1. Latest Economic Trends and Domestic and Foreign Outlook for 2014
The recent economic indicators suggest that while production, shipment, capital investment, and private consumption are overall sluggish, the domestic economy is slowly entering a state of recovery on the strength of increasing investment in construction. The gross domestic product (GDP) growth rate for the second quarter was 1.1%, up from 0.8% for the first quarter. The cyclical component of the leading composite index rose for consecutive three months, indicating that the market is on track to pick up during the latter half of this year. However, although the domestic economy for 2013 was originally projected to increase 2.8% year on year (announced in April 2013), there is still a risk that the economic growth rate will decline due to the weak yen and a slowdown in China's economic growth.
The gradual recovery of the world economy is likely to somewhat improve the circumstances for domestic exports. Improved foreign conditions will boost domestic demand as the effects of government's policies become tangible. In this regard, the domestic economy for 2014 is expected to grow at the potential growth rate of 3.7%.
2. Direction for the Government's Budget Compilation for 2014
In June, the government projected the national economic growth rate would be 4.0% considering the global economy's steady growth externally and the government's pump-priming policies internally. Even though such a projection has not been finalized as a premise for the budget compilation for next year, if the current economic outlook remains unchanged, the 4.0% growth is unlikely to be achieved given the actual economic and financial conditions. In light of past cases, the government tends to take an optimistic view of economic conditions when compiling its budget. Such a tendency requires extra care and effort to rectify.
In 2014, the national agendas and priorities of the new government will be carried out in full scale. As such, the budget needs to be prepared to lay the groundwork for carrying out the national agendas. The budget necessary for these agendas to be implemented in 2014 totals KRW 15.3 trillion. There are four key policy goals, namely, economic revival, the people's happiness, cultural prosperity, and the establishment of a foundation for peaceful reunification, of which the budget for the people's happiness accounts for 63% of the entire budget. The total budget demanded by all ministries for 2014 is KRW 364.7 trillion, up by KRW 15.7 trillion (4.5%) from the revised supplementary budget for 2013 of KRW 349.0 trillion.
Given such financial requirements, the seamless implementation of the new government's administrative goals needs to be underpinned by the expansion of revenues and a structural change in expenditures during the budget compilation process. It is regarded as advisable for the government, in terms of necessity and timeliness, to strive to expand the revenue base by incorporating the underground economy into the official economy. However, as it may be difficult to secure such revenues as planned, the government needs to seek other alternatives to expand revenues. Moreover, even though it is essential to reduce expenditures through spending restructuring, given the difficulty in executing government spending cuts, reasonable rules for spending cuts should be put in place and budgetary authorities should indicate their will to rigorously observe the rules.
3. Analysis of Major Issues
The recent shortfall in tax revenues is unlikely to be resolved in a short period of time due to the weak economic recovery and structural issues. The share of corporate tax revenue in the operating surplus has continued to decline due to the revision of the tax code intended to relieve the corporate tax burden through a reduction in the corporate tax rate. The share of asset-related taxes in the total national tax revenue has fallen sharply (15.1% in 2007 to 10.2% in 2012) due to the recent depression in the real estate and stock markets. The effective tariff rate has also fallen (about 8% in the 1980s to 1.7% in 2012) due to trade liberalization. For these reasons, the tax revenue shortfall for 2013 has been more severe than expected. Therefore, appropriate countermeasures should be formulated and extra care needs to be taken in compiling the budget for 2014.
To obtain sufficient fiscal revenues to resolve the shortfall in tax revenues, an array of methods to broaden financial sources first needs to be taken into consideration in line with the main trend in tax reforms in advanced countries: a broad tax base and low tax rate. First, the tax exemption and reduction system needs to be overhauled on the basis of the sunset principle, the elimination of duplicate benefits, and the shift from the income tax deduction scheme to the tax credit scheme. Second, it merits consideration to reduce the scope of the value added tax exemption, raise the minimum corporate tax rate, and tighten up tax equity with regard to financial income. If the minimum tax rate for the bracket exceeding KRW 10 billion increases 1%p, tax revenues are expected to increase by KRW 1.6 trillion between 2014 and 2018. Third, measures such as imposing taxes on the earnings of clergymen and raising the cigarette consumption tax to expand local tax revenues should be taken into consideration. An increase in the cigarette price by KRW 500 would amount to a tax revenue increase of KRW 1.4 trillion in 2014. Fourth, strengthening international cooperation for the sharing of information on bank accounts and taxation to dig into tax resources from the underground economy, improving the appropriate systems to prevent offshore tax evasion, and revising laws to toughen the real-name financial transaction system all warrant further review. Fifth, mid- and long-term methods of directly raising tax revenues should also be reviewed by adjusting the highest income tax bracket.
