Tax Reform for Aging Societies in Korea Joosung Jun (Ewha Womans University) 1
Organization of Talk Population Aging and Related Facts Policy actions, fiscal conditions, etc. Current Korean Tax System Evolving toward ones observed in rich countries Still, narrow bases / non-optimal features Directions for Reform Informal activity and base-broadening (PIT/VAT) Role of corporate tax: Conventional vs. Revenue raiser? Tax on the rich? (income shifting, rent tax) Tax expenditures, earmarking, transaction taxes, surcharges, etc. 2
Population Aging in Korea (% of total population) 3
Population Aging in Korea 1960 1970 1980 1990 2000 2010 2020 2030 2040 2050 2060 0-14 / POP. 42.3 42.5 34.0 25.6 21.1 16.1 13.2 12.6 11.2 9.9 10.2 15-64 / POP. 54.8 54.4 62.2 69.3 71.7 72.8 71.1 63.1 56.5 52.7 49.7 65-99 / POP. 2.9 3.1 3.8 5.1 7.2 11.0 15.7 24.3 32.3 37.4 40.1 Old age dependency rate Life expectancy 4.9 5.1 5.4 6.4 10.1 15.1 22.1 38.5 57.1 70.8 80.2-61.9 65.7 71.3 76.0 80.8 82.6 84.3 86.0 87.4 88.6 Births (in thousands) Total Fertility Rate - 1,007 863 650 635 470 451 409 325 307 285-4.53 2.82 1.57 1.47 1.23 1.35 1.41 1.42 n.a. n.a. 4
Population Aging in Korea Rapidly aging population Old age dependency rate: (1980) 5.4 (2010) 15.1 The lowest total fertility rate(2011) (FRA) 2.0 (US) 1.89 (OECD) 1.70 (EU28) 1.56 (JPN) 1.39 (KOR) 1.24 The highest relative poverty rates among the elderly (old age / total population, 2011) (KOR) 48.6/ 14.6 (US) 18.8 / 17.4 (JPN) 19.4 / 16.0 (OECD) 12.3/ 11.5 (SWE) 10.1 / 9.7 5
Policy Measures to Address Aging Pensions: Expanded coverage, but unsustainable Need to fix low burden, high-benefits scheme Expenditure: Rising welfare expenditure Focused on child-care support Revenue: Subsidies for old-aged & families with children Piecemeal revisions; no serious reform efforts 6
Changing Spending Priorities (% GDP) Source: The Bank of Korea 7
Welfare Expenditures (% of GDP) 1990 1995 2000 2005 2010 2012 Korea 2.8 3.2 4.8 6.5 9.0 9.6 OECD 17.5 19.3 18.6 19.4 21.7 21.6 Sweden 28.5 31.8 28.2 28.7 27.9 27.7 U.S. 13.1 15.0 14.2 15.5 19.3 18.7 Japan 11.1 14.1 16.3 18.4 22.1 n.a. Source: OECD SOCX Database 8
Fiscal Policy and Gini coefficient Source: Statistics Korea, The Bank of Korea 9
Comparison of Personal Income Tax Korea OECD U.S. Sweden 1990 1995 2000 2005 2010 2012 % of GDP 3.7 3.4 3.1 3.0 3.3 3.7 % of tax rev. 20.0 18.1 14.6 13.3 14.3 15.0 Top rate 53.8 43.0 44.0 38.5 38.5 41.8 % of GDP 10.1 9.1 9.1 8.6 8.2 8.6 % of tax rev. 29.4 25.9 25.3 23.9 24.0 24.5 Top rate 50.6 49.1 46.5 42.9 41.8 42.5 % of GDP 9.7 9.5 11.9 9.1 7.9 9.2 % of tax rev. 37.0 35.7 41.8 35.0 33.2 37.7 Top rate 35.6-46.7 41.4 41.9 41.9 % of GDP 19.1 15.3 16.3 14.7 12.0 11.9 % of tax rev. 38.5 33.5 33.3 31.6 28.0 28.2 Top rate 66.2 61.3 55.4 56.6 56.6 56.6 Notes: Surtaxes are included. Source: OECD Tax database 10
Budget Deficits and Public Debt (% of GDP) Source: Ministry of Strategy and Finance 11
Consolidated Central Government (% GDP, National Assembly Budget Office) 2014 2020 2030 2040 2050 2060 Total revenue(1) 26.2 24.8 23.7 22.7 21.7 21.3 Tax revenue 15.2 14.7 14.6 14.7 14.7 14.7 Social security contributions 3.4 3.2 2.9 2.6 2.5 2.5 Nontax revenue 7.6 6.9 6.2 5.4 4.5 4.1 Total expenditure(2) 25.4 24.6 26.8 28.6 30.5 32.6 Mandatory spending 11.8 12.2 13.7 15.5 17.4 19.6 Social insurances 1.8 2.0 2.1 2.3 2.5 2.7 Pensions 2.6 3.3 4.5 5.6 6.7 7.7 Discretionary spending 13.6 12.4 13.1 13.1 13.1 13.1 Consolidated fiscal balance(3)=(1)-(2) 0.8 0.2-3.1-5.9-8.8-11.4 Social security funds balance(4) 2.6 2.3 1.0-0.5-1.9-3.1 Adjusted balance(5)=(3)-(4) -1.8-2.1-4.1-5.4-6.9-8.2 Public debts 37.0 37.4 58.0 85.1 121.3 168.9 12
