1. Introduction
In Korea, fiscal demand is expected to increase rapidly due to the low fertility rate, aging population, and maturity of welfare systems. It is not easy, however, to secure additional tax revenues due to many problems including the financial crisis in Europe, stagnation in domestic demand, and high unemployment among young people. As a means to realize tax equity and secure additional tax revenue, full imposition of the minority stockholders' capital gains tax can be considered. This scheme is enforced in most advanced countries, and the Ministry of Strategy and Finance also announced its intention to expand the taxpayer base by gradually easing the requirements of major stockholders in imposing capital gains taxes on them.
The administration's approach to ease the qualifications of major stockholders can hardly be regarded as a practical taxation method as the number of people falling under the category is not high enough, and it is an intermittent and short-term approach. The stock market needs a mid- and long-term taxation program. The number of transfers of listed stocks by major stockholders in 2011 stood at a mere 1,488 cases, making the administration's approach inappropriate for an effective taxation scheme. To broaden the tax base, therefore, it merits consideration to fully impose taxes on the minority stockholders' capital gains on listed shares, which are currently exempted as per the Income Tax Act. In this case, a mid- and long-term taxation plan is required to include financial derivatives, to gradually expand the capital gains tax, and to lower the transaction tax rate.
This report intends to propose a mid- and long-term taxation plan for the stock market by considering the two schemes: the capital gains tax and the transaction tax that needs to be lowered as the capital gains tax gradually expands. It also suggests ways to estimate tax revenues generated through the proposed approach and analyzes the tax revenue effect and the tax incidence effect for each stock market circumstance (i.e. boom, rally, and bust).
2. Current Stock Market
The market capitalization of listed companies in Korea has grown quantitatively from KRW 78 trillion in 1997 to KRW 1,272 trillion in 2012. The market capitalization as a percentage of nominal GDP also grew qualitatively to 99.3% in 2012. The listed stock markets in Korea are divided into the Korea Exchange and the KOSDAQ, both of which have continued to grow with fluctuations in market capitalization and trading value. The KOSPI market, about 10 times larger than the KOSDAQ, has led the growth of the entire stock market with a value of KRW 1,154 trillion as of 2012. With the venture boom in 1999, the KOSDAQ market grew sharply, but when the dot-com capital bubble later burst, its market capitalization fell sharply from KRW 99 trillion to KRW 29 trillion. Thereafter, the market steadily recovered before the global financial crisis deprived it of more than half of its market capitalization. It is presently on track to pick up.
In Korea, for shares, capital gains taxes are imposed partially and securities transaction taxes are levied entirely, while financial derivatives are non-taxable. Taxation standards for shares held by individuals differ depending on the type of share. In the case of a transfer of unlisted stocks by individuals, taxes are imposed on all shareholders including minority shareholders, while in the case of listed stocks, taxes are only imposed on individuals who are qualified as a major shareholder. Capital gains taxes were not imposed on minority shareholders most likely in an attempt to mobilize savings and accumulate capital through the stock market in the early stages of industrialization. For stock trading, not only capital gains tax but also transaction tax is imposed. At present, securities transaction tax is levied at 0.15% of the transfer amount for listed stocks and 0.5% of the transfer amount for unlisted stocks; and 0.15% of the transfer amount for listed stocks is imposed as a special tax for rural development.
3. Necessity for the Tax and Foreign Case Studies
At the moment, changes to the minority stockholders' capital gains tax system necessitate discussion for the following reasons. First, the market capitalization of the securities market as a percentage of nominal GDP rose qualitatively and quantitatively from 15.4% in 1997 to 99.3% in 2012. Second, inequity in tax burdens or in taxation among income categories leads to the distortion of investment. The tax exemption of capital gains on shares, which tend to arise more for higher income earners, might cause vertical inequity. The tax exemption of minority stockholders' capital gains on shares is a violation of equity in income categories in that capital gains on land and buildings, financial assets such as interest and dividends, and earned income are all taxable. Third, most OECD countries fully impose tax on capital gains on securities and financial derivatives with the exception of some countries that make all of them non-taxable or levy transaction taxes only. Fourth, in Japan, only transaction taxes had been imposed, but capital gains on shares were taxed across the board in April 1989 immediately before the country entered into a protracted slump. Japan succeeded in its gradual shift from the system of securities transaction tax to the system of capital gains tax on shares. Fifth, if during the introductory stage of this tax, the minimum taxable amount is set high and the transaction tax rate is lowered, a majority of minority shareholders with capital gains of less than the minimum taxable amount can be tax-exempt and subject to a low transaction rate, thereby lowering their overall tax burden.
