The World Bank Indonesia Fiscal Reform DPL 3 (P167297) Program Information Document (PID) Appraisal Stage | Date Prepared/Updated: 17-Mar-2019 | Report No: PIDA26632 Page 1 of 6 The World Bank Indonesia Fiscal Reform DPL 3 (P167297) BASIC INFORMATION A. Basic Project Data OPS TABLE Country Project ID Project Name Parent Project ID (if any) Indonesia Fiscal Reform DPL Indonesia P167297 P161475 3 (P167297) Region Estimated Board Date Practice Area (Lead) Financing Instrument Macroeconomics, Trade Development Policy EAST ASIA AND PACIFIC 07-May-2019 and Investment Financing Borrower(s) Implementing Agency Republic of Indonesia Fiscal Policy Agency, Ministry of Finance Proposed Development Objective(s) The objective of this operation is to support fiscal sector reforms that will assist the Government of Indonesia (GOI) in achieving its medium-term economic development and poverty reduction goals. This programmatic DPL series comprises of three pillars and PDOs: Pillar A: Improving Quality of Spending. PDO: Improving the composition of spending, budget execution and efficiency of spending Pillar B: Strengthening Revenue Administration. PDO: Increasing tax administration efficiency, compliance management and audit capability, and reducing the cost of paying taxes Pillar C: Enhancing Tax Policy. PDO: Increasing revenue potential and economic efficiency of tax policy This Development Policy Operation is part of the World Bank Group's overall support to the Government's efforts to improve revenue collection and quality of spending, which are central to its overall development agenda. Financing (in US$, Millions) FIN_SUMM_PUB_TBL SUMMARY Total Financing 1,000.00 DETAILS -NewFin3 Total World Bank Group Financing 1,000.00 World Bank Lending 1,000.00 Decision Page 2 of 6 The World Bank Indonesia Fiscal Reform DPL 3 (P167297) B. Introduction and Context This proposed DPL aims to support the Government of the Republic of Indonesia’s priorities for improving the quality of spending, strengthening revenue administration and enhancing tax policy to further the country’s medium-term economic development and poverty reduction goals. The Government is committed to the implementation of the actions supported by the operation and has a strong track record of effective implementation of fiscal reforms. This third operation supports the continuation of fiscal reform efforts in 2018 and 2019. Momentum has been sustained on all three pillars of the supported reform program, with notable progress on the implementation of previous reforms supported by the first and second DPLs of this series. Such reforms have already led to a turnaround in revenue performance and improved the quality of spending. This third operation also includes actions on improving natural disaster and climate resilience, as additional avenues to further enhance the quality of spending. This DPL will also support government reconstruction efforts due to the natural disasters in the second half of 2018, which have inflicted large economic costs. Preliminary estimates of the impact from the West Nusa Tenggara (Lombok) earthquakes and the Central Sulawesi (Palu) earthquake and tsunami, amounted to at least US$ 2.2 billion in direct damages and US$ 0.8 billion in economic losses. The reconstruction needs are estimated at about US$ 3.4 billion between 2019 and 2021.1 These amounts exclude damages and losses from the Sunda Strait tsunami (Anak Krakatau), estimates of which are still pending. Resources from this operation support government reconstruction efforts. The operation endorses Indonesia’s continued sound macroeconomic management in the context of global financial volatility in 2018 and elections in 2018 and 2019. 2 Indonesia’s macroeconomic fundamentals remain strong, with robust economic growth, stable inflation and strong labor market conditions, narrow fiscal deficits and low debt. Indonesia’s sovereign credit is considered investment grade by four major credit ra tings agencies with rating upgrades since May 2017, corroborating the country’s improved economic environment, fiscal management, and overall creditworthiness. Poverty rates have steadily declined, reaching a record low in 2018. Inequality has also continued to moderate. In addition, decisive monetary policy, together with coordinated prudent fiscal and exchange rate policies, have successfully maintained macroeconomic stability during challenging times. Relationship to CPF This proposed operation, the third in the DPL series, is part of the World Bank Group's overall support to the Government's efforts to improve revenue collection and quality of spending, which are central to its overall development agenda.3 The operation is also central to the Indonesia Country Partnership Framework (CPF) “Collecting More and Spending Better� pillar, which aims to support the Government’s fiscal reforms. A stronger focus on human and physical capital investment will also contribute to more sustainable growth and job creation in the medium term and will build more financial capacity to manage the impact of climate change and natural disasters. The operation will also support an improved business environment by reducing the cost of paying taxes. 