

The Tax Misery Index and Index of economic freedom (tax burden index) reveal
the relative degree of tax burden aspect between Japan and Indonesia. Regarding
different methodologies, both indexes are ensuing in different results. In policymaker
points of view, Tax Misery index provide better arguments to decide a new policy. On
the other hand, from investors’ perspective, Index of Economic Freedom offers obvious
guidelines in where to invest.
Absolutely, there are many other factors that investors need to consider before
deciding whether to invest in a country. A strong rule of law is ultimately very important,
which includes strong protection of property rights and enforcement of contracts.
Corruption level and the extent of the underground economy, effectiveness of monetary
policy, trade policy and the skill level of the labor are fundamental factors as well.

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