Most major advanced countries enforce a capital gains tax on shares. In the US, since 1913 when the Federal Income Tax was enacted, capital gains on shares have been taxed in the same way as ordinary income. In the UK, the short-term capital gains on shares were added to ordinary income for taxation starting in 1962. At present, the capital gains tax rate is between 18% and 28% depending on the income bracket, and a securities transaction tax (0.5%) is also imposed in the form of a stamp tax. As mentioned earlier, Japan is the only country that has successfully shifted its taxation system from the transaction tax to the capital gains tax. In Japan, as of 2012, the tax rate of capital gains on listed stocks was 20% (income tax of 15% and local tax of 5%) figured separately from ordinary income. In Japan, small-amount investment in listed stocks is non-taxable. The 11 EU finance ministers have recently finally approved the introduction of a financial transaction tax on financial products such as stocks, bonds, and financial derivatives, separately from the existing capital gains tax.
4. Mid- and Long-Term Taxation Plans for the Stock Market
It should be considered, in principle, to separately impose taxes at 20% on annual capital gains on shares exceeding KRW 10 million as a standard (long-term) plan. However, as a transitional plan to minimize the market impact at the initial stage, the minimum taxable amount can be set at KRW 30 million with the tax rate of 10%, and the transaction tax rate can be lowered to 0.25%. Then, over time, the minimum taxable amount (= basic deduction) can be lowered gradually to expand the tax base and the tax rate can be raised. Considering the separate taxation scheme employed by most OECD countries to prevent an excessive tax burden and streamline the taxation process, it merits consideration to separately impose capital gains taxes on shares like capital gains taxes on other assets and not to include them in the composite financial income.
(Transitional plan) To cushion the market impact and generate tax revenues exceeding a certain amount, setting the minimum taxable amount at KRW 30 million and the tax rate at 10% and lowering the transaction rate for minority shareholders should be considered. The taxable amount of KRW 30 million is proposed considering that the minimum taxable amount for composite financial income was lowered from KRW 40 million to KRW 20 million in the tax law revisions in 2012; that tax revenues are expected to be generated even with a stagnant stock market (2011); and that most minority shareholders who realize small gains are likely to be exempt from the capital gains tax. Furthermore, under this transitional plan, minority shareholders with annual capital gains exceeding KRW 30 million are subject to the capital gains tax but are eligible for a lowered transaction tax rate. Therefore, most minority shareholders who realize small gains can have their tax burden mitigated.
(Long-term plan) For capital gains of over KRW 10 million, it would be proper to apply the tax rate of 20% for the transfer of shares held for less than one year and the preferential tax rate of 10% for those held for one year or longer. The minimum taxable amount is proposed to be KRW 10 million on grounds that annual capital gains of KRW 3 million to 30 million are tax exempt in major advanced countries where the capital gains tax on shares is already in full force. Given the fact that the current tax rate for major shareholders' transfer of large companies' stocks held for less than one year is 30%, it would be advisable to set the rate for minority shareholders at 20%, in principle, while reducing it to 10% for stocks held for one year or longer. In general, advanced countries regard assets held for one year or longer as 'long-term investments' and provide the benefit of reducing the tax rate: UK (six months), US (one year), France (two years), and Japan (five years).
5. Analysis of Tax Revenue Effects
The previously announced tax revenue effects from a minority stockholders' capital gains tax were estimated mostly based on the total market capitalization. This approach had the problems that tax revenues from capital gains on shares relied heavily on the stock market conditions and tax revenues were not generated when the market capitalization declined. If annual market capitalization for each issue is calculated separately and all estimates are summed, tax revenues will be generated even during a bear market. However, the approach of imposing the capital gains tax only on the issues of which market capitalization has increased may result in overestimation of tax revenues. As such, in this report, virtual shareholders were created by reflecting the investment behavior of financial investors, each of them with randomly formulated virtual portfolios consisting of real issues. In this model, the amount of capital gains of each virtual portfolio was determined according to its annual return rate.
