Reforming the tax system in Korea to promote economic growth and cope with rapid population ageing

Korea has one of the lowest tax burdens in the OECD area, reflecting its small public sector.However, it is likely to continue rising with rapid population ageing and the development of a social safety net which will put upward pressure on government spending.

This paper begins by presenting the key challenges facing the Korean tax system – sustaining economic growth, meeting the long-term need for greater revenue, coping with rising income inequality and rising relative poverty and improving the local tax system. It then compares the Korean tax system with other OECD countries and analyses how each of the major taxes can be reformed to meet the key challenges.

The author argues that:

• the challenge is to meet the long-run need for greater expenditures and tax revenue while sustaining strong economic growth
• a pro-growth tax reform implies relying primarily on consumption taxes for additional revenue
• there is scope for raising personal income tax revenue from its current low level by broadening the base by reducing the exemptions for personal income
• planned cuts in the corporate tax rate should be financed at least in part by reductions in tax expenditures
• broadening of direct tax bases would also help finance an expansion of the earned income tax credit to address widening income inequality
• the local tax system should be simplified and reformed to enhance the autonomy of local governments

The paper concludes with recommendations for a comprehensive tax reform, and argues that implementing a comprehensive tax reform requires clear communication of the plan and its objectives, suggesting that:

• the authorities should demonstrate their commitment to improving the efficiency of spending before asking the public to pay higher taxes. The plan to privatise some state-owned enterprises and increase the efficiency of public organisations is useful in this regard
• as Korea’s income level converges to the OECD average and as rapid population ageing makes it one of the oldest countries in the OECD, it will be difficult to maintain such a low share of taxes in GDP
• reform must be fair to the extent possible across different segments of the population. In particular, it is essential that the broadening of the tax base also includes the self-employed, thus avoiding an unfair burden on salaried workers
• nearly all OECD countries have launched substantial tax reforms in recent years, driven by the need to provide a fiscal environment that is more conducive to investment, risk-taking and work incentives. It is important to avoid falling behind in an increasingly integrated and competitive world economy
• proposed tax reform should address emerging concerns about inequality primarily by expanding the EITC. Such an approach would avoid increasing the rates of the personal income tax, which tends to discourage human capital formation and labour supply