Korea s Evolving Tax Structure During the past thirty years, Korean per capita GDP grew from $4,000 to $23,000 (2005 $) Korea s tax structure has changed dramatically during the same period (1980-2012) Tax Revenue has grown from 17% of GDP to 25% Excise taxes and customs duties fell from 40.7% of tax revenue to 14.0% of revenue Income and payroll taxes grew from 26.6% of tax revenue to 54.6% of revenue Consumption taxes fell from 47.5% to 28.2% 13
Korea s Evolving Tax Structure Still, narrow base - PIT plays a minor role (15.0% of revenue/3.7% GDP vs. 24.5%/8.6% OECD in 2012) - Tax expenditures for PIT ( 33.4% of taxes paid) - Informal sector 26% (OECD 17%, US 9%. Avg99-10) - CIT/VAT fall mostly on large corporations Unconventional instruments - Earmarked taxes (17.3% revenue / 3.5% GDP) - Transaction taxes; surcharges (8% revenue) 14
Tax Revenue as percentage of GDP 1980 1990 1995 2000 2005 2010 2012 1980-2012 Change Korea 16.8 16.9 16.8 17.9 17.8 17.9 18.7 1.9 (16.9) (18.8) (19.1) (21.5) (22.5) (23.2) (24.8) (7.8) OECD 2 23.2 24.8 24.8 25.7 25.4 24.0 24.7 1.5 (30.1) (32.2) (33.6) (34.3) (34.0) (32.8) (33.7) (3.6) U.S. 19.9 19.7 20.1 21.8 19.7 17.6 18.9-1.0 (25.5) (26.3) (26.7) (28.4) (26.1) (23.7) (24.4) (-1.1) Sweden 31.2 36.0 33.0 36.1 34.1 32.3 32.4 1.2 (43.7) (49.5) (45.6) (49.0) (46.6) (43.1) (42.3) (-1.4) Notes: 1. Figures in parentheses are with social security contributions included. 2. Unweighted averages. Source: OECD (2014), Revenue Statistics 1965-2013 15
Structure of Tax Revenue % of GDP % of total tax revenue 1980 2012 1980 2012 Total tax revenue 16.9 24.8 100.0 100.0 Income 4.3 7.4 25.5 29.9 Personal income tax 1.9 3.7 11.5 15.0 Corporate income tax 1.9 3.7 11.0 14.9 Social security contributions 0.2 6.1 1.1 24.7 Consumption 8.0 7.0 47.5 28.2 Value added tax 3.7 4.3 22.0 17.2 Excise taxes 4.3 2.7 25.5 11.0 Property 1.4 2.6 8.0 10.6 Taxes on wealth holding 0.5 0.7 3.1 3.0 Taxes on transactions 0.8 1.9 5.0 7.6 Customs duties 2.6 0.7 15.2 3.0 Note: 1. Surtaxes are included where relevant. 2. Local consumption tax is included in value added tax in 2010. 16
Structure of Tax Revenue Korea (% of total tax revenue) OECD 1980 1990 2000 2005 2010 2012 2012 Income taxes 26.6 42.8 45.5 50.4 51.0 54.6 59.2 Personal income tax 11.5 20.0 14.6 13.3 14.3 15.0 24.5 Corporate income tax 11.0 12.8 14.1 15.9 13.9 14.9 8.5 Social Security Contributions 1.1 10.1 16.7 21.2 22.8 24.7 26.2 Property taxes 8.0 11.8 12.4 11.9 11.4 10.6 5.5 Consumption taxes 62.7 44.3 38.4 34.3 33.9 31.2 30.9 Other taxes 2.7 1.1 3.8 3.4 3.6 3.6 4.5 Notes: 1. Surtaxes are included where relevant. 2. Customs duties are included in consumption taxes. Source: OECD Tax database 17
Trends in Major Taxes (% of GDP) 18
Tax expenditures, 2012 Central government tax revenue Tax expenditure billion won % billion won % (1) (2) (3) (4) (3)/(1) Personal income tax 45,767 23.8 15,294 45.8 33.4 Corporate income tax 45,932 23.9 8,486 25.4 18.5 Value added tax 55,668 29.0 7,298 21.9 13.1 Other taxes 44,898 23.3 2,302 6.9 5.1 Total tax revenue 192,264 100.0 33,381 100.0 17.4 19
Comparison of Tax Structures Tax Revenue (% of GDP) Income and Social Security Taxes (% of Re venue) Corp Income Tax (% of income taxes) Consumption and Production Taxes (% of R evenue) Border Taxes (% of Revenue) Informal Economy (% of GDP) All dev 21.1 43.9 24.9 42.5 7.1 30.0 eloping Korea 25.3 45.1 31.6 29.2 3.9 26 OECD 35.9 68.6 9.9 23.0 0.5 14.0 Source: Gordon and Jun (2014) 20
Comparison of Tax Structures Korea s tax structure at this point is intermediate between those seen in other developing countries and the typical tax structure among OECD countries As the economy grows, the expectation is that the personal income tax will grow in importance and the corporate tax will play a less dominant role. 21