The analysis of the 2012 stock market through this virtual shareholder simulation revealed that 3.2 million virtual minority shareholders (57%) experienced gains, 2.4 million virtual minority shareholders (43%) sustained losses, and 410,000 virtual minority shareholders (7%) had capital gains of KRW 30 million or more. If the transitional plan is introduced into this scenario, the revenue from transaction taxes is estimated to fall by KRW 0.9 trillion, but KRW 1.9 trillion of capital gains taxes is levied on 380,000 virtual minority shareholders, thereby increasing the total tax revenue by KRW 1 trillion. If the long-term plan under which the minimum taxable amount is KRW 10 million won and the transaction tax rate is maintained at 0.1% is adopted in this scenario, the revenue from transaction taxes is KRW 1.8 trillion, and the revenue from capital gains taxes stands at KRW 6.3 trillion, totaling KRW 8.1 trillion in tax revenues, KRW 2.7 trillion higher than tax revenues under the current tax laws. In short, when the stock market is bullish (2012), it is possible to change from the transaction tax scheme to the capital gains tax scheme without witnessing a decline in the total tax revenue.
In light of the tax incidence effect for 2012 under the transitional plan, there are 5.2 million virtual minority shareholders (93%) with their capital gains being less than the minimum taxable amount (KRW 30 million). Therefore, if the transitional plan including the reduction in the transaction tax rate is enforced, the tax burden per capita is reduced by an average of KRW 150,000, resulting in a total tax burden reduction of KRW 770 billion. On the other hand, 377,000 virtual minority shareholders with capital gains being KRW 30 million or more is imposed with an additional KRW 1.8 trillion in capital gains taxes, thereby increasing the total tax revenue by KRW 1 trillion.
Chae Eun-dong
In Korea, fiscal demand is expected to increase rapidly due to the low fertility rate, aging population, and maturity of welfare systems. It is not easy, however, to secure additional tax revenues due to many problems including the financial crisis in Europe, stagnation in domestic demand, and high unemployment among young people. As a means to realize tax equity and secure additional tax revenue, full imposition of the minority stockholders' capital gains tax can be considered. This scheme is enforced in most advanced countries, and the Ministry of Strategy and Finance also announced its intention to expand the taxpayer base by gradually easing the requirements of major stockholders in imposing capital gains taxes on them.
The administration's approach to ease the qualifications of major stockholders can hardly be regarded as a practical taxation method as the number of people falling under the category is not high enough, and it is an intermittent and short-term approach. The stock market needs a mid- and long-term taxation program. The number of transfers of listed stocks by major stockholders in 2011 stood at a mere 1,488 cases, making the administration's approach inappropriate for an effective taxation scheme. To broaden the tax base, therefore, it merits consideration to fully impose taxes on the minority stockholders' capital gains on listed shares, which are currently exempted as per the Income Tax Act. In this case, a mid- and long-term taxation plan is required to include financial derivatives, to gradually expand the capital gains tax, and to lower the transaction tax rate.
This report intends to propose a mid- and long-term taxation plan for the stock market by considering the two schemes: the capital gains tax and the transaction tax that needs to be lowered as the capital gains tax gradually expands. It also suggests ways to estimate tax revenues generated through the proposed approach and analyzes the tax revenue effect and the tax incidence effect for each stock market circumstance (i.e. boom, rally, and bust).
2. Current Stock Market
The market capitalization of listed companies in Korea has grown quantitatively from KRW 78 trillion in 1997 to KRW 1,272 trillion in 2012. The market capitalization as a percentage of nominal GDP also grew qualitatively to 99.3% in 2012. The listed stock markets in Korea are divided into the Korea Exchange and the KOSDAQ, both of which have continued to grow with fluctuations in market capitalization and trading value. The KOSPI market, about 10 times larger than the KOSDAQ, has led the growth of the entire stock market with a value of KRW 1,154 trillion as of 2012. With the venture boom in 1999, the KOSDAQ market grew sharply, but when the dot-com capital bubble later burst, its market capitalization fell sharply from KRW 99 trillion to KRW 29 trillion. Thereafter, the market steadily recovered before the global financial crisis deprived it of more than half of its market capitalization. It is presently on track to pick up.
