1. Summary and Evaluation of Tax Revision Plan
Under the goal of realizing a "principle-based normalization of the taxation system," the administration has established a tax revision plan that actively supports national agendas, the operation of a public-oriented taxation system, a more balanced taxation system, and the expansion of tax revenue sources in order to achieve adequate tax burden allocations, the normalization of the taxation structure, and support for a more efficient taxation system. Moreover, the administration has proposed the direction of taxation policy, the very foundation of national financial management, for the next five years, requiring a transparent and consistent implementation of the plan.
The tax revision plan was checked against its policy direction to determine whether it is in line with the changes in the economic and policy environment as well as whether the right measures for improvement were identified. First, the medium- to long-term taxation policy, announced together with the '2013 Tax Revision Plan,' targets a consistent taxation policy, which is deemed advisable to sustain a strong backbone of national finances. However, the policy strategy remains somewhat incomplete in terms of its details. Fiscal outlays were proposed following the National Financial Management Plan based on the annual fiscal operation plan. As such, tax revenues should also be suggested based on the annual tax management plan. However, the plan only presents the general ratio of taxation against national income (20.2% in 2012 →approximately 21% by 2017). It also presents a broad scope for the tax burden increases on income and consumption as well as growth-favoring adjustments on corporate and property taxes. In the future, a more concrete and effective medium- to long-term taxation policy needs to be implemented and submitted to the National Assembly. The conversion of items for income tax deduction (coverage insurance, medical expenses, education expenses, etc.) which share the characteristics of necessary expenses, into items of tax credit, which are mainly applied for the purpose of achieving national policy objectives, also needs to be reviewed for its appropriateness. Due to the proposed conversion, the tax revision plan seems to offer a limited direction, only based on the rationale of adjusting the tax burden and expanding tax revenues mainly from wage and salary income earners.
Moreover, since the initial announcement on 8 Aug, a negative public consensus was built around the increase in the tax burden on wage and salary income earners through the reduction in the ratio of income tax deductions. Soon thereafter, the Ministry of Strategy and Finance made a revised announcement on 13 Aug to increase the ratio of deductions for earned income to offset such increases in tax burdens, causing confusion among the public. In the case of items that require improvements and adjustments through consensus among diverse opinions, it seems the most appropriate that such changes should go through the proposal finalizing process in the order of pre-announcement of legislation (9 Aug ~ 12 Sep) and inter-ministerial discussions (21 Aug ~ 2 Sep), official announcement, and submission to the National Assembly. In regards to tax exemptions and reductions, the revision mainly focuses on the above conversion of items of income tax deductions into items of tax credits and takes on a somewhat passive approach in regards to corporate tax, making adjustments in the deduction ratio on only some of the deduction items on investment tax. Therefore, without further action on the revision for tax exemptions and reductions, it is expected that the tax revenue of KRW 8.7 trillion initially forecasted by the government won't be achieved (2014 to 2017 KRW 10.6 trillion).
2. Analysis on Tax Revenue
NABO estimates that the tax revenue effect against the baseline for 2014~2018 will decrease by a total of KRW 2.4 trillion (decreases of KRW 0.8 trillion in 2014 and 1.0 trillion in 2015) according to the ｢2013 Tax Revision Plan｣. Key factors of increases are the conversion of income tax deduction items into tax credit items (KRW 5.0 trillion) and the new limit on deemed input tax deductions (KRW 1.9 trillion), including deductions on tax-free agricultural and marine products. Key reduction factors are the expansion of Earned Income Tax Credit (decrease of KRW 3.5 trillion) and the introduction of the Child Tax Credit (decrease of KRW 3.6 trillion). NABO and the administration have a gap of KRW 0.8 trillion between their 2014 to 2018 tax revenue estimates against the baseline (NABO:decrease of KRW 2.4 trillion; the administration: decrease of KRW3.2 trillion). The gap is due to differences in estimation assumptions. For the conversion of income tax deductibles to tax credit items (NABO: increase of KRW 5.0 trillion; the administration: increase of KRW 3.4 trillion), the administration does not consider the natural increase of tax revenue and assumes that the tax revenue of the first year will be maintained for the following years. There are also differences in estimating the tax revenue effect of the expansion of tax deductions on R&D expenses (NABO: decrease of KRW 0.4 trillion; the administration: not estimated). Even if tax exemption and reduction volumes are decreased by revising their policies, the tax revenue against the baseline may still decrease when the phasing out of such revised items are extended over a longer term. To overcome such shortcomings, the tax revenue effect following the revisions of tax exemption and reduction policies were estimated without accounting for gradual phasing out. As a result, the estimated tax revenue effect was forecasted at KRW 8.7 trillion, which is KRW 2 trillion short of the targeted tax exemption and reduction amount (2014~2017 KRW 10.6 trillion) as per the pledged national finance book during the presidential campaign.
