Optimal Excise Tax on Indonesia's Unhealthy Food

Abstract

A recent report by Indonesia's Ministry of Health shows that diabetes prevalence is doubled in the last decade, and it happens globally. Unhealthy food consumption is alleged to be the cause, and imposing taxes on unhealthy food to reduce its consumption. This study aims to analyze optimal taxation for unhealthy foods as a policy alternative to reduce the surge increase of diabetes in Indonesia. The study analyzes Indonesian consumption data on several types of food that fall into the unhealthy category by the World Health Organization. By estimating household demand for unhealthy food using the Almost Ideal Demand System (AIDS) and categorizing them based on income, we could simulate the optimal tax rate for unhealthy food and contemplate the pros and cons. The findings identified three food groups that fall into the unhealthy category: snacks, instant noodles, and processed meat, and all the groups have inelastic demand elasticity. Applying the Ramsey rule, this study estimates the optimal tax rate for each food at 12-13% and can increase the state revenue by IDR 4 trillion annually. Nevertheless, it is noteworthy that most instant noodle consumers were households in the bottom 40% of incomes, contrary to snacks and processed meat. The study advises considering income distribution when the excise tax will be applied by looking at a combination of food demand analysis with a tax-imposition simulation.