The following should be examined during the budget compilation and fiscal management for 2014. First, the welfare budget that is rapidly increasing due to the basic senior pension, childcare, and coverage for the four serious illnesses should be reviewed from the standpoint of its mid- and long-term fiscal soundness. The average annual growth rate of spending in the areas of health, welfare, and labor between 2007 and 2013 was 8.4%, exceeding the growth rate of total government spendings (6.7%) during the same period. Second, to strengthen fiscal responsiveness to the business cycle to revitalize economy, for the short term, financial resources should be allocated to areas, such as employment, that have large ripple effects on the private sector, and for the long term, public finances should be managed in such a way that growth potential can be maximized. Third, considering the weak financial situation of local governments, projects subsidized by the central government need to be revamped through an upward adjustment of the government subsidy rate, and so on, and institutional complementation is also required to keep the sprawling fiscal management of local governments in check. Among the functions of the spending of local governments for the last five years, the average annual growth rate of spending on the social welfare was 9.8%, which was the highest area. In particular, spending on government-subsidized projects increased an average of 11.2% annually, indicating that they were the key cause for the increase in spendings on social welfare. Fourth, as the re-investment plans for key policy agendas proposed as a method of raising the funds required to enforce the key policy agendas of the Park Geun-hye administration lack specific plans, detailed materials containing subject projects or their size need to be submitted to the National Assembly together with the budget draft for 2014. The financing plans to secure funds required to carry out the campaign pledges of President Park Geun-hye during the 2013-2017 period include plans for expenditure savings of KRW 3.0 trillion in mandatory spending, KRW 34.8 trillion in discretionary spending, KRW 5.5 trillion in shifts to interest rate equalization, and KRW 40.8 trillion in re-investment for policy agendas.
4. Mid- and Long-Term Fiscal Management and Policy Tasks
To enhance the effectiveness of mid-term fiscal management plans to respond to economic and societal structural changes such as the low birth rate and aging population, the following should be taken into account. First, the mid-term fiscal management objective should be 'structural balances,' which are the financial balances less automatic increases in revenues and expenditures stemming from business cycles, rather than 'financial balances under management.' Second, the legislation of 'debt rules' as an aggregate fiscal discipline system to manage fiscal soundness is worth considering. The debt rules are believed to have significantly affected the fiscal soundness of the EU between 1990 and 2011. Third, sustainable national economic growth needs to be secured through an overall increase in productivity. To that end, the government needs to strengthen growth engines and improve the employment rate by placing its development priority on small and medium-sized enterprises and service industries that have high growth potential. Lastly, the government should seek ways to ensure sustainable financial resources for the ever-increasing welfare budget, expand welfare benefits for the underprivileged, and further explore the redistribution aspect of social welfare policies.
Chae Eun-dong
The recent economic indicators suggest that while production, shipment, capital investment, and private consumption are overall sluggish, the domestic economy is slowly entering a state of recovery on the strength of increasing investment in construction. The gross domestic product (GDP) growth rate for the second quarter was 1.1%, up from 0.8% for the first quarter. The cyclical component of the leading composite index rose for consecutive three months, indicating that the market is on track to pick up during the latter half of this year. However, although the domestic economy for 2013 was originally projected to increase 2.8% year on year (announced in April 2013), there is still a risk that the economic growth rate will decline due to the weak yen and a slowdown in China's economic growth.
The gradual recovery of the world economy is likely to somewhat improve the circumstances for domestic exports. Improved foreign conditions will boost domestic demand as the effects of government's policies become tangible. In this regard, the domestic economy for 2014 is expected to grow at the potential growth rate of 3.7%.
2. Direction for the Government's Budget Compilation for 2014
In June, the government projected the national economic growth rate would be 4.0% considering the global economy's steady growth externally and the government's pump-priming policies internally. Even though such a projection has not been finalized as a premise for the budget compilation for next year, if the current economic outlook remains unchanged, the 4.0% growth is unlikely to be achieved given the actual economic and financial conditions. In light of past cases, the government tends to take an optimistic view of economic conditions when compiling its budget. Such a tendency requires extra care and effort to rectify.
In 2014, the national agendas and priorities of the new government will be carried out in full scale. As such, the budget needs to be prepared to lay the groundwork for carrying out the national agendas. The budget necessary for these agendas to be implemented in 2014 totals KRW 15.3 trillion. There are four key policy goals, namely, economic revival, the people's happiness, cultural prosperity, and the establishment of a foundation for peaceful reunification, of which the budget for the people's happiness accounts for 63% of the entire budget. The total budget demanded by all ministries for 2014 is KRW 364.7 trillion, up by KRW 15.7 trillion (4.5%) from the revised supplementary budget for 2013 of KRW 349.0 trillion.
Given such financial requirements, the seamless implementation of the new government's administrative goals needs to be underpinned by the expansion of revenues and a structural change in expenditures during the budget compilation process. It is regarded as advisable for the government, in terms of necessity and timeliness, to strive to expand the revenue base by incorporating the underground economy into the official economy. However, as it may be difficult to secure such revenues as planned, the government needs to seek other alternatives to expand revenues. Moreover, even though it is essential to reduce expenditures through spending restructuring, given the difficulty in executing government spending cuts, reasonable rules for spending cuts should be put in place and budgetary authorities should indicate their will to rigorously observe the rules.