3. Analysis by Tax Types
(1) Income Tax
The changes in the method of income tax deduction, where certain items for income deduction are converted to tax credit items, the decreased deduction ratio for wage and salary income, and the increased cap on tax credits on wage and salary income are likely to have a direct impact only on the taxation and tax burdens of wage and salary income earners.
The tax revenue effects estimated by the administration and NABO, following the changes in the income tax deduction method for wage and salary income earners, are KRW 0.86 trillion and KRW 0.99 trillion, respectively, based on 2011 figures. The accumulated tax revenue effects from 2014 to 2018 are estimated at KRW 3.4 trillion and KRW 5.0 trillion, respectively. Moreover, the percentage of the wage and salary income earners that have an increased tax burden, as announced by the administration (total wage and salary of KRW 55 million or higher, 13.2%), may in fact increase. For the potential conversion of income deductions for special deduction items to tax credits, the items subject to conversion need to be reviewed to check whether they are necessary expenses or whether they are for attaining national policy objectives. In particular, for special deduction items that are necessary expenses, case studies should also be carried out on five key nations (US, UK, Japan, Germany and France) that mostly maintain the income deduction method on special deduction items. Moreover, the revision lacks consistency in its direction since it reduces the deduction ratio on wage and salary income while at the same time increasing the cap on tax credits. The revised taxation proposal seems not to have thoroughly reviewed the intended policy and its effect and is mostly focused towards securing tax revenue by simply looking at its increases and decreases. Thus, a rather comprehensive review and analysis need to be performed for the evaluation of the plan.
The tax revenue effect from the expansion of the Earned Income Tax Credit (EITC) and introduction of the Child Tax Credit (CTC) for 2014 to 2018 is estimated at a decrease of KRW 7.9 trillion, an annual average of KRW 1.4 trillion (Ministry of Strategy and Finance 2014~2018, decrease of KRW 6.6 trillion, decrease of KRW 1.3 trillion per annum). While the policy has been rapidly expanding since its launch, currently there are no evaluations on its work incentive effects. For such an assessment, the National Tax Service needs to disclose sample data on the EITC recipients and applicants. In order to review the income level of the low-income bracket, inter-ministerial collaboration is required, and considering the fact that EITC has characteristics of an expense, managing it as an item of tax expenditure should be reviewed.
Regarding the decrease (15%→10%) in the income tax deduction ratio for credit cards, analysis has shown that since credit card payments were mainly used to fill up the deduction cap, there won't be much change in the per capita tax deduction amount.
Considering that the policy has already achieved its objective, that the income tax deduction system is regressive, and that the use of credit cards are not necessary expenses under the policy objective of boosting credit card usage, the current system of income tax deductions for credit cards should be converted to tax credits. However, once the tax credit policy is implemented, a further review seems to be necessary for gradually decreasing the ratio of tax credit.
(2) Corporate Tax
The scope of tax credits on R&D expenses has been extended to include certain service industries. This seems favorable since the service industries have the capacity to generate added value and it will likely increase the efficiency of the tax system. In regards to the extended phasing out of tax credits on investments, such as for energy-saving facilities, and the differentiated decreases in the tax credit ratios by the size of the company, these should be continuously monitored for future performance assessment.
For the Small and Medium Enterprise Special Tax Reductions, while the range of service sectors subject to the reductions has been expanded, there is little differentiation from the service industries that are currently included under the policy. Moreover, due to the possibility that such new industries are already tax-free businesses, few benefits are expected in practice following the expanded scope. The tax credit policy on job creation investments has been expanded to include common part-time employment. However, the policy needs to be reviewed for its directionality and effectiveness since the resulting economic benefits are limited, as the changes are small improvements to the current policy, and the policy is intended for gradual phase out.
