1. Introduction
Tax expenditure programs, introduced for certain policy objectives, have been perpetuated and have given rise to vested interests, resulting in an annual revenue loss of KRW 30 trillion. For this reason, the administration indicated that its stance will be to abolish tax expenditures for certain tax items that are to expire, with no exceptions, on the basis of the sunset principle. The administration announced its financing plans to carry out its campaign pledges. As part of the plans, the administration will raise a total of KRW 18 trillion during the 2013-2017 period by revamping tax expenditure programs. As such, this report first proposes rules to revamp the current tax expenditure programs and analyzes 20 major items currently subject to tax expenditures that are to expire in 2013 and 2014 to find methods of revamping tax expenditures. The possible increase in tax revenues from such proposed modifications is also estimated.
2. Current Operation of Tax Expenditures
The Ministry of Strategy and Finance announced that there were 228 items subject to tax expenditures with a combined amount of KRW 29.8 trillion as of 2013. However, the statistics announced by the administration have several errors in that they differ from the data released in 2012, revisions of tax laws made in 2012 have not been reflected, and some items were omitted. After correcting these errors, it was found that there were 218 items eligible for tax expenditures with an amount of KRW 32.6 trillion in 2013.
Tax expenditures under operation have the following characteristics. First, the items eligible for tax expenditures that went into effect longer ago are more likely to have no sunset provisions and have higher tax expenditure amounts. While the average amount of tax credits for the 67 items newly enforced after 2008 was KRW 17.7 billion, that for the 89 items newly enforced before 1998 was as high as KRW 236.8 billion. Second, the tax expenditure amount from the ten highest tax expenditure items (KRW 16.5 trillion) accounts for more than a half of the total tax expenditure amount (KRW 32.6 trillion) and has been operated for more than ten years. Third, the three tax items accounted for a substantial portion (KRW 27.6 trillion) of all items: KRW 14 trillion for income tax, KRW 8 trillion for corporate tax, and KRW 5 trillion for value added tax. Fourth, although each of the previous administrations announced its plans to expand financial resources through the overhaul of tax expenditures, the tax expenditure amount has continued to grow. Since 1998, the five-year average amount of tax expenditure in national taxes has increased by about KRW 10 trillion (or 0.3%p of GDP): KRW 12 trillion (2.0% of GDP) for the People's Government (President Kim Dae-jung), KRW 20 trillion (2.3% of GDP) for the Participatory Government (President Roh Mu-hyun), and KRW 30 trillion (2.6% of GDP) for the Pragmatic Government (President Lee Myung-bak). Fifth, the administration proposed its plan to revamp the program by abolishing 17 items among 102 items that would expire at the end of 2012. However, the National Assembly's reviews discovered that only 11 items, equivalent to KRW 26.5 billion, were abolished. Although the government originally intended to abolish tax credits for individuals, those who were benefitting from the tax credits refused to pay taxes, making it difficult to revamp tax expenditures, the National Assembly and the administration only tightened the limit of tax expenditures for individuals' income tax and the corporate tax in revising tax laws in 2012.
3. Approach to Revamping Tax Expenditure Programs
(1) Revamping Rules
The rules to revamp the current tax expenditures based on tax reform principles are proposed as follows. First, in order to improve the current practice where tax expenditures create vested rights through an extension of sunset date, any tax expenditure program or scheme that has an insignificant effect needs to be abolished according to its sunset provision. The abolition of tax expenditure programs according to their sunset clauses would generate stable revenues and eliminate tax benefits perpetuated for certain classes. Second, if tax incentives are provided on an item in addition to government subsidies, the tax incentives need to be enforced from mid- and long-term perspectives and, moreover, eliminated, unless the tax incentives have more significant effects than the government subsidies. Third, items eligible for income deductions implemented for political purposes need to be subjected to tax credits to resolve the problem of vertical inequalities arising from income deduction programs. While tax credits are more appropriate for items required for the public interest such as credit cards, income deductions are more suitable for necessary expense items such as medical fees.
