For years, Indonesia has placed its bets on tax incentives as a primary strategy to lure investors. The logic is straightforward: by offering tax breaks, the government hopes to make it cheaper and more profitable to do business in Indonesia, especially in strategic sectors.

These incentives are expected to drive foreign direct investment (FDI), which in turn will boost the economy by creating jobs, transferring technology, in increasing exports, and spurring local business activities.

Billions of rupiah have been sacrificed in the name of this goal through tax holidays, tax allowances, and tax base and taxable base reductions. According to the 2023 Tax Expenditure Report by the Fiscal Policy Agency (2024), Indonesia gave up Rp362.5 trillion (USS21.9 billion) in revenue, equivalent to 1.73 percent of gross domestic product (GDP), to stimulate economic activity.

But the fundamental question remains: How effective are these fiscal incentives, really? Behind the impressive numbers lies a grimmer reality.

A recent investigation by the Kompas daily revealed an embrassing truth: More than half of the investment barriers in industrial zones do not stem from local NGOs and mass organizations that act like mafia groups. They control waste projects, demand a cut of employment quotas and threaten factories with protests if their demands aren’t met.

In 2023 alone, one industrial area in West Java received 130 proposals from such groups, most concerning waste management. The pattern continued into the following year: of 122 proposals, only one addressed labor issues, while the rest targeted waste, now seen as a goldmine by thuggish groups cloaked as social organizations.

This troubling pattern coincides with a broader decline in investor confidence, as reflected in weakening FDI performance over the years. According to data from the International Monetary Fund, FDI net inflows as a percentage of Indonesia’s GDP have been on a downward trend, falling from 2.2 percent in 2019 to 1.8 percent in 2020 and 2021, and then rising slightly to 1.9 percent in 2022, before dropping significantly to 1.6 percent in 2023.

This phenomenon echoes the situation in southern Italy, where organized crime has systematically deterred investment. In their study “Organized crime, the quality of local institutions and FDI in Italy”, Daniele and Marani found a significant negative correlation between organized crime and FDI, even when tax incentives were offered. In other words, no matter how attractive the tax deal, investors will walk away if faced with extortion and intimidation.

So when mafia-style grups infiltrate core industrial functions, tax incentives lose their bite. Becoming cosmetic perks without substance.

Worse still, these thuggish practices do not operate in isolation. They are entangled with local actors, namely village officials and community leaders, who openly extort factories through forced labor recommendations, licensing raids and vendor coercion. This is not merely lawlessness; it is institutionalized crime.

When the state focuses solely on tax perks without strengthening local institutional resilience, the result is a criminal ecosystem empowered by pseudo legality.

Meanwhile, from a fiscal perspective, the forgonr massive revenue doesn’t guarantee added value. Megersa notes in “Review of tax incentives and their impacts in Asia,” (2019) that Indonesia’s incentives significantly slashed the effective tax rate (ETR) by more than half. Without accurately measuring behavioral responses, these incentives risk being wasteful, merely padding the profits of investors who would have come anyway.

In their paper “FDI and investment barriers in developing economies” (2013), Arita and Tanaka founf that removing entry barriers, such as discriminatory procedures and informal violence, had a far more significant impact on investment decisions than simply cutting corporate tax rates. Multinational were more likely to expand operations in countries that eliminate nontax hurdles than those offering mere tax discounts.

The government can no longer look the other way. The rise of thuggish behavior in industrial zones is not just a public safety issue; it is an economic threat. This isn’t just about crime; it’s a systemic failure to uphold the rule of law and create an enabling business environment.

When the state offers tax incentives, it is essentially “paying” to make Indonesia more attractive to investors. But if that environment is riddled with threats and coercion, the incentives do nothing but fuel the fire.

Three steps are urgently needed to ensure that tax incentives do not go to waste and instead translate into real investment gains.

First, a sweeping reform of NGO and mass organization oversight, especially in industrial zones. The Home Ministry and the National Police must proactively audit their legal status, funding sources, and activities. A re-certification or periodic verification, possibly involving local administrations and business owners, should be put in place to shut down rogue organizations.

Second, establish a cross-agency Industrial Security Task Force that focuses on economic thuggery, not on petty street crime. This task force should collaborate with the Investment Coordinating Board to serve as a real protector of investment, not just in name.

Third, tax incentive evaluations must include behavioral response models, as is done in advanced economies. The Computable General Equilibrium (CGE) model, currently used to estimate the impacts of value-added tax, should be expanded to assess the real effects of tax holidays and allowances on new investment. That way, the government know not just how much revenue it loses but what it’s getting in return.

Economic thuggery cannot be solved with money. The best tax incentive means nothing in the face of extortion. If we truly want to be seen as a global investment hub, the battle doesn’t begin in the boardrooms of the Tax Office or the BKPM: it starts in the streets of industrial zones, now ruled by organizations armed with proposals and threats.

The government must choose: continue burning trillions on wasted incentives, or start building a system where every rupiah of fiscal support delivers real development value. Because if thuggery goes unchecked, tax incentives will only fertilize the black economy. And no investor will plant roots in poisoned soil.

By: Ismail Khozen, S.I.A., M.A., Lecturer in Fiscal Administration, University of Indonesia

Source: TheJakartaPost