1 Reconstruction costs for public and private assets from preliminary post-disaster needs assessments: Gempa Nusa Tenggara Barat Rekapitulasi Kerusakank dan Kerugian (Recapitulation of Earthquake Damage and Losses, West Nusa Tenggara, October 12, 2018) and Dampak Nencana Alam Gempa Bumi, Tsunami dan Likuifaksi di Wilayah Padagimo Provinsi Sulawesi Tengah (Impact of the Earthquake, Tsunami and Liquefaction in Central Sulawesi Province, January 30, 2019). 2 Indonesia held regional elections in 2018 and is holding General Elections, which include the Presidential Election, in 2019. 3 The first two DPLs were approved in May 2016 (P156655, http://projects.worldbank.org/P156655?lang=en) and October 2017 (P161475, http://projects.worldbank.org/P161475?lang=en), respectively. Page 3 of 6 The World Bank Indonesia Fiscal Reform DPL 3 (P167297) C. Proposed Development Objective(s) The objective of this operation is to support fiscal sector reforms that will assist the Government of Indonesia (GOI) in achieving its medium-term economic development and poverty reduction goals. The operation aims to do so through supporting reforms in three key policy areas: Pillar A: Improving Quality of Spending. PDO: Improving the composition of spending, budget execution and efficiency of spending. Pillar B: Strengthening Revenue Administration. PDO: Increasing tax administration efficiency, compliance management and audit capability, and reducing the cost of paying taxes. Pillar C: Enhancing Tax Policy. PDO: Increasing revenue potential and economic efficiency of tax policy. Key Results The expected results are for Pillar A: an increase in the number of PBI-JKN subsidized health insurance premium recipients; improved financial resilience to natural disasters through the expansion of number of ministries and agencies covered by disaster insurance; better accounting of climate change adaptation expenditures in the budget through the expansion of the number of ministries and agencies undertaking budget tagging of these expenditures; better accounting of expenditures in sub-national budgets through the usage of a standardized chart of accounts. For Pillar B, the expected results are: reducing the cost of paying taxes via increased usage of the streamlined VAT refund procedure that will improve firms’ cash flows; improved data and risk management capabilities with an enhanced Data Management Team centralized within the Directorate-General of Taxation. For Pillar C: broadening of the tax base and improved compliance with an e-commerce and a MSME tax reforms; and increased fiscal transparency through the publication of tax expenditure statements with estimations of tax revenue foregone. D. Project Description The DPL is structured around the following three pillars: Pillar A: Improving Quality of Spending . This pillar will cover policy actions on maintaining higher spending on the priority areas of infrastructure, health and social assistance relative to that of 2012-14; enabling the purchase of disaster risk insurance; the expansion of climate finance budget tagging to climate change adaptation; and adopting the framework for standardizing and harmonizing the subnational budget chart of accounts. Pillar B: Strengthening Revenue Administration . This pillar will cover policy actions on streamlining the process to obtain VAT refunds and establishing a risk management unit at the Ministry of Finance in charge of taxpayer compliance risk management. Pillar C: Enhancing Tax Policy. This pillar will cover policy actions on applying the VAT to the digital economy, reforming MSME taxation, and publishing a tax expenditure analysis and adopting a strategy to sustain this effort. E. Implementation Institutional and Implementation Arrangements The Fiscal Policy Agency (FPA), Ministry of Finance (MoF), is responsible for the monitoring and evaluation of the program supported by this DPL series. As the main implementing agency, FPA will coordinate with other relevant MoF agencies, such as the Directorate-General of Budget, Directorate-General of Taxation and Directorate-General Fiscal Balance. FPA will also continue to collaborate with the Ministry of Home Affairs (MoHA) on the issuance of the standardized sub-national chart of accounts. Page 4 of 6 The World Bank Indonesia Fiscal Reform DPL 3 (P167297) F. Poverty and Social Impacts and Environmental Aspects Poverty and Social Impacts The overall poverty