Mandatory CSR only makes sense where government is completely incompetent (and, even then, not really)

The Indonesian parliament is currently considering issuing a new law on Corporate Social Responsibility ("CSR"). I haven't seen a draft, but I understand that parliament is considering an article making CSR spending mandatory under law. 

Berita Satu quoted Komisi VII member Hamka Haq saying "There's not yet a decision, everything is still tentative. Some have said 2%, 3%, up to 10%" (translation mine). It wasn't specified in the article, but I understand the 2-10% figures mentioned refer to a percentage of revenues.

There are a range of competitiveness, and business arguments against mandatory CSR, which largely relate to the fact that it's a new tax, and new taxes harm Indonesian businesses and business-owners. My aim in writing this article isn't to take a view as to whether it harms businesses or competitiveness, but rather I'm aiming to explain whether it actually achieves a public development objective. (Hint: it doesn't).

Mandatory CSR effectively functions as a tax, with services delivered by a private party

As I noted above, forcing companies to spend on CSR activities, effectively functions as a tax. The idea is that the private companies take a proportion of their cashflows, and spend them on something that is good for society. This is also the philosophy behind taxation in general, except it's government spending on things that are good for society, rather than a private company.

You can see a simple calculation of profit and taxation in the table below:

  Note that the effective tax rate with a mandatory CSR rate as a proportion of revenues changes depending on the profit margin.

Note that the effective tax rate with a mandatory CSR rate as a proportion of revenues changes depending on the profit margin.

As you can see, in Scenario 1, with no mandatory CSR, the government applies a tax rate of 25%, collects tax of 12.5. In Scenario 2, they decide to keep the impact of total mandatory "public interest" payments constant, with a 10% mandatory CSR rate, which creates a tax rate of 6.3%. This keeps the total transfers as 12.5 in total, but now 80% of that is delivered by the private sector, rather than the public sector. 

Another way to impose mandatory CSR is on top of existing taxes, where it now functions as an additional tax, modeled in Scenario 3, where the 10% mandatory CSR payment creates an effective tax rate of 40%, with "public interest" spending delivered equally by the public and private sectors. The equivalence to a scenario where government just imposes a tax rate of 40% is illustrated in Scenario 4.

So, as we can see, in a very simple model, mandatory CSR has identical impacts to taxes on returns to shareholders, and in spending on "public interest" purposes. But then, of course, the question arises: is private spending on public interest purposes equivalent to public spending?

Spending in the public interest is the government's job

One of the core jobs of government is to levy taxes on their citizenry and businesses, decide how to allocate those taxes, then actually spend them. Throughout that process, they are subject to a range of checks and balances, which can include auditors, parliamentary approvals, publication of governmental accounts, and so on. In a democracy, if a government does this incompetently--maybe by spending inefficiently, or on the wrong things--at the end of the day, it is likely to get voted out.

When a private company spends on CSR, it gets to decide what it wants to spend on, and doesn't have anywhere near the same level of scrutiny on its spending. Furthermore, private companies can't (and shouldn't be allowed to) spend on the delivery of major public-interest projects, like infrastructure, or defense, through their CSR. So, in imposing mandatory CSR, the government is taking money out of its consolidated revenue, and allowing private companies to decide to spend that money however they choose, say, on orchestras, or museums named after their major shareholders.

I'm not saying companies shouldn't be allowed to spend on orchestras or dubiously-named museums, but I don't want them to do so to the detriment of the government's ability to spend on infrastructure. Indeed, concerns about the efficiency of CSR spending mean that most developed countries put limits on exactly the types of CSR spending that is tax deductible at all.

The only way in which this sort of mandatory CSR policy is actually in the public interest is where the private sector better understands the needs of the public as a whole than the government, is better at spending than the government, and can address large-scale market failures and collective action problems better than the government. Given private companies can't (and shouldn't be allowed to) plan and spend on things like infrastructure, and defense through their CSR, mandatory CSR only actually creates value for the public where governments are massively incompetent.

But then, if the governments are so incompetent at governing that they can't deliver roads better than a private company can through their CSR, then they probably can't effectively monitor the CSR spending by the companies either. In such a case, you're even more likely to see this CSR spending on vanity projects, or more likely again, in transfers to directly-owned foundations that just transfer the profits back to the owners.

The Indonesian government is not that bad

The Indonesian public sector has its problems, like all governments, but I cannot believe that it is so incompetent that mandatory CSR makes sense. I hope this policy doesn't go much further than the wacana stage...