Financing the elderly in Indonesia

Abstract

In developing countries, where the informal labor sector is large, the pay-as-you-go pension system is inapplicable. However, in order to maintain the distributional effect of a pension system, a kind of cash transfer for the elderly, taken from consumption taxes, is applicable. This notion of applying consumption taxes for older people's income is novel as it has never been applied anywhere, not even in Indonesia. This study analyzes how the capacity of consumption tax in Indonesian provinces is able to finance the economic lives of the elderly. The methodology and steps taken in this research are as follows: (a) Identifying consumption function for each province by using the life cycle-permanent income hypothesis (LCPIH) consumption function econometric model; (b) Predicting consumption function according to population trajectory for each province by using the Arima econometrics model; (c) Predicting the necessary amount to finance the elderly; and (d) Calculating the deficits (surplus) of the consumption tax under the older person financing. The findings are as follows. From the 30 provinces observed, four provinces show a low marginal tax rate (ranges lower than 2 per cent). While 13 provinces have a medium marginal tax rate (ranges from 2 to 4 per cent), the remaining 13 provinces show a high marginal tax rate (4 per cent and above). In addition, from the 30 provinces observed, 10 provinces show decreasing marginal tax indicators, three provinces show relatively constant marginal tax indicators, and the remaining 17 provinces show increasing marginal tax indicators. The conclusions are, first, that consumption taxes are applicable in Indonesia to finance the economic lives of the elderly; and second, that because not all Indonesian provinces are able to levy this type of tax without charging an overly high tax rate, some of the provinces that are not capable should seek assistance from the central government in terms of a block grant.