(2) Reviews of Items to Expire in 2013
For the special tax treatment system for the input tax credit for the recycling of waste resources, given the fact that it may distort VAT, it is advisable to eliminate it. However, considering the economic circumstances of petty waste resource collectors, it can be reviewed to reduce or abolish it in phases. Although the deemed input tax credit was introduced to eliminate the cascade effect and catch-up effect, the system is used to preserve the income of the waste resource collectors, and furthermore, wrongfully used for tax evasion through transactions without authentic documentation because waste resources do not incur the cascade effect.
In the case of tax credit programs introduced with consideration for the external effects of energy conservation and environmental preservation facilities, their sunset dates need to be extended, but their tax credit rates should be adjusted in consideration of the concentration of tax benefits on large companies, the effects of investment expansion, and the balance with other investment-related tax credit programs. According to 2011 tax returns, more than 95% of the deductions under these tax credit programs were concentrated on large companies, and the correlation coefficient between the tax credit rate and investment amount was 0.18 for energy facilities and –0.63 for environmental preservation facilities, indicating that the effects of the programs were not significant. Even though the programs need to be maintained considering their externalities, the current deduction rate (10%) should be reduced in comparison with other investment tax credit programs, and items under these programs need to be selected based on more rigorous evaluations of external effects.
For the special tax treatment system for cash receipt issuing businesses and cash receipt merchants, if the government abolishes tax benefits for the voluntarily issued cash receipts of less than KRW 5,000, which are susceptible to excessive issuance to obtain more deductions, revenues of KRW 49.5 billion are expected to be gained on the basis of 2011 figures.
In the case of the system to include research and human resource development reserves in deductible expenses to allow businesses to prepare R&D investment funds using their profits, given its effectiveness or equity between businesses in terms of their size, it is advisable to have it abolished in the future.
The tax credits for social insurance premiums that are granted to small and medium-sized enterprises (SMEs) that increase their hiring were introduced to support employment at SMEs as part of the revision of the tax code in 2011. Given the impact of social insurance premiums on employment at SMEs, the expiry date of this program should be extended, but administrative coordination is required to prevent any duplicate government spending on this program.
The tax credit program to improve the promissory note system was introduced to prevent SMEs' financial distress and chain bankruptcies. Considering the tax credit concentration on SMEs, the effectiveness of the program, and the reduction in cash payment ratio, it is appropriate to maintain this program.
The tax credit program for electronic tax receipt issuance was introduced to settle the e-commerce tax receipt system early. As the program is not effective since the system is currently mandatory for corporations, it needs to be suspended only for individuals for a certain period of time.
The special tax treatment system for the input tax credit for gold, which has a low level of effectiveness, needs to be abolished in that the administration currently seeks to open a gold exchange to make gold transactions official, and finds ways to expand the tax base.
(3) Reviews of Items to Expire in 2014
The tax credit program for job creation investment created during the 2011 tax reforms (formerly a tax credit program for temporary investment) aims at business cycle control through investment expansion and job creation. Therefore, the abolition of its basic deduction at the expiry date needs to be taken into consideration after close examination of the business environment. This program was introduced due to the need for job creation, doubts over the effects of tax credits for temporary investments on business cycle control, and the reversion of deductions to large companies. During the 2012 tax reforms, basic and additional deduction rates for large companies were changed from 4% + 2% to 3% + 3%. The basic deduction rate was further reduced to 2% at the extra session of the National Assembly on July 2, 2013. The income deduction program for credit card consumption needs to be switched to the tax credit program considering that the political objectives of the former have already been achieved, the income deduction system has a regressive nature, and credit card use is not a necessary expense as it was introduced for the political purpose of encouraging credit card consumption. Once the tax credit program is settled, lowering the tax credit rate can be reviewed. The reduction in the tax credit rate for credit cards from 15% to 10% that the administration is pursuing currently will not affect the value of expenditure per capita because credit card use is generally dependent on the possibility of increasing tax credits.
For the zero rate VAT for agricultural, stockbreeding, and forestry machinery and equipment, given that a variety of tax, financial, and fiscal support initiatives are currently provided for the agricultural and fisheries sectors, tax incentives, one of the direct budget support schemes, need to be reduced. Therefore, the application of the zero rate needs to be reduced in phases.