The current corporate taxation system needs to be revised in its medium- to long-term scope by reflecting on the trends of key economic indicators: employment and income distribution, the current structures of corporate tax reductions and exemptions, and the future weakening of the nation's financial capacity. However, when considering the global trends of tax rate cuts and competition over foreign capital, increasing the corporate tax rate is practically not feasible. Thus, the corporate taxation system should be revised, focusing on revamping exemption or reduction policies by establishing their governing principles. Since corporate tax exemption and reduction are currently concentrated towards some top ranking companies, increasing the minimum tax rate can be additionally reviewed to improve taxation fairness and secure stable tax revenue.
(3) Value Added Tax and others
The administration has proposed to set a limit on deemed input tax deductions (30% of sales) on tax-free agricultural and marine products to prevent unjust and excessive deductions. The proposal should be thoroughly reviewed since it lacks a rational basis, such as the appropriateness of the deduction ratio. Furthermore, the proposal on the adjustment of the deduction ratio on deemed input tax (waste resource 3/103, used cars 5/105) should be reviewed for gradual downsizing and abolishment as waste resources for recycling do not have fixed tax amounts from which to make deductions and their purchasing prices cannot be verified due to the nature of their trade.
In order to relax the gift tax for parent-subsidiary unfair large-volume trades, the administration proposed a relaxation of the tax requirements for SMEs, an expanded scope of tax waivers on internal transactions between specially-related companies, and an adjustment for double taxation on income taxes. The relaxation on the ratio of allowed transactions between inter-related parties (30%→50%) is an issue that requires prudent review. The transactions should be based on rational causes (logical reasons) for managing the business. Regulations, based on rational business reasons, should be first introduced and then relaxed for fair taxation and asset protection of the tax payers.
The administration proposed to include medium-sized enterprises with annual revenue of KRW 30 million and below to be subject to tax deductions for the succession of family businesses and relaxed the policy on inheritance where joint succession of an inheritor reserve is allowed. The excessive expansion in the number of the target companies for the deduction of family business succession tax does not seem to be in line with the function of inheritance tax, which intends to proactively prevent the concentration of wealth. The policy on joint succession cannot be a fundamental resolution to the conflict between the family business succession tax system and the inheritance reserve system under civil law. Thus, this issue needs to be resolved by establishing an Act on exemption from civil law for family business succession, similar to what is found in Japan.
Under the goal of realizing a "principle-based normalization of the taxation system," the administration has established a tax revision plan that actively supports national agendas, the operation of a public-oriented taxation system, a more balanced taxation system, and the expansion of tax revenue sources in order to achieve adequate tax burden allocations, the normalization of the taxation structure, and support for a more efficient taxation system. Moreover, the administration has proposed the direction of taxation policy, the very foundation of national financial management, for the next five years, requiring a transparent and consistent implementation of the plan.
The tax revision plan was checked against its policy direction to determine whether it is in line with the changes in the economic and policy environment as well as whether the right measures for improvement were identified. First, the medium- to long-term taxation policy, announced together with the '2013 Tax Revision Plan,' targets a consistent taxation policy, which is deemed advisable to sustain a strong backbone of national finances. However, the policy strategy remains somewhat incomplete in terms of its details. Fiscal outlays were proposed following the National Financial Management Plan based on the annual fiscal operation plan. As such, tax revenues should also be suggested based on the annual tax management plan. However, the plan only presents the general ratio of taxation against national income (20.2% in 2012 →approximately 21% by 2017). It also presents a broad scope for the tax burden increases on income and consumption as well as growth-favoring adjustments on corporate and property taxes. In the future, a more concrete and effective medium- to long-term taxation policy needs to be implemented and submitted to the National Assembly. The conversion of items for income tax deduction (coverage insurance, medical expenses, education expenses, etc.) which share the characteristics of necessary expenses, into items of tax credit, which are mainly applied for the purpose of achieving national policy objectives, also needs to be reviewed for its appropriateness. Due to the proposed conversion, the tax revision plan seems to offer a limited direction, only based on the rationale of adjusting the tax burden and expanding tax revenues mainly from wage and salary income earners.