3. Analysis of Major Issues
The recent shortfall in tax revenues is unlikely to be resolved in a short period of time due to the weak economic recovery and structural issues. The share of corporate tax revenue in the operating surplus has continued to decline due to the revision of the tax code intended to relieve the corporate tax burden through a reduction in the corporate tax rate. The share of asset-related taxes in the total national tax revenue has fallen sharply (15.1% in 2007 to 10.2% in 2012) due to the recent depression in the real estate and stock markets. The effective tariff rate has also fallen (about 8% in the 1980s to 1.7% in 2012) due to trade liberalization. For these reasons, the tax revenue shortfall for 2013 has been more severe than expected. Therefore, appropriate countermeasures should be formulated and extra care needs to be taken in compiling the budget for 2014.
To obtain sufficient fiscal revenues to resolve the shortfall in tax revenues, an array of methods to broaden financial sources first needs to be taken into consideration in line with the main trend in tax reforms in advanced countries: a broad tax base and low tax rate. First, the tax exemption and reduction system needs to be overhauled on the basis of the sunset principle, the elimination of duplicate benefits, and the shift from the income tax deduction scheme to the tax credit scheme. Second, it merits consideration to reduce the scope of the value added tax exemption, raise the minimum corporate tax rate, and tighten up tax equity with regard to financial income. If the minimum tax rate for the bracket exceeding KRW 10 billion increases 1%p, tax revenues are expected to increase by KRW 1.6 trillion between 2014 and 2018. Third, measures such as imposing taxes on the earnings of clergymen and raising the cigarette consumption tax to expand local tax revenues should be taken into consideration. An increase in the cigarette price by KRW 500 would amount to a tax revenue increase of KRW 1.4 trillion in 2014. Fourth, strengthening international cooperation for the sharing of information on bank accounts and taxation to dig into tax resources from the underground economy, improving the appropriate systems to prevent offshore tax evasion, and revising laws to toughen the real-name financial transaction system all warrant further review. Fifth, mid- and long-term methods of directly raising tax revenues should also be reviewed by adjusting the highest income tax bracket.
The following should be examined during the budget compilation and fiscal management for 2014. First, the welfare budget that is rapidly increasing due to the basic senior pension, childcare, and coverage for the four serious illnesses should be reviewed from the standpoint of its mid- and long-term fiscal soundness. The average annual growth rate of spending in the areas of health, welfare, and labor between 2007 and 2013 was 8.4%, exceeding the growth rate of total government spendings (6.7%) during the same period. Second, to strengthen fiscal responsiveness to the business cycle to revitalize economy, for the short term, financial resources should be allocated to areas, such as employment, that have large ripple effects on the private sector, and for the long term, public finances should be managed in such a way that growth potential can be maximized. Third, considering the weak financial situation of local governments, projects subsidized by the central government need to be revamped through an upward adjustment of the government subsidy rate, and so on, and institutional complementation is also required to keep the sprawling fiscal management of local governments in check. Among the functions of the spending of local governments for the last five years, the average annual growth rate of spending on the social welfare was 9.8%, which was the highest area. In particular, spending on government-subsidized projects increased an average of 11.2% annually, indicating that they were the key cause for the increase in spendings on social welfare. Fourth, as the re-investment plans for key policy agendas proposed as a method of raising the funds required to enforce the key policy agendas of the Park Geun-hye administration lack specific plans, detailed materials containing subject projects or their size need to be submitted to the National Assembly together with the budget draft for 2014. The financing plans to secure funds required to carry out the campaign pledges of President Park Geun-hye during the 2013-2017 period include plans for expenditure savings of KRW 3.0 trillion in mandatory spending, KRW 34.8 trillion in discretionary spending, KRW 5.5 trillion in shifts to interest rate equalization, and KRW 40.8 trillion in re-investment for policy agendas.
4. Mid- and Long-Term Fiscal Management and Policy Tasks
To enhance the effectiveness of mid-term fiscal management plans to respond to economic and societal structural changes such as the low birth rate and aging population, the following should be taken into account. First, the mid-term fiscal management objective should be 'structural balances,' which are the financial balances less automatic increases in revenues and expenditures stemming from business cycles, rather than 'financial balances under management.' Second, the legislation of 'debt rules' as an aggregate fiscal discipline system to manage fiscal soundness is worth considering. The debt rules are believed to have significantly affected the fiscal soundness of the EU between 1990 and 2011. Third, sustainable national economic growth needs to be secured through an overall increase in productivity. To that end, the government needs to strengthen growth engines and improve the employment rate by placing its development priority on small and medium-sized enterprises and service industries that have high growth potential. Lastly, the government should seek ways to ensure sustainable financial resources for the ever-increasing welfare budget, expand welfare benefits for the underprivileged, and further explore the redistribution aspect of social welfare policies.
Chae Eun-dong