Special tax expenditures for SMEs were designed to support financially vulnerable SMEs through a given rate of tax breaks. Even though the utilization rate of tax expenditures is high, their eligibility needs to be adjusted to realize equal and uniform taxation and improve the efficiency of tax breaks. Considering that the gains of the SMEs in the top 10% are 57 times higher than those of large companies in the bottom 10%, uniform tax benefits for SMEs are not desirable.
The special tax treatment system in corporate tax for associative cooperatives was introduced in consideration of the compliance costs stemming from the reduction in their organization scale. Given the loss of its purpose, tax equity with other ordinary businesses, and overlap with general government spending projects, its abolishment needs to be cautiously reviewed. As agricultural or fisheries cooperative federations increasingly compete with ordinary companies in the areas of sales, distribution, and credit facility, they are being changed to general business entities. As such, the application of the special tax treatment system results in the undermining of tax equity.
In the cases of the tax-exempt savings plan for the elderly or the disabled and the tax-preferential comprehensive savings plan, revisions to tax credit requirements and rescinding them upon expiration need to be reviewed in that their overall effectiveness is not high enough to trigger behavioral changes. The value of tax expenditures stemming from both plans stood at KRW 500 billion in 2012, while the benefits per person were merely between KRW 15,000 per annum (tax-preferential comprehensive savings plan) and KRW 126,000 per annum (tax-exempt savings plan for the elderly or the disabled). It is recommended to abolish the special tax treatment for the tax-preferential comprehensive savings plan upon expiration as it has been applied regardless of income level and its effectiveness is low. For the tax-exempt savings plan for the elderly or the disabled, its entire tax expenditure needs to be maintained, but its benefits should be concentrated on actual low income earners. Furthermore, income requirements should be newly established, and the current upper saving limit per person of KRW 30 million needs to be raised.
The corporate and income tax expenditures for companies that are relocated from the Seoul Metropolitan area to non-overpopulation control areas need to be abolished at the sunset date in that KRW 100 billion per annum in subsidies is presently allocated and the number of companies relocating to provinces is decreasing. For the program to include all reserves for proper purpose businesses in deductible expenses for schools, as most of non-profit corporations having a medical corporation use the program to avoid paying corporate taxes, and both national and private university hospitals receive financial support from the government, the abolishment of the program would increase the revenues from corporate taxes by KRW 100 billion.
(4) Tax Revenue Effects
The National Assembly Budget Office (NABO) selected 20 key items subject to tax expenditures that are to expire in 2013 and 2014 for analysis and proposed the abolition and curtailment of 17 items (85%). The execution of NABO's proposal would bring an increase in tax revenues (if levied) of a total of KRW 10.5 trillion consisting of KRW 6.5 trillion in corporate tax, KRW 2.2 trillion in value added tax, and KRW 1.8 trillion in income tax during the 2014-2017 period. While the NABO proposal allows the revenue from corporate tax to account for 62% on the entire proposed revenue increase, the administration's tax reforms currently under discussion seem to have insufficient plans to revamp tax expenditures relating to corporate taxes. The expected annual revenue increase through the NABO's proposal (an average of KRW 2.6 trillion for four years) would stand at 26% of a total of KRW 10 trillion, which is the annual average tax expenditure amount for the items set to expire in 2013 and 2014.
4. Summary and Implications
Pre-control measures need to be strengthened in the legislative process, in addition to the improvement of the current tax expenditure programs through the termination of less effective items at their sunset dates, elimination of tax break programs that also benefit from government spending projects, and granting of tax credits, rather than income deductions, for the items of a strong political nature. The tax expenditure performance management system in force from this year is likely to tighten up the evaluation of tax expenditures. In addition to this, however, it should be mandatory to submit to the National Assembly the tax expenditure evaluation report and the recommendations, which are currently used only as internal data for the government. Furthermore, although the special tax treatment system causes problems with tax equity among tax payers and with economic behavior, it is not sufficiently assessed, and only the cost estimates for legislative proposals are conducted in connection with the changes in tax revenues resulting from the special tax treatment system. In the UK, tax information and impact notes (TIINs) are published to assess the implications of a tax expenditure bill in advance. Starting in 2011, the UK analyzes the size of reductions in tax revenues and their economic impact before implementing new tax reduction measures.
