seeun jeong department of economics, chungnam national university, south korea korean economy and...

Seeun JEONG Department of Economics, Chungnam National University, South Korea Korean economy and its tax system at crossroads

Polarization between exports and domestic demand after the crisis of 1997 (Growth rates of macroeconomic expenditure categories) GDP Private Consumption Government Consumption InvestmentExportsImports 90-928.88.57.513.89.912.8 93-958.89.04.711.717.020.1 96-983.91.33.6-4.315.41.1 99-016.97.94.27.19.311.1 01-033.91.44.33.214.110.2 04-064.53.76.22.610.89.1 07-093.62.53.72.29.28.3 10-123.11.93.13.23.61.9 13-143.91.44.33.214.110.2 Low growth and polarization between export and domestic demand I. Korean economy at a crossroads

Figure 2. Ratio of Corporate Income to Household Income in Korea (1975 2010)

Head of householdsHouseholds Gini coefficient of market income

Income share of the top 1%

Figure 1. Trends in the incidence of low pay in the Republic of Korea, 19862010

On this backdrop, the wage-led growth theory has gained its popularity as an alternative growth strategy in Korea. Empirical results of the total effect on the aggregate demand show that the demand regime in Korea was weakly wage-led in 1981-1997, and strongly wage-led in 1999-2012. An increase of the minimum wage can be a good instrument to jump-start the wage-led growth model. However, if the minimum wage is raised substantially at once, the employers in a relatively good condition can comply with it, but struggling marginal employers might have to reduce employment or hide the fact of employment. Considering severe duality of Korean economy, the welfare expansion will play an important role in the wage-led growth model as it can increase the disposable income of low income household directly.

II. Korean fiscal policy from a historical perspetive General government expenditure structure (as percentage of GDP) Neo-liberal 1 Neo-liberal 2

Tax burden with and without social insurance contributions (as percentage of GDP) Tax cut policy Neo-liberal 1 Neo-liberal 2

Tax revenue structure (as percentage of GDP)

Ratio of individual income tax revenue / consumption tax revenue

The Park administration (2013~2017) made clear that it would maintain the tax cut policy of the previous government. With the promise of a welfare without more tax, its tax reform has been limited to the reduction of tax expenditure. In particular, the tax reform was the reduction of tax deductions given to the individual income tax, which triggered the anger of households struggling due to decreased income. The combination of the maintenance of a low tax burden ratio and the welfare expansion trend has deteriorated fiscal soundness in the backdrop of sluggish growth and a tax revenue deficient. Government debt as a share of GDP has shown an increasing tendency since the year of 2003. The increase of government debt during 2003 to 2006 was attributable to the failure to recover the public funds poured into the banks in the aftermath of the financial crisis of 1998. Yet the increase since 2008 has been mainly due to the shortage of tax revenue.

Genral government debt of Korea (as percentage of GDP)

Tax burden*Tax burden ** Total expenditure Public social expenditure Total governme nt debt Scandinavian35.443.752.727.353.0 Anglo-Saxon25.829.341.320.1100.1 Western Europ ean 25.740.550.827.897.3 Southern Euro pean 23.934.950.026.5131.3 Korea18.724.832.79.634.7 OECD average24.733.745.021.683.7 III. Korean fiscal policy compared to other OECD countries Tax burden ratio, total expenditure and total debt size (2012, as a percentage of GDP) * With social insurance contributions, ** without social insurance contributions

General public services Defense Public order and safety Economic affairs Environ- mental protection Recreation, culture and religion Education Social expenditure Scandinavian6.71.51.34.20.41.36.629.5 Anglo-Saxon5.32.01.94.60.70.85.622.0 Western European 6.51.31.84.81.01.35.628.0 Southern European 8.91.62.04.00.70.94.925.6 Japan4.60.91.34.11.20.43.525.1 Korea4.92.81.36.50.80.75.19.1 OECD5.91.51.74.50.71.25.421.6 Expenditure structure of central government by function (2009, as a percentage of GDP)

Income taxConsumption taxProperty tax Social insurance contributions Individual (A) corporate revenue (B) A/Btotal holding tax totalemployeeemployer Scandi- navian 14.64.613.41.11.30.87.92.45.5 Anglo- Saxon 10.33.49.21.12.92.23.41.32.1 Western European 9.22.311.20.82.21.012.95.37.6 Southern European 7.92.211.40.72.01.19.83.06.8 Korea3.7 8.40.42.80.75.32.62.7 OECD average 8.62.911.00.81.81.18.43.35.1 Tax revenue structure including social insurance contributions (2012, % of GDP)