and social impact of the DPL is positive. While most of the prior actions are broadly neutral, some will likely have a direct impact on poverty in the short and medium run. The prior action on improving the composition of spending to increase the share of central government budget allocated to infrastructure, health and social assistance has the strongest potential for being the most poverty and inequality reducing. This reform has led to the creation of new public assets, including housing, transport and rural electrification. In addition, the coverage of the health insurance premium (PBI) waiver for the poor has been expanded and the transformation of the rice for the poor program through the implementation of non-cash food assistance (BPNT) is continuing. The benefit level for the conditional cash transfer program (PKH) has also doubled, following the rapid expansion of its coverage from 6 million in 2017 to 10 million beneficiary families in 2018. The portfolio of reforms geared towards enhancing revenue collection and better budgetary planning, management and execution has the potential to be pro-poor. The expansion of climate change budget tagging and the standardized subnational budget chart of accounts could benefit the poor, if they eventually lead to meaningful improvements in the quantity and quality of spending. Similarly, improving tax administration and policy, through improved taxpayer compliance, better management of VAT refunds, and enhanced compliance risk management, could be pro-poor to the extent that improved revenue collection leads to prioritization of expenditures that benefit the poor and the bottom 40 percent. Environmental Aspects The environmental impacts of the fiscal reform actions supported by the DPL series continue to be overall positive. The prior actions for the first pillar on the quality of spending aim to increase the level and improve the quality of public spending as well as improve the budgeting process, in order to achieve efficiency of spending. Prior Action #1 on improving central government budget allocation can bring significant environmental, economic and social benefits. However, public infrastructure development can also have significant costs on the environment, both in its construction and use. The benefits are positive for Prior Action #3 on climate budget tagging, especially in the more efficient utilization of scarce natural resources and adapting to future climate conditions and extreme weather events. These actions are unlikely to have any adverse impact but will have positive impact in improving resilience to disaster events or preparing for climate change events, thus better safeguarding human lives, livelihood, and public health. Other prior actions under the revenue administration and tax policy pillars are expected to yield more tax revenues and could therefore expand resources for the mitigation of negative effects from environmental, climatic and disaster events. G. Risks and Mitigation The overall risk rating of this operation is substantial. While macroeconomic risks have subsided significantly since the first DPL in the series, other risks remain, including those for (a) political and governance, (b) sector strategies and policies, (c) institutional capacity for implementation. These risks, if materialized, could negatively impact the implementation of prior actions and the achievement of the intended results, which would in turn affect the meeting of the development objectives for this operation. Continued World Bank policy engagements offer some mitigation against the above risks. Through an array of technical assistance projects and capacity enhancement programs, the World Bank remains strongly engaged in policy dialogue with the Ministry of Finance and other central ministries, which would support continued reform momentum in Indonesia. At the same time, in an effort to mitigate political risk, the World Bank is finalizing a Development Policy Review that outlines a comprehensive structural reform agenda, which senior management will use to engage the new administration to encourage continued reforms. Page 5 of 6 The World Bank Indonesia Fiscal Reform DPL 3 (P167297) . CONTACT POINT World Bank Derek Hung Chiat Chen, Daniel Alvarez Estrada, Ralph Van Doorn Senior Economist Borrower/Client/Recipient Republic of Indonesia Implementing Agencies Fiscal Policy Agency, Ministry of Finance Suahasil Nuzara Head of Fiscal Policy Agency, MoF suahasilnazara@hotmail.com FOR MORE INFORMATION CONTACT The World Bank 1818 H Street, NW Washington, D.C. 20433 Telephone: (202) 473-1000 Web: http://www.worldbank.org/projects APPROVAL Task Team Leader(s): Derek Hung Chiat Chen, Daniel Alvarez Estrada, Ralph Van Doorn Approved By APPROVALTBL Country Director: Rolande Simone Pryce 05-Mar-2019 Page 6 of 6