Why do revenue figures vary so much among countries? Maximum Corp Tax Rate Maximum Personal Tax Rate Maximum VAT rate Developing 26.7% 34.7% 14.7% Korea 24.2% 38.5% 10% Developed 29.6% 42.8% 16.2% Source: Gordon and Jun (2014) 22
Why do revenue figures vary so much among countries? As seen in the table, the sharp differences in tax revenue from each of the major taxes do NOT primarily reflect differences in tax rates. Korean statutory tax rates a bit on the low side in comparison to other countries, but differences are small. Instead revenue difference largely reflects differences in the size of the informal economy. Tax revenue/(gdp in the formal sector) broadly comparable in Korea and OECD countries as a whole (25% / 74% = 33%; 42.2% for OECD) 23
Rates of evasion then central to the evolution of tax structures Given high evasion rates on broad-based income and consumption taxes, developing countries make use of many supplementary sources of revenue that are easier to enforce Tariffs Excise taxes Seignorage 24
Rates of evasion then central to the evolution of tax structures Policies also commonly favor those sectors where compliance is greater Favorable access to bank loans; Protection through tariffs; Protection from competition from foreign subsidiaries Only when evasion rates drop enough do we see tax structures that broadly correspond to the recommendations of existing optimal tax theories 25
Optimal tax theory vs. Tax Structure Standard optimal-tax theory focuses on changes in labor supply / saving But changes in evasion can be the dominant source of efficiency losses in many developing countries. When evasion rates are important, policy choice must focus primarily on reforms that reduce evasion rates 26
What policies can reduce evasion? Economic growth per se More productive firms find it more costly to operate in the informal economy Publicly traded firms face pressures from market to report higher profits, even at cost of paying higher taxes Economic growth in Korea during the last thirty years has indeed increased tax revenue/gdp: from 16.9% to 24.8%, largely due to increased compliance 27
What policies can reduce evasion? Various policies already in use in Korea: Encourage more firms to list on the stock exchanges Subsidize use of credit cards (cash receipts) Subsidize firms to adopt electronic reporting of transactions to the government Presumptive value-added taxes at reduced rate, to pull more firms into the formal sector But informal economy remains large 28
Compliance and Self-employed Informal sector consists largely of self-employed - The self-employed (+unpaid family members): about 30% of the formal labor force; a much larger fraction of the overall labor force Evasion opportunities in the formal sector - 54% of PIT through withholding taxes on wages/salaries; dividends/interest ( shifting ) - 22% from taxes on the self-employed Simplified tax schemes (PIT/VAT) 29
Personal Income Tax, 2012 Taxpayers Taxes paid (in thousands) (%) (%) Wages and Salaries tax (withholding) 15,768 100.0 Under-threshold 5,156 32.7 Paying taxes 10,612 67.3 100.0 88 million won+(high bracket, 35-38%) 150 1.4 33.0 46-88 million won(24%) 623 5.9 27.2 Global income taxes (tax returns) 5,585 100.0 Under-threshold 1,232 22.1 Paying taxes 4,353 77.9 100.0 Bookkeeping 2,450 43.9 Income estimation 1 1,903 34.1 88 million won+(high bracket, 35-38%) 181 4.2 71.9 46-88 million won(24%) 247 5.7 12.9 Source: National Tax Service (2014), Statistical Yearbook of National Tax, and author's calculations 1. Also includes those who do not file tax returns, the number of which are estimated by the National Tax Service using business-registration information. 30