Individual i ncome tax Corporate income tax VAT Standard rate Social insurance contributions rates totalemployeeemployer Sweden56.722.025.038.427.0031.42 Denmark60.425.0 8.00 0.00 U.S46.339.1-21.307.6513.65 U.K45.023.022.025.8012.0013.80 Germany47.530.219.039.4620.1819.28 France54.534.419.655.5313.8041.73 Greece46.026.023.045.0616.5028.56 Italy48.627.521.042.5710.4932.08 Japan50.837.05.028.3613.9414.42 Korea41.824.210.018.508.2910.23 OECD43.425.318.926.810.4317.27. Top marginal tax rates of major countries (2013, % of GDP)

KoreaU.K.U.S.CanadaJapan Tax base of 1981*3.305.637.528.119.45 Tax base of 2012**18.3312.086.4013.378.79 Tax base of corporate income tax of OECD countries (Unit: as apercentage of GDP) Note: 1982 for Korea, 2011 for the U.S. and Japan

4. Tax system reform for a new growth regime In a bid to transform into welfare-led model, the first question in designing the tax system reform is how to balance the roles played by the tax system and the social insurance system. Currently, Korea relies mainly on the social insurance system for its welfare programs although its level of coverage is still weak compared to other OECD countries. As for this question, the experiences of the advanced countries clearly showed that the social insurance system faced the sustainability problem when the economy entered the stage marked by mass unemployment and the proliferation of irregular workers. In that Korea is marked by much more severe labor instability, the taxation should take stronger responsibility than so far.

How much of welfare expenditure is covered by social insurances? (Social insurance contributions/welfare expenditure*100)

Then, how should the tax system be reformed in a way to raise more revenue without damaging the efficiency and the equity of the system? Low tax-low welfareHigh tax-high welfare Corporate tax Individual income tax Consumption tax Growth bloc Welfare first bloc Tax fairness first bloc

It would be desirable to start by the tax fairness reforms. The corporate income tax is a good candidate. As we already examined, Korean income distribution is highly distorted to the advantage of corporations. Despite this trend, tax payment by corporations has decreased notably. Indeed, the effective tax rates of corporate income tax has declined since 2008 due to the drastic tax cut policy. Furthermore, the largest companies that have paid tax at a lower rate in effective terms though the statutory marginal rate for them has been the highest. It was because they have been the main beneficiary of tax relief offered for R&D activities or investment.

20082009201020112012 All20.519.616.6 16.8 Large21.621.017.717.617.8 The 10 largest18.716.311.413.0 The 100 largest20.920.416.716.817.5 SMEs17.215.313.113.213.3 Table 8. Effective tax rates of corporate income tax by corporate size Considering the polarization between large and small companies, the corporate income tax should be reformed to intensify the burden of top Companies. Tax relief should be cut down and the tax rate for the highest tax bracket should be increased.

Arguments of proponents for the increase in consumption tax Consumption tax is more efficient and faces less political resistance than the direct tax, being a good candidate for financing expansion of welfare program(Yang, 2015). Although the consumption tax is said to be regressive and could deteriorate the equity of tax system, the increased tax revenue, if it is used only for the expansion of the welfare program, would improve the equity of the whole system. The advanced welfare states are highly financed by indirect taxes. One of the outstanding features observed in the changes of tax system of OECD countries from the 1980s has been the rate cut of direct taxes. This change was observed also in the European countries where the leftist parties had taken power for a long time..

Figure 7. Redistributive impacts of household taxes and public cash and transfers Point reduction in the concentration coefficients, in the late 2000s If Korea would like to improve the redistributive effects of its fiscal system, it should make efforts in both directions. In this situation, if Korea increases the consumption taxes, the improvement of redistributive impact of household taxes would be realized.

Figure 8. Characteristics of household taxes If Korea would like to enhance the redistributive impact of taxes, the most reasonable way is to increase both progressivity and tax revenue at the same time To achieve this goal, the effective tax rates of high income households should be raised

5. Conclusion Upcoming presidential election of 2017 would be crucial for the future of Korean economy The main opposing progressive party recently adopted the slogan of wage-led growth policy and the civil society has been asking for a fairer tax system. However, the trade unions have been focused more on the issues related directly to the maintenance of the regular workers rights because it comprises mostly of insider workers. And most importantly, the traditional economic model is still strongly influencing strongly Koreans attitudes While Korea is indeed at a crossroads, the progressive bloc has not yet found a break-through toward paradigm change.

seeun jeong department of economics, chungnam national university, south korea korean economy and...

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