Chae Eun-dong
Tax expenditure programs, introduced for certain policy objectives, have been perpetuated and have given rise to vested interests, resulting in an annual revenue loss of KRW 30 trillion. For this reason, the administration indicated that its stance will be to abolish tax expenditures for certain tax items that are to expire, with no exceptions, on the basis of the sunset principle. The administration announced its financing plans to carry out its campaign pledges. As part of the plans, the administration will raise a total of KRW 18 trillion during the 2013-2017 period by revamping tax expenditure programs. As such, this report first proposes rules to revamp the current tax expenditure programs and analyzes 20 major items currently subject to tax expenditures that are to expire in 2013 and 2014 to find methods of revamping tax expenditures. The possible increase in tax revenues from such proposed modifications is also estimated.
2. Current Operation of Tax Expenditures
The Ministry of Strategy and Finance announced that there were 228 items subject to tax expenditures with a combined amount of KRW 29.8 trillion as of 2013. However, the statistics announced by the administration have several errors in that they differ from the data released in 2012, revisions of tax laws made in 2012 have not been reflected, and some items were omitted. After correcting these errors, it was found that there were 218 items eligible for tax expenditures with an amount of KRW 32.6 trillion in 2013.
Tax expenditures under operation have the following characteristics. First, the items eligible for tax expenditures that went into effect longer ago are more likely to have no sunset provisions and have higher tax expenditure amounts. While the average amount of tax credits for the 67 items newly enforced after 2008 was KRW 17.7 billion, that for the 89 items newly enforced before 1998 was as high as KRW 236.8 billion. Second, the tax expenditure amount from the ten highest tax expenditure items (KRW 16.5 trillion) accounts for more than a half of the total tax expenditure amount (KRW 32.6 trillion) and has been operated for more than ten years. Third, the three tax items accounted for a substantial portion (KRW 27.6 trillion) of all items: KRW 14 trillion for income tax, KRW 8 trillion for corporate tax, and KRW 5 trillion for value added tax. Fourth, although each of the previous administrations announced its plans to expand financial resources through the overhaul of tax expenditures, the tax expenditure amount has continued to grow. Since 1998, the five-year average amount of tax expenditure in national taxes has increased by about KRW 10 trillion (or 0.3%p of GDP): KRW 12 trillion (2.0% of GDP) for the People's Government (President Kim Dae-jung), KRW 20 trillion (2.3% of GDP) for the Participatory Government (President Roh Mu-hyun), and KRW 30 trillion (2.6% of GDP) for the Pragmatic Government (President Lee Myung-bak). Fifth, the administration proposed its plan to revamp the program by abolishing 17 items among 102 items that would expire at the end of 2012. However, the National Assembly's reviews discovered that only 11 items, equivalent to KRW 26.5 billion, were abolished. Although the government originally intended to abolish tax credits for individuals, those who were benefitting from the tax credits refused to pay taxes, making it difficult to revamp tax expenditures, the National Assembly and the administration only tightened the limit of tax expenditures for individuals' income tax and the corporate tax in revising tax laws in 2012.
3. Approach to Revamping Tax Expenditure Programs
(1) Revamping Rules
The rules to revamp the current tax expenditures based on tax reform principles are proposed as follows. First, in order to improve the current practice where tax expenditures create vested rights through an extension of sunset date, any tax expenditure program or scheme that has an insignificant effect needs to be abolished according to its sunset provision. The abolition of tax expenditure programs according to their sunset clauses would generate stable revenues and eliminate tax benefits perpetuated for certain classes. Second, if tax incentives are provided on an item in addition to government subsidies, the tax incentives need to be enforced from mid- and long-term perspectives and, moreover, eliminated, unless the tax incentives have more significant effects than the government subsidies. Third, items eligible for income deductions implemented for political purposes need to be subjected to tax credits to resolve the problem of vertical inequalities arising from income deduction programs. While tax credits are more appropriate for items required for the public interest such as credit cards, income deductions are more suitable for necessary expense items such as medical fees.