In Korea, for shares, capital gains taxes are imposed partially and securities transaction taxes are levied entirely, while financial derivatives are non-taxable. Taxation standards for shares held by individuals differ depending on the type of share. In the case of a transfer of unlisted stocks by individuals, taxes are imposed on all shareholders including minority shareholders, while in the case of listed stocks, taxes are only imposed on individuals who are qualified as a major shareholder. Capital gains taxes were not imposed on minority shareholders most likely in an attempt to mobilize savings and accumulate capital through the stock market in the early stages of industrialization. For stock trading, not only capital gains tax but also transaction tax is imposed. At present, securities transaction tax is levied at 0.15% of the transfer amount for listed stocks and 0.5% of the transfer amount for unlisted stocks; and 0.15% of the transfer amount for listed stocks is imposed as a special tax for rural development.
3. Necessity for the Tax and Foreign Case Studies
At the moment, changes to the minority stockholders' capital gains tax system necessitate discussion for the following reasons. First, the market capitalization of the securities market as a percentage of nominal GDP rose qualitatively and quantitatively from 15.4% in 1997 to 99.3% in 2012. Second, inequity in tax burdens or in taxation among income categories leads to the distortion of investment. The tax exemption of capital gains on shares, which tend to arise more for higher income earners, might cause vertical inequity. The tax exemption of minority stockholders' capital gains on shares is a violation of equity in income categories in that capital gains on land and buildings, financial assets such as interest and dividends, and earned income are all taxable. Third, most OECD countries fully impose tax on capital gains on securities and financial derivatives with the exception of some countries that make all of them non-taxable or levy transaction taxes only. Fourth, in Japan, only transaction taxes had been imposed, but capital gains on shares were taxed across the board in April 1989 immediately before the country entered into a protracted slump. Japan succeeded in its gradual shift from the system of securities transaction tax to the system of capital gains tax on shares. Fifth, if during the introductory stage of this tax, the minimum taxable amount is set high and the transaction tax rate is lowered, a majority of minority shareholders with capital gains of less than the minimum taxable amount can be tax-exempt and subject to a low transaction rate, thereby lowering their overall tax burden.
Most major advanced countries enforce a capital gains tax on shares. In the US, since 1913 when the Federal Income Tax was enacted, capital gains on shares have been taxed in the same way as ordinary income. In the UK, the short-term capital gains on shares were added to ordinary income for taxation starting in 1962. At present, the capital gains tax rate is between 18% and 28% depending on the income bracket, and a securities transaction tax (0.5%) is also imposed in the form of a stamp tax. As mentioned earlier, Japan is the only country that has successfully shifted its taxation system from the transaction tax to the capital gains tax. In Japan, as of 2012, the tax rate of capital gains on listed stocks was 20% (income tax of 15% and local tax of 5%) figured separately from ordinary income. In Japan, small-amount investment in listed stocks is non-taxable. The 11 EU finance ministers have recently finally approved the introduction of a financial transaction tax on financial products such as stocks, bonds, and financial derivatives, separately from the existing capital gains tax.
4. Mid- and Long-Term Taxation Plans for the Stock Market
It should be considered, in principle, to separately impose taxes at 20% on annual capital gains on shares exceeding KRW 10 million as a standard (long-term) plan. However, as a transitional plan to minimize the market impact at the initial stage, the minimum taxable amount can be set at KRW 30 million with the tax rate of 10%, and the transaction tax rate can be lowered to 0.25%. Then, over time, the minimum taxable amount (= basic deduction) can be lowered gradually to expand the tax base and the tax rate can be raised. Considering the separate taxation scheme employed by most OECD countries to prevent an excessive tax burden and streamline the taxation process, it merits consideration to separately impose capital gains taxes on shares like capital gains taxes on other assets and not to include them in the composite financial income.
