The Economy-wide Impact of Better Governance: Cutting Informal Taxes in Indonesia

In some developing economies the costs of meeting informal taxes (corruption of various sorts) have been put as high as 30 percent of the market value of output in some industries. Current political reform in Indonesia raises the prospect of a substantial fall in such costs. To assess the consequences for Indonesia's international competitiveness and national welfare requires the development and use of an applied general equilibrium model which explicitly recognises the existence of non-official imposts and the substantial (but socially wasteful) economic activity expended in attempting to reduce them. ORANI-RSA is such a model, recently developed for this purpose. In short- and long-run simulations the nominal rate at which informal taxes are levied is halved and the response of the economy determined. Not unexpectedly, competitiveness and the trade account improve substantially (with a 2 percent short-run fall in the real foreign-currency cost of the Rupiah). Indonesian welfare also improves. The only industry to decline is the service providing sector (corresponding roughly to the bureaucrats who supply intermediation between legitimate producers and the corrupt members of the power elite). The reform causes a fall in income from corruption, while redistributive effects via differential consumption patterns reinforce the improvement in the trade balance.