(2) Reviews of Items to Expire in 2013
For the special tax treatment system for the input tax credit for the recycling of waste resources, given the fact that it may distort VAT, it is advisable to eliminate it. However, considering the economic circumstances of petty waste resource collectors, it can be reviewed to reduce or abolish it in phases. Although the deemed input tax credit was introduced to eliminate the cascade effect and catch-up effect, the system is used to preserve the income of the waste resource collectors, and furthermore, wrongfully used for tax evasion through transactions without authentic documentation because waste resources do not incur the cascade effect.
In the case of tax credit programs introduced with consideration for the external effects of energy conservation and environmental preservation facilities, their sunset dates need to be extended, but their tax credit rates should be adjusted in consideration of the concentration of tax benefits on large companies, the effects of investment expansion, and the balance with other investment-related tax credit programs. According to 2011 tax returns, more than 95% of the deductions under these tax credit programs were concentrated on large companies, and the correlation coefficient between the tax credit rate and investment amount was 0.18 for energy facilities and –0.63 for environmental preservation facilities, indicating that the effects of the programs were not significant. Even though the programs need to be maintained considering their externalities, the current deduction rate (10%) should be reduced in comparison with other investment tax credit programs, and items under these programs need to be selected based on more rigorous evaluations of external effects.
For the special tax treatment system for cash receipt issuing businesses and cash receipt merchants, if the government abolishes tax benefits for the voluntarily issued cash receipts of less than KRW 5,000, which are susceptible to excessive issuance to obtain more deductions, revenues of KRW 49.5 billion are expected to be gained on the basis of 2011 figures.
In the case of the system to include research and human resource development reserves in deductible expenses to allow businesses to prepare R&D investment funds using their profits, given its effectiveness or equity between businesses in terms of their size, it is advisable to have it abolished in the future.
The tax credits for social insurance premiums that are granted to small and medium-sized enterprises (SMEs) that increase their hiring were introduced to support employment at SMEs as part of the revision of the tax code in 2011. Given the impact of social insurance premiums on employment at SMEs, the expiry date of this program should be extended, but administrative coordination is required to prevent any duplicate government spending on this program.
The tax credit program to improve the promissory note system was introduced to prevent SMEs' financial distress and chain bankruptcies. Considering the tax credit concentration on SMEs, the effectiveness of the program, and the reduction in cash payment ratio, it is appropriate to maintain this program.
The tax credit program for electronic tax receipt issuance was introduced to settle the e-commerce tax receipt system early. As the program is not effective since the system is currently mandatory for corporations, it needs to be suspended only for individuals for a certain period of time.
The special tax treatment system for the input tax credit for gold, which has a low level of effectiveness, needs to be abolished in that the administration currently seeks to open a gold exchange to make gold transactions official, and finds ways to expand the tax base.
(3) Reviews of Items to Expire in 2014
The tax credit program for job creation investment created during the 2011 tax reforms (formerly a tax credit program for temporary investment) aims at business cycle control through investment expansion and job creation. Therefore, the abolition of its basic deduction at the expiry date needs to be taken into consideration after close examination of the business environment. This program was introduced due to the need for job creation, doubts over the effects of tax credits for temporary investments on business cycle control, and the reversion of deductions to large companies. During the 2012 tax reforms, basic and additional deduction rates for large companies were changed from 4% + 2% to 3% + 3%. The basic deduction rate was further reduced to 2% at the extra session of the National Assembly on July 2, 2013. The income deduction program for credit card consumption needs to be switched to the tax credit program considering that the political objectives of the former have already been achieved, the income deduction system has a regressive nature, and credit card use is not a necessary expense as it was introduced for the political purpose of encouraging credit card consumption. Once the tax credit program is settled, lowering the tax credit rate can be reviewed. The reduction in the tax credit rate for credit cards from 15% to 10% that the administration is pursuing currently will not affect the value of expenditure per capita because credit card use is generally dependent on the possibility of increasing tax credits.
For the zero rate VAT for agricultural, stockbreeding, and forestry machinery and equipment, given that a variety of tax, financial, and fiscal support initiatives are currently provided for the agricultural and fisheries sectors, tax incentives, one of the direct budget support schemes, need to be reduced. Therefore, the application of the zero rate needs to be reduced in phases.
