From Taxation to Redistribution: How Universal Pensions Could Rescue Indonesia’s Middle Class
| Note: This article was prepared to respond to an Indonesian media company that interviewed me recently.
In recent days, there has been news that the number of middle-class residents has decreased by more than 8.5 million people since 2018. The LPEM UI study stated that the class considered economically stable comprises 52 million people, but on the other hand, the number of people in economic classes below it, the prospective middle class and vulnerable, has actually increased.
The decline in Indonesia’s middle class is particularly concerning given the government’s long-term development plans, which focus on expanding this demographic to achieve sustainable and inclusive growth. The middle class is central to the government’s strategy. |
I am not surprised if a study shows the middle class struggling. Many factors are involved in generating such a trend, but I would like to focus on tax and social protection here.
Increasing value-added tax (VAT) (to 11% in 2022 and 12% in 2025) will theoretically impact middle-class and low-income earners by potentially decreasing their disposable income. The Government must think about how to redistribute collected tax through social protection instruments. Currently, the collected tax is primarily used for narrowly, vaguely, and often inaccurately targeted programs for the poor through PKH, PBI-JKN and other social assistance programmes. The middle class pays more costs now than in the past, but they are not benefitted from such programmes.
A more effective approach to promote and sustain the middle class through social protection would be to achieve pension coverage for all residents. Ageing and illness are experienced by most people throughout life. While JKN has almost achieved universal coverage, pension is the most pressing agenda in Indonesia.
Increasing VAT can be an opportunity for building a more effective redistribution mechanism for the middle class. A Japan’s experience may be relevant for Indonesia. Japan’s National Pension is half-subsidized (taxes cover half the expenditure, while contributions from residents cover the other half), and it is mandatory for all residents to pay a flat contribution. The government acts as a de facto employer of citizens to ease their costs. When the subsidy became a permanent arrangement, the government increased the VAT from 5% to 8% and earmarked it for the National Pension subsidy (and other social security programs). In this way, Japan linked a universal pension system with a universal ‘collection’ method.
We proposed a similar model to the Government of Indonesia last year. According to APINDO, an employers’ organization (as reported by TEMPO News), the 2025 VAT increase will boost state revenue by at least Rp. 80 trillion. According to our estimates in the ILO proposal, this amount would be sufficient to start paying at least Rp. 500,000 monthly (equivalent to the poverty line value) to all individuals above age 75 in Indonesia.
Implementing such a system is technically feasible. The key factor now is political will to shift from narrowly targeted programmes to a more universal approach that supports the government’s goal of expanding the middle class. This strategy could address both the immediate challenges of declining middle-class numbers and contribute to long-term, inclusive economic growth.