Taxing the Untaxed: A Policy Analysis of Income Taxation on Illegal Economic Activities in Indonesia

Abstract

Indonesia's persistently low tax-to-GDP ratio—hovering between 9.6% and 10.4% in recent years—reflects, among other factors, a substantial and largely untaxed shadow economy estimated at 30–40% of GDP. This paper examines the feasibility and policy implications of extending income tax obligations to cover income derived from illegal economic activities in Indonesia. Drawing on a comparative analysis of existing frameworks in the United States and Australia, and situating these within Indonesia's current legal architecture under Law No. 7 of 2021 on Tax Regulation Harmonization (Undang-Undang Harmonisasi Peraturan Perpajakan/HPP), the paper identifies a legal grey area: illegal-source income is neither explicitly included in nor excluded from taxable income under current Indonesian law. The paper proposes a two-tier classification of illegal economic activities—distinguishing activities involving legal goods or services conducted illegally from those intrinsically illegal in nature—and recommends differentiated tax treatment for each. The paper further argues that enhanced inter-agency cooperation among the Directorate General of Taxes (DGT), the Financial Transaction Reports and Analysis Centre (PPATK), law enforcement bodies, and financial institutions is essential for operationalising such a framework. The findings suggest that, if carefully implemented, taxation of illegal income can simultaneously increase tax revenue, reduce the shadow economy, raise the tax ratio, and serve as an ancillary enforcement tool against organised crime.