Special tax expenditures for SMEs were designed to support financially vulnerable SMEs through a given rate of tax breaks. Even though the utilization rate of tax expenditures is high, their eligibility needs to be adjusted to realize equal and uniform taxation and improve the efficiency of tax breaks. Considering that the gains of the SMEs in the top 10% are 57 times higher than those of large companies in the bottom 10%, uniform tax benefits for SMEs are not desirable.
The special tax treatment system in corporate tax for associative cooperatives was introduced in consideration of the compliance costs stemming from the reduction in their organization scale. Given the loss of its purpose, tax equity with other ordinary businesses, and overlap with general government spending projects, its abolishment needs to be cautiously reviewed. As agricultural or fisheries cooperative federations increasingly compete with ordinary companies in the areas of sales, distribution, and credit facility, they are being changed to general business entities. As such, the application of the special tax treatment system results in the undermining of tax equity.
In the cases of the tax-exempt savings plan for the elderly or the disabled and the tax-preferential comprehensive savings plan, revisions to tax credit requirements and rescinding them upon expiration need to be reviewed in that their overall effectiveness is not high enough to trigger behavioral changes. The value of tax expenditures stemming from both plans stood at KRW 500 billion in 2012, while the benefits per person were merely between KRW 15,000 per annum (tax-preferential comprehensive savings plan) and KRW 126,000 per annum (tax-exempt savings plan for the elderly or the disabled). It is recommended to abolish the special tax treatment for the tax-preferential comprehensive savings plan upon expiration as it has been applied regardless of income level and its effectiveness is low. For the tax-exempt savings plan for the elderly or the disabled, its entire tax expenditure needs to be maintained, but its benefits should be concentrated on actual low income earners. Furthermore, income requirements should be newly established, and the current upper saving limit per person of KRW 30 million needs to be raised.
The corporate and income tax expenditures for companies that are relocated from the Seoul Metropolitan area to non-overpopulation control areas need to be abolished at the sunset date in that KRW 100 billion per annum in subsidies is presently allocated and the number of companies relocating to provinces is decreasing. For the program to include all reserves for proper purpose businesses in deductible expenses for schools, as most of non-profit corporations having a medical corporation use the program to avoid paying corporate taxes, and both national and private university hospitals receive financial support from the government, the abolishment of the program would increase the revenues from corporate taxes by KRW 100 billion.
(4) Tax Revenue Effects
The National Assembly Budget Office (NABO) selected 20 key items subject to tax expenditures that are to expire in 2013 and 2014 for analysis and proposed the abolition and curtailment of 17 items (85%). The execution of NABO's proposal would bring an increase in tax revenues (if levied) of a total of KRW 10.5 trillion consisting of KRW 6.5 trillion in corporate tax, KRW 2.2 trillion in value added tax, and KRW 1.8 trillion in income tax during the 2014-2017 period. While the NABO proposal allows the revenue from corporate tax to account for 62% on the entire proposed revenue increase, the administration's tax reforms currently under discussion seem to have insufficient plans to revamp tax expenditures relating to corporate taxes. The expected annual revenue increase through the NABO's proposal (an average of KRW 2.6 trillion for four years) would stand at 26% of a total of KRW 10 trillion, which is the annual average tax expenditure amount for the items set to expire in 2013 and 2014.
4. Summary and Implications
Pre-control measures need to be strengthened in the legislative process, in addition to the improvement of the current tax expenditure programs through the termination of less effective items at their sunset dates, elimination of tax break programs that also benefit from government spending projects, and granting of tax credits, rather than income deductions, for the items of a strong political nature. The tax expenditure performance management system in force from this year is likely to tighten up the evaluation of tax expenditures. In addition to this, however, it should be mandatory to submit to the National Assembly the tax expenditure evaluation report and the recommendations, which are currently used only as internal data for the government. Furthermore, although the special tax treatment system causes problems with tax equity among tax payers and with economic behavior, it is not sufficiently assessed, and only the cost estimates for legislative proposals are conducted in connection with the changes in tax revenues resulting from the special tax treatment system. In the UK, tax information and impact notes (TIINs) are published to assess the implications of a tax expenditure bill in advance. Starting in 2011, the UK analyzes the size of reductions in tax revenues and their economic impact before implementing new tax reduction measures.
Chae Eun-dong