1. Administration and Streamlining of Tax Expenditures
The Tax Expenditure Proposal which has been submitted with the budget for next year since 2010 pursuant to the National Finance Act reconciles information on tax expenditures, which have the effect of indirect financing, with the classifications of appropriations, and provides projections for next year’s tax expenditures.
According to the 2014 Tax Expenditure Proposal submitted to the National Assembly on the 2nd of October, tax reductions and exemptions will total 33 trillion 169.4 billion won in 2014, 1.4 percent less than the 33 trillion 627.2 billion won in 2013. Consequently, the tax reduction and exemption rate for 2014 (the rate of tax reduction and exemption to total tax revenues) is projected at 13.2 percent, down 0.6 percentage points from 13.8 percent in 2013. The tax reduction and exemption rate has been declining steadily since 2009, when it was 16.7 percent. Tax expenditures will account for 8.5 percent (33.2 trillion won) of the total government expenditures of 390.9 trillion won according to the budget for 2014. The 20 largest programs in 2009 accounted for 71.6 percent of the total tax expenditures granted that year, and the corresponding percentage for these programs in 2014 will be significantly higher-76.2 percent-leading overall tax expenditures. Twelve of these 20 programs are not subject to expiration, or the sunset rule, and the sunset dates for the remaining eight programs have been regularly extended.
This report analyzes the streamlining of tax expenditure programs outlined in the 2014 Tax Expenditure Proposal reflecting the 2013 tax revision plan, and projects that its subsequent impact on tax revenues would reach 8.7 trillion won during the period from 2014 to 2017. This estimation is 0.6 trillion won less than the 9.2 trillion won estimated by the administration. This gap in estimates is due to the difference in major programs including conversion of special deductions to tax credits and imposition of a new limit on deemed input tax credits for agricultural products, as well as the fact that the administration did not include estimations for some programs that would cause a decrease in tax revenues such as tax credits for R&D costs allowed in the service industry.
After calculating the amounts of tax expenditures for 44 tax benefit programs that face sunsetting at the end of 2013, the administration announced that it would eliminate or reduce 34 programs (77 percent): 17 programs will be eliminated and the other 17 programs will be reduced. This report, however, regards only the tax benefit programs of which deduction rates and deductible objects are reduced as programs subject to the “tax expenditure system streamlining” and determines that only 29 programs (66 percent) are actually being eliminated (16) or reduced (13).
In particular, the administration considers the program for tax reduction or exemption related to electronic tax invoicing by businesses as being eliminated, but this tax benefit program continues to apply to sole proprietorships, which in effect means that the program will only be reduced. As to reduction of value added tax for ordinary taxi transportation businesses, which was classified as a program subject to the tax expenditure system streamlining by the administration, the amount of tax expenditures is set to increase in 2014.
2. Analysis of Tax Expenditure Programs by Item
(1) Income Tax
The administration is trying to redefine the special deduction program as tax credits instead of income deductions in order to make the tax code less regressive. However, further in-depth review is needed in consideration of the public policy objectives and effectiveness of each special deduction item. One possibility is to review each special deduction item and continue to treat the deduction items accounted for as necessary expenses as income deductions and to treat the items devised for public policy goals as tax credits. If this program continues to treat all such items as income deductions, a different deduction limit and the like will need to be set for every income level in order to have the same income redistribution effect as tax credits.
The administration suggested in its tax revision plan to retain income deductions but to decrease the deduction rate on credit card spending. However, the public policy objectives have been substantially achieved; credit card spending does not constitute a necessary expense, which is a requirement for income deduction; and deducting credit card spending is likely to have a regressive effect. Given these facts, modification of the current program to adopt the tax credit method may be an option to consider.
The administration seeks to reduce only the deduction rate on credit card spending-from 15 percent to 10 percent-under the current income deduction program. However, analysis shows that per capita tax exemption would not significantly change because credit card spending is mainly used to fill up the deduction limit. In addition, as the original purpose of deductions on credit card spending was to expand the tax base by revealing the revenue sources of the self-employed, a comprehensive review is necessary rather than focusing on minor details. It seems that this program has substantially achieved its policy objectives so far. Conversion of this program into a tax credit program needs to be considered because this program was initiated mainly to serve the policy objective of expanding the tax base, credit card spending may not be incurred for necessary expenses (i.e. double deduction when paying medical expenses or education expenses with a credit card), and the program has a regressive effect.