Moreover, since the initial announcement on 8 Aug, a negative public consensus was built around the increase in the tax burden on wage and salary income earners through the reduction in the ratio of income tax deductions. Soon thereafter, the Ministry of Strategy and Finance made a revised announcement on 13 Aug to increase the ratio of deductions for earned income to offset such increases in tax burdens, causing confusion among the public. In the case of items that require improvements and adjustments through consensus among diverse opinions, it seems the most appropriate that such changes should go through the proposal finalizing process in the order of pre-announcement of legislation (9 Aug ~ 12 Sep) and inter-ministerial discussions (21 Aug ~ 2 Sep), official announcement, and submission to the National Assembly. In regards to tax exemptions and reductions, the revision mainly focuses on the above conversion of items of income tax deductions into items of tax credits and takes on a somewhat passive approach in regards to corporate tax, making adjustments in the deduction ratio on only some of the deduction items on investment tax. Therefore, without further action on the revision for tax exemptions and reductions, it is expected that the tax revenue of KRW 8.7 trillion initially forecasted by the government won't be achieved (2014 to 2017 KRW 10.6 trillion).
2. Analysis on Tax Revenue
NABO estimates that the tax revenue effect against the baseline for 2014~2018 will decrease by a total of KRW 2.4 trillion (decreases of KRW 0.8 trillion in 2014 and 1.0 trillion in 2015) according to the ｢2013 Tax Revision Plan｣. Key factors of increases are the conversion of income tax deduction items into tax credit items (KRW 5.0 trillion) and the new limit on deemed input tax deductions (KRW 1.9 trillion), including deductions on tax-free agricultural and marine products. Key reduction factors are the expansion of Earned Income Tax Credit (decrease of KRW 3.5 trillion) and the introduction of the Child Tax Credit (decrease of KRW 3.6 trillion). NABO and the administration have a gap of KRW 0.8 trillion between their 2014 to 2018 tax revenue estimates against the baseline (NABO:decrease of KRW 2.4 trillion; the administration: decrease of KRW3.2 trillion). The gap is due to differences in estimation assumptions. For the conversion of income tax deductibles to tax credit items (NABO: increase of KRW 5.0 trillion; the administration: increase of KRW 3.4 trillion), the administration does not consider the natural increase of tax revenue and assumes that the tax revenue of the first year will be maintained for the following years. There are also differences in estimating the tax revenue effect of the expansion of tax deductions on R&D expenses (NABO: decrease of KRW 0.4 trillion; the administration: not estimated). Even if tax exemption and reduction volumes are decreased by revising their policies, the tax revenue against the baseline may still decrease when the phasing out of such revised items are extended over a longer term. To overcome such shortcomings, the tax revenue effect following the revisions of tax exemption and reduction policies were estimated without accounting for gradual phasing out. As a result, the estimated tax revenue effect was forecasted at KRW 8.7 trillion, which is KRW 2 trillion short of the targeted tax exemption and reduction amount (2014~2017 KRW 10.6 trillion) as per the pledged national finance book during the presidential campaign.
3. Analysis by Tax Types
(1) Income Tax
The changes in the method of income tax deduction, where certain items for income deduction are converted to tax credit items, the decreased deduction ratio for wage and salary income, and the increased cap on tax credits on wage and salary income are likely to have a direct impact only on the taxation and tax burdens of wage and salary income earners.
The tax revenue effects estimated by the administration and NABO, following the changes in the income tax deduction method for wage and salary income earners, are KRW 0.86 trillion and KRW 0.99 trillion, respectively, based on 2011 figures. The accumulated tax revenue effects from 2014 to 2018 are estimated at KRW 3.4 trillion and KRW 5.0 trillion, respectively. Moreover, the percentage of the wage and salary income earners that have an increased tax burden, as announced by the administration (total wage and salary of KRW 55 million or higher, 13.2%), may in fact increase. For the potential conversion of income deductions for special deduction items to tax credits, the items subject to conversion need to be reviewed to check whether they are necessary expenses or whether they are for attaining national policy objectives. In particular, for special deduction items that are necessary expenses, case studies should also be carried out on five key nations (US, UK, Japan, Germany and France) that mostly maintain the income deduction method on special deduction items. Moreover, the revision lacks consistency in its direction since it reduces the deduction ratio on wage and salary income while at the same time increasing the cap on tax credits. The revised taxation proposal seems not to have thoroughly reviewed the intended policy and its effect and is mostly focused towards securing tax revenue by simply looking at its increases and decreases. Thus, a rather comprehensive review and analysis need to be performed for the evaluation of the plan.