Personal Income Tax, 2012 Billion won % of GDP % of PIT Personal income tax 45,767 3.32 100.00 Wages and salaries income (withholding) 19,627 1.42 42.88 Global income (tax returns) 9,938 0.72 21.71 Dividends and interest income (withholding) 5,152 0.37 11.26 Capital gains (tax returns) 7,455 0.54 16.29 Other income 1 3,595 0.26 7.86 Source: Ministry of Finance and Economy 1 Withheld parts of business and retirement income, timber income, etc. 31
VAT Burden, 2012 Taxpayers (in thousands) (%) Taxes paid (billion won) (%) General 3,704 68.8 58,948 99.9 Corporation 591 11.0 43,873 74.3 Individuals 3,113 57.8 15,075 25.5 Simplified+Exemptions 1,681 31.2 71 0.1 Total 5,385 100.0 59,019 100.0 32
Compliance among the self-employed 33
Compliance with VAT and corporate tax in Korea 0.18 0.16 0.14 0.12 0.10 0.08 0.06 0.04 0.02 0.00 C-efficiency of VAT (right scale) Implicit base of CIT (left scale) 1978 1983 1988 1993 1998 2003 2008 2013 0.70 0.65 0.60 0.55 0.50 0.45 0.40 34
Suggestions on other policies to increase size of formal sector Presumptive tax (corporate plus VAT) on any sales to an unregistered firm Reduces an existing tax advantage faced by informal firms Leads some informal firms to become formal, generating both revenue and an efficiency gain Contract enforcement limited to firms in the formal sector. Potentially a revenue and efficiency gain as well. 35
Suggestions on policies to increase compliance with the income tax Link corporate tax base more closely to accounting profits reported to shareholders Tie social benefits (UI and SS) more closely to reported income under the personal tax. This converts a tax into a user fee, reducing tax distortions. 36
The Role of the Corporate Tax Politically popular (tax on chaebols, the rich?) Conventional recommendations A backstop to PIT (esp. self-employed) Revenue raiser despite distortions? Large base; better compliance and, The Interplay between PIT and CIT Corporate rates far below top personal rates Corporate governance: owner-managers Taxing rents? (mobile vs. Locally embedded?) Managerial diversion 37
Why Is Corporate Tax Base Large? Revenue Raiser (3.7% of GDP; 14.9% of taxes) Even higher than developing country average Easy to monitor capital-intensive firms High ETRs on these firm which are less likely to evade taxes; lower rates on the rest (shifting tax burden from labor to capital income) Such distortions can be offset through other policies favoring firms paying more taxes Leaving personal income within corporations 38
Personal and Corporate Tax Rates Personal income tax Corporate income tax Top Rate Top Rate Inclusive of Surcharges 1 Top Rate Top Rate Inclusive of Surcharges 1 Bottom Rate Inclusive of Surcharges 1 (2)-(4) (2)-(5) (1) (2) (3) (4) (5) (6) (7) 1981 62.0 79.1 40.0 53.0 31.9 26.1 47.2 1991 50.0 53.8 34.0 36.6 21.5 17.2 32.3 1995 45.0 48.4 30.0 34.3 19.4 14.1 29.0 1996 40.0 44.0 28.0 30.8 17.6 13.2 26.4 2002 36.0 39.6 27.0 29.7 16.5 9.9 23.1 2005 35.0 38.5 25.0 27.5 14.3 11.0 24.2 2009 35.0 38.5 22.0 24.2 12.1 14.3 26.4 2010 35.0 38.5 22.0 24.2 11.0 14.3 27.5 2012 38.0 41.8 22.0 24.2 11.0 17.6 30.8 Note: 1. Currently, a 10 percent local income tax is levied on personal/corporate income taxes payable. 39
Better coordination of personal and corporate tax rates To avoid distortions to where income is reported, tax rate should be the same regardless of whether income is reported as personal or corporate Current rate difference, in contrast, encourages shifting expenses to non-corporate firms, e.g. noncorporate investment funds, and income to corporate firms. Low corporate rate undermines accurate reporting of wages paid to high-bracket employees Rate difference helps explain high corporate tax base 40