(2) Corporation Tax
It is acknowledged that tax credit programs for investment in energy-efficient facilities and investment in environmental conservation facilities, which the administration is now moving to sunset, are necessary, but their credit rates, etc. should be adjusted in recognition of the inordinate percentage of the benefits going to large enterprises, their effectiveness, and balance with other tax credit programs.
Large enterprises accounted for over 95 percent (based on the 2011 report) of the credits granted under these programs, and the correlation coefficient between credit rate and investment amount is 0.18 for energy facilities and –0.63 for environmental conservation facilities, showing that the programs have only been of the slightest effectiveness. The administration proposed extending the sunset dates of these programs but with lower deduction rates and applying different rates according to the sizes of enterprises. More thorough evaluation is called for concerning the effectiveness of these programs.
A tax credit for improvement of the commercial paper system, which the administration also seeks to sunset, was introduced to prevent a liquidity crisis and a chain reaction of bankruptcies of small and medium enterprises. Considering the recent liquidity crunch, etc. of small and medium enterprises, measures to reduce or maintain the program including adjustment of the deduction rate need to be explored. Based on the 2011 report, out of a total of 42.2 billion won in tax reductions and exemptions, small and medium enterprises accounted for 92.6 percent, or 39.1 billion won, and the cash or cash-equivalent payment ratio rose from 58.6 percent in 2002 to 71.7 percent in 2011. The administration intends to sunset the program on the grounds that enterprises’ cash or cash-equivalent payment ratio increased. However, a more careful approach is required given that the ratio of cash or cash-equivalent payment is dropping and the volume of dishonored commercial paper is increasing as a result of the recent economic slowdown. It seems that the deduction rate needs to be lowered to a certain extent considering the rising ratio of cash and cash-equivalent payment and the improvement in the commercial paper system.
(3) Value Added Tax
The administration is planning to reduce the rates of deemed input tax credits (waste resources 6/106→3/103, used vehicles 9/109→5/105). Considering such facts as distortion of the value added tax system and abuse for fraudulent granting of tax credits, measures to reduce and abolish the deemed input tax credit program in phases need to be explored, but a separate measure is also required to support petty waste resource collectors, etc. to take into account their poor business conditions. This program is acknowledged for having substantially helped achieve its public policy purposes, such as raising the recycling rate of waste materials (as of 2010, 60.5 percent for residential wastes, 72.5 percent for business wastes), but it may be abused to take advantage of the taxation structure of value added tax and to evade taxes through fraudulent granting of tax credits.
In consideration of this program’s ineffectiveness at achieving the policy purposes for corporations that are obligated to issue electronic tax invoices, and the tax compliance costs of sole proprietorships for whom electronic tax invoicing is not yet mandatory, the administration is trying to limit tax benefits to sole proprietorships. However, as sole proprietorships will also be subject to mandatory electronic tax invoicing in the future, reduction of the scope of tax benefits needs to be reviewed. This program was introduced in 2009 in order to help make electronic tax invoicing standard practice as quickly as possible. It became mandatory for corporations in 2011 and for sole proprietorships whose revenues totaled at least one billion won in 2012. In July 2014, the system will expand to include sole proprietorships with at least 300 million won in revenues, so reduction of tax benefits for sole proprietorships should also be reviewed.
The administration’s plan to expire the special input tax deductions for scrap gold is plausible in that this special taxation program was not very effective. Even after the program was implemented, more than half of all gold trades were conducted unofficially. A government-controlled gold exchange is set to open soon, and the tax base needs to be further expanded. The gold exchange will block trading of gold without records (60 percent of current gold trades) and retailers of gold bullion will be obligated to issue cash receipts starting in July 2014 to help expand the tax base, which will render this program completely ineffective.
3. Issues and Measures for Improvement Concerning Preparation of Tax Expenditure Proposal
The 2014 Tax Expenditure Proposal presented some improvements concerning some issues that had been criticized in the past. However, further efforts at rectification and improvement are called for to deal with persistent issues such as lack of consistency in preparing the Tax Expenditure Proposal, appropriation of earned income tax credits in the budget and their management, and extension of the scope of preparation of the Tax Expenditure Proposal.
