By: Adrian N. Perwira – Economics Researcher, GREAT Institute
Published in Kontan, September 1, 2025
The government has stated that it will not introduce new taxes or increase tax rates in 2026. However, the government’s tax revenue target in the 2026 State Budget (RAPBN) is quite ambitious: a 13 percent increase from IDR 2,387 trillion compared to the 2025 outlook. In detail, income tax (PPh) is targeted to increase by 15 percent and VAT plus luxury goods tax (PPn and PPnBM) by 12 percent, respectively, from the 2025 outlook. This means that without new taxes or higher rates, the main strategy is expanding the tax base and improving tax compliance.
The Minister of Finance has identified the shadow economy as one of the areas to be regulated in order to achieve this target. Specifically, he mentioned focusing on retail trade, food and beverages, gold, and fisheries. The public has questioned why small retailers are still being targeted in the midst of an uncertain economy.
Understanding the Shadow Economy
In the literature, the definition of the shadow economy is not fully standardized. The OECD defines the shadow economy as part of the non-observed economy (NOE), which consists of three components: the underground economy (legal activities hidden from authorities), the informal economy (production not recorded due to scale or compliance costs), and the illegal economy (criminal activities).
Friedrich Schneider, the German economist who popularized the term, chose to measure the shadow economy using only the underground economy component, excluding both informal and illegal activities as defined by the OECD (Feige, 2016).
In his lectures, Italian economist Vito Tanzi argued that it is more appropriate not to conflate the shadow economy with the informal economy, since their root causes differ. This article also separates the two phenomena, although they are technically interlinked.
According to Tanzi, there are four causes of the shadow economy: (1) tax evasion through unreported or underreported economic activity; (2) avoidance of government regulations such as minimum wages, workplace safety, social security, and working hours; (3) illegal markets such as prostitution, illicit drug trade, and online gambling; and (4) corruption, including bribery to avoid formal obligations or unrecorded illicit income.
These activities erode the tax base. As a result, the quality of public goods and services declines, further pushing economic actors away from the formal economy and creating a vicious cycle.
Within the ILO framework, “informal” refers to activities or employment not covered by formal regulations—generally due to scale, costs, or administrative barriers. Therefore, definitions matter: if the shadow economy is treated as synonymous with the underground economy, enforcement should focus on high-value nodes using data-driven approaches.
Efforts to break this “vicious cycle” are necessary. A study by Lukman and Kartiasih (2025) measuring the shadow economy across 34 provinces in Indonesia estimates an average of 14.6 percent of GDP. This indicates a real urgency to address it in order to increase state revenue.
However, caution is needed regarding how the government applies the term “shadow economy.” Based on priority sectors—retail, food and beverages, gold, and fisheries—there is a risk of mixing different phenomena: retail and food sectors are dominated by micro-scale informality, gold is primarily underground with high-value underreporting potential, while fisheries combine informality (small-scale fishers) and illegality. The implication is clear: micro informal actors should not be treated as quick wins; enforcement should focus on high-value underground activity.
On the Informal Sector
Over the past decade, Indonesia’s informal sector share has remained largely stagnant. As of February 2025, it reached 59.4 percent. According to the ILO, informal workers tend to have low incomes, are vulnerable to poverty, and lack social protection. The slow formalization process in Indonesia is linked to uneven job growth, as most informal workers have low educational attainment.
Micro-level evidence shows that many informal actors operate at a scale where compliance costs outweigh benefits; for them, formalization is often not “worth it.” This article does not romanticize the informal sector. Many studies show that a large informal sector is negatively associated with economic growth and tax revenue.
However, the informal sector should not be seen purely as a fully voluntary rational choice; it is also a structural consequence of skills mismatch, limited inclusive job opportunities, and compliance costs exceeding benefits. Therefore, addressing the shadow economy must focus on high-value underground activity rather than small informal livelihoods.
First, the government should implement a targeted Compliance Improvement Program (CIP) using intelligence analysis and cross-data integration to map high-risk actors in priority sectors. Second, accelerate tax compliance simplification and reform so that actors previously operating in the shadows due to high regulatory costs can transition into the formal system.
Third, for medium and large segments, strengthen withholding and platform-based taxation (VAT and income tax collection via e-commerce platforms) at high-value nodes to reduce underreporting without targeting micro businesses. Fourth, for areas involving illegal activity and corruption (such as illegal fishing or gold smuggling/document manipulation), prioritize non-tax enforcement through relevant agencies (Ministry of Marine Affairs and Fisheries, Customs, PPATK).
Finally, the government should establish a “fairness threshold” (such as VAT registration thresholds or exemptions for small sellers in platform taxation) to ensure that tax expansion does not turn into enforcement pressure on small traders. With these measures, the 2026 revenue target can be pursued without burdening informal actors who are merely surviving rather than accumulating wealth.