Raising corporate rate and reducing personal tax rate? Possible compensating tax changes: corporate Introduce expensing for new investment, linked to an increase in the corporate tax rate Cut taxes on financial sector, linked to an increase in the corporate tax rate Possible compensating tax changes: personal Introduce excise taxes on luxury goods, linked to a cut in top personal tax rates Cut wage subsidies, and compensate by cutting personal tax rates 41
Corporate Tax Burden, 2012 Tax base Taxpayers Taxes paid (100 million won) (Number of firms) (%) (billion won) (%) Low bracket(10%) 422,490 87.55 924 2.29 Deficit 222,597 46.13 14 0.04 0-2 199,893 41.42 910 2.26 Middle (20%) 59,146 12.26 9,941 24.64 2-20 52,457 10.87 3,726 9.24 20-200 6,689 1.39 6,215 15.41 High bracket(22%) 938 0.19 29,472 73.06 200-500 521 0.11 3,031 7.51 500-1000 164 0.03 2,128 5.28 1000-5000 191 0.04 7,730 19.16 5000-62 0.01 16,583 41.11 Total 482,574 100.00 40,338 100.00 42
Rents and Corporate Governance Profits (taxes) are highly concentrated 62/191 firms (0.01/0.04%) 41.1/19.2% of tax Immobile rents? Return on entrepreneurial efforts vs. locally embedded (linked to government, affiliates, etc.) Foreign ownership 33%; Samsung elect. 49.7% Rent subject to managerial diversion less mobile? (Korean firm data: corporate governance affects the effects of tax-induced rents on firm value - extent of rent diversion) 43
Note on international tax issues Multinationals here and elsewhere face incentive to shift reported earnings abroad To lessen these distortions, repatriated profits should be subject to domestic corporate taxes, with a credit for taxes paid abroad to abide by OECD rules Korea can also face threat of portfolio investments shifting abroad to avoid domestic taxes. Can justify cut in taxes on personal financial income. 44
Taxation of Financial Sector, 2012 Taxes on financial services 6.38 trillion won 0.46% of GDP Education tax 0.93 0.07 Special tax for rural development 1.77 0.13 Security transaction tax 3.68 0.27 Source: National Tax Service (2013), Statistical Yearbook of National Tax. 1 The education tax is levied on financial institutions at 0.5 percent of gross receipts. 2 The securities transaction tax (0.15 percent and up) and a special tax for rural development (0.15 percent) are levied on the value of securities transactions. 45
Taxation of Financial Sector Significant source of tax revenue in Korea Gross receipts; Financial Transactions Justifications for these taxes questionable Tax discourages use of financial sector, leading firms to operate instead in the cash economy To neutralize this incentive to shift into the informal sector, other tax rates must fall A drop in taxes on financial sector pulls firms into the formal sector 46
Earmarking, etc. Earmarked taxes have been important source of tax revenue in Korea (Bird and Jun 2005) - About 17% of revenue from such taxes But, T&E linkage is mostly loose and not based on benefit rationale - Earmarked funds are inframarginal; mostly used for compliance purpose - Fiscal transparency/accountability issues remain Surcharges; Transactions taxes 47
Social Security Financing Earmarking vs. General Budget Economic rationale Relatively tight linkage of T&E based on benefit rationale (efficiency) (Inter-temporal) contractual arrangements General-fund financing Revenue pressure may be larger Partial (mandatory) subsidization may cause bigger problems (government-employee pension in Korea) 48