(Transitional plan) To cushion the market impact and generate tax revenues exceeding a certain amount, setting the minimum taxable amount at KRW 30 million and the tax rate at 10% and lowering the transaction rate for minority shareholders should be considered. The taxable amount of KRW 30 million is proposed considering that the minimum taxable amount for composite financial income was lowered from KRW 40 million to KRW 20 million in the tax law revisions in 2012; that tax revenues are expected to be generated even with a stagnant stock market (2011); and that most minority shareholders who realize small gains are likely to be exempt from the capital gains tax. Furthermore, under this transitional plan, minority shareholders with annual capital gains exceeding KRW 30 million are subject to the capital gains tax but are eligible for a lowered transaction tax rate. Therefore, most minority shareholders who realize small gains can have their tax burden mitigated.
(Long-term plan) For capital gains of over KRW 10 million, it would be proper to apply the tax rate of 20% for the transfer of shares held for less than one year and the preferential tax rate of 10% for those held for one year or longer. The minimum taxable amount is proposed to be KRW 10 million on grounds that annual capital gains of KRW 3 million to 30 million are tax exempt in major advanced countries where the capital gains tax on shares is already in full force. Given the fact that the current tax rate for major shareholders' transfer of large companies' stocks held for less than one year is 30%, it would be advisable to set the rate for minority shareholders at 20%, in principle, while reducing it to 10% for stocks held for one year or longer. In general, advanced countries regard assets held for one year or longer as 'long-term investments' and provide the benefit of reducing the tax rate: UK (six months), US (one year), France (two years), and Japan (five years).
5. Analysis of Tax Revenue Effects
The previously announced tax revenue effects from a minority stockholders' capital gains tax were estimated mostly based on the total market capitalization. This approach had the problems that tax revenues from capital gains on shares relied heavily on the stock market conditions and tax revenues were not generated when the market capitalization declined. If annual market capitalization for each issue is calculated separately and all estimates are summed, tax revenues will be generated even during a bear market. However, the approach of imposing the capital gains tax only on the issues of which market capitalization has increased may result in overestimation of tax revenues. As such, in this report, virtual shareholders were created by reflecting the investment behavior of financial investors, each of them with randomly formulated virtual portfolios consisting of real issues. In this model, the amount of capital gains of each virtual portfolio was determined according to its annual return rate.
The analysis of the 2012 stock market through this virtual shareholder simulation revealed that 3.2 million virtual minority shareholders (57%) experienced gains, 2.4 million virtual minority shareholders (43%) sustained losses, and 410,000 virtual minority shareholders (7%) had capital gains of KRW 30 million or more. If the transitional plan is introduced into this scenario, the revenue from transaction taxes is estimated to fall by KRW 0.9 trillion, but KRW 1.9 trillion of capital gains taxes is levied on 380,000 virtual minority shareholders, thereby increasing the total tax revenue by KRW 1 trillion. If the long-term plan under which the minimum taxable amount is KRW 10 million won and the transaction tax rate is maintained at 0.1% is adopted in this scenario, the revenue from transaction taxes is KRW 1.8 trillion, and the revenue from capital gains taxes stands at KRW 6.3 trillion, totaling KRW 8.1 trillion in tax revenues, KRW 2.7 trillion higher than tax revenues under the current tax laws. In short, when the stock market is bullish (2012), it is possible to change from the transaction tax scheme to the capital gains tax scheme without witnessing a decline in the total tax revenue.
In light of the tax incidence effect for 2012 under the transitional plan, there are 5.2 million virtual minority shareholders (93%) with their capital gains being less than the minimum taxable amount (KRW 30 million). Therefore, if the transitional plan including the reduction in the transaction tax rate is enforced, the tax burden per capita is reduced by an average of KRW 150,000, resulting in a total tax burden reduction of KRW 770 billion. On the other hand, 377,000 virtual minority shareholders with capital gains being KRW 30 million or more is imposed with an additional KRW 1.8 trillion in capital gains taxes, thereby increasing the total tax revenue by KRW 1 trillion.
Chae Eun-dong