Tax Incentives and the Formalization of Informal MSMEs in Indonesia

Abstract

Micro, Small, and Medium Enterprises (MSMEs) hold a vital role in Indonesia’s economy, contributing over 60% to GDP and employing 97% of the labor force. However, the majority still operate informally with restricted access to financing, legal protection, and market participation. To address this, tax incentives such as the 0.5% final income tax stipulated in Government Regulation (PP) Number 23 of 2018 are introduced to foster formalization and growth of informal MSMEs. This study explores the contribution of tax incentives in promoting formality, enhancing productivity, and uncovering barriers to implementation. Adopting a qualitative design through literature review, secondary data from academic journals, government reports, and official regulations were analyzed using content analysis and triangulation. Findings reveal that tax incentives improve liquidity, competitiveness, and employment capacity of informal MSMEs, while facilitating formalization through simplified administration. Nevertheless, limited tax knowledge, bureaucratic hurdles, and insufficient dissemination weaken policy outcomes. Integrated efforts involving training, mentoring, and infrastructure are required to optimize impact toward inclusive and sustainable economic transformation