The tax revenue effect from the expansion of the Earned Income Tax Credit (EITC) and introduction of the Child Tax Credit (CTC) for 2014 to 2018 is estimated at a decrease of KRW 7.9 trillion, an annual average of KRW 1.4 trillion (Ministry of Strategy and Finance 2014~2018, decrease of KRW 6.6 trillion, decrease of KRW 1.3 trillion per annum). While the policy has been rapidly expanding since its launch, currently there are no evaluations on its work incentive effects. For such an assessment, the National Tax Service needs to disclose sample data on the EITC recipients and applicants. In order to review the income level of the low-income bracket, inter-ministerial collaboration is required, and considering the fact that EITC has characteristics of an expense, managing it as an item of tax expenditure should be reviewed.
Regarding the decrease (15%→10%) in the income tax deduction ratio for credit cards, analysis has shown that since credit card payments were mainly used to fill up the deduction cap, there won't be much change in the per capita tax deduction amount.
Considering that the policy has already achieved its objective, that the income tax deduction system is regressive, and that the use of credit cards are not necessary expenses under the policy objective of boosting credit card usage, the current system of income tax deductions for credit cards should be converted to tax credits. However, once the tax credit policy is implemented, a further review seems to be necessary for gradually decreasing the ratio of tax credit.
(2) Corporate Tax
The scope of tax credits on R&D expenses has been extended to include certain service industries. This seems favorable since the service industries have the capacity to generate added value and it will likely increase the efficiency of the tax system. In regards to the extended phasing out of tax credits on investments, such as for energy-saving facilities, and the differentiated decreases in the tax credit ratios by the size of the company, these should be continuously monitored for future performance assessment.
For the Small and Medium Enterprise Special Tax Reductions, while the range of service sectors subject to the reductions has been expanded, there is little differentiation from the service industries that are currently included under the policy. Moreover, due to the possibility that such new industries are already tax-free businesses, few benefits are expected in practice following the expanded scope. The tax credit policy on job creation investments has been expanded to include common part-time employment. However, the policy needs to be reviewed for its directionality and effectiveness since the resulting economic benefits are limited, as the changes are small improvements to the current policy, and the policy is intended for gradual phase out.
The current corporate taxation system needs to be revised in its medium- to long-term scope by reflecting on the trends of key economic indicators: employment and income distribution, the current structures of corporate tax reductions and exemptions, and the future weakening of the nation's financial capacity. However, when considering the global trends of tax rate cuts and competition over foreign capital, increasing the corporate tax rate is practically not feasible. Thus, the corporate taxation system should be revised, focusing on revamping exemption or reduction policies by establishing their governing principles. Since corporate tax exemption and reduction are currently concentrated towards some top ranking companies, increasing the minimum tax rate can be additionally reviewed to improve taxation fairness and secure stable tax revenue.
(3) Value Added Tax and others
The administration has proposed to set a limit on deemed input tax deductions (30% of sales) on tax-free agricultural and marine products to prevent unjust and excessive deductions. The proposal should be thoroughly reviewed since it lacks a rational basis, such as the appropriateness of the deduction ratio. Furthermore, the proposal on the adjustment of the deduction ratio on deemed input tax (waste resource 3/103, used cars 5/105) should be reviewed for gradual downsizing and abolishment as waste resources for recycling do not have fixed tax amounts from which to make deductions and their purchasing prices cannot be verified due to the nature of their trade.
In order to relax the gift tax for parent-subsidiary unfair large-volume trades, the administration proposed a relaxation of the tax requirements for SMEs, an expanded scope of tax waivers on internal transactions between specially-related companies, and an adjustment for double taxation on income taxes. The relaxation on the ratio of allowed transactions between inter-related parties (30%→50%) is an issue that requires prudent review. The transactions should be based on rational causes (logical reasons) for managing the business. Regulations, based on rational business reasons, should be first introduced and then relaxed for fair taxation and asset protection of the tax payers.
The administration proposed to include medium-sized enterprises with annual revenue of KRW 30 million and below to be subject to tax deductions for the succession of family businesses and relaxed the policy on inheritance where joint succession of an inheritor reserve is allowed. The excessive expansion in the number of the target companies for the deduction of family business succession tax does not seem to be in line with the function of inheritance tax, which intends to proactively prevent the concentration of wealth. The policy on joint succession cannot be a fundamental resolution to the conflict between the family business succession tax system and the inheritance reserve system under civil law. Thus, this issue needs to be resolved by establishing an Act on exemption from civil law for family business succession, similar to what is found in Japan.