Out of ten new programs planned under the 2013 tax revision plan, only three were added to the 2014 Tax Expenditure Proposal. Use of the term “memorandum” account to refer to tax expenditures under individual tax laws in the 2013 Tax Expenditure Proposal was excluded, showing inconsistency in preparing the proposal. The earned income tax credit, which is being managed as a tax expenditure, is rather a spending program as the subsidies are granted directly, and is to be expanded to a great extent. In the United States, it is accounted for as an appropriation. In this light, it seems necessary to convert the program from a tax expenditure to an appropriation and manage it as such. In addition, under the Restriction of Special Taxation Act, tax expenditure proposals are prepared for a three-year period including the previous and the following year of the year of preparation. To identify the continued tax revenue effect, it would be necessary to discuss ways to extend the subject period of an expenditure proposal to five years or longer.
4. Ways to Improve Tax Expenditure Budget System
Principles should be established for streamlining of major tax expenditures programs in the 2014 Tax Expenditure Proposal in recognition of the effectiveness of the programs, equity in taxation, and securing tax revenues, and the preliminary evaluation and post implementation evaluation system for the tax expenditure budget system needs to be improved.
First, it is deemed appropriate that in setting up the principles for system streamlining, tax reductions or exemptions for economic activities which do not require strong tax incentives should be excluded in principle; for tax expenditures that effectively serve as subsidies since tax reductions or exemptions are granted to anyone who qualifies for them, the recipients of such tax reductions or exemptions should be limited; and the tax expenditures should not overlap with appropriations. Furthermore, for sunsetting programs, sunsetting should be allowed in principle. However, depending on the findings of detailed performance evaluation, the programs need to be supplemented by such means as redesign or reintroduction.
Second, preliminary evaluation of tax expenditures needs to compare tax expenditures with fiscal programs in order to minimize overlapping with fiscal expenditures. If it is determined that a certain tax expenditure prevails over a fiscal expenditure in terms of effectiveness, practicality, and administrative cost in support of policy, the tax expenditure needs to be allowed, and double support from tax expenditure and fiscal expenditure may be applied as an extraordinary case only when it is clearly effective for policy implementation.
Third, the central administrative agency currently prepares tax reduction or exemption recommendations and evaluation reports for preliminary and follow-up management of special taxation cases under the Restriction of Special Taxation Act, but it is hard to recognize whether such recommendations and evaluation results are adopted. Therefore, it is necessary to seek ways to improve the feedback process for the tax expenditure system, by such means as disclosing the evaluation information and submitting it to the National Assembly
Lastly, for local tax expenditures, which accounted for approximately 60 percent (17.3 trillion won) of total tax expenditures (29.6 trillion won) as of 2011, it is hard to examine the current state of local tax expenditures and their preliminary or follow-up control is inadequate. Accordingly, measures to strengthen the control over non-taxation and over reductions or exemptions of local taxes should be pursued, including mandatory submission of reports on local tax expenditures as well as evaluation reports of and recommendations for reductions or exemptions of local taxes to the National Assembly.
The Tax Expenditure Proposal which has been submitted with the budget for next year since 2010 pursuant to the National Finance Act reconciles information on tax expenditures, which have the effect of indirect financing, with the classifications of appropriations, and provides projections for next year’s tax expenditures.
According to the 2014 Tax Expenditure Proposal submitted to the National Assembly on the 2nd of October, tax reductions and exemptions will total 33 trillion 169.4 billion won in 2014, 1.4 percent less than the 33 trillion 627.2 billion won in 2013. Consequently, the tax reduction and exemption rate for 2014 (the rate of tax reduction and exemption to total tax revenues) is projected at 13.2 percent, down 0.6 percentage points from 13.8 percent in 2013. The tax reduction and exemption rate has been declining steadily since 2009, when it was 16.7 percent. Tax expenditures will account for 8.5 percent (33.2 trillion won) of the total government expenditures of 390.9 trillion won according to the budget for 2014. The 20 largest programs in 2009 accounted for 71.6 percent of the total tax expenditures granted that year, and the corresponding percentage for these programs in 2014 will be significantly higher-76.2 percent-leading overall tax expenditures. Twelve of these 20 programs are not subject to expiration, or the sunset rule, and the sunset dates for the remaining eight programs have been regularly extended.
This report analyzes the streamlining of tax expenditure programs outlined in the 2014 Tax Expenditure Proposal reflecting the 2013 tax revision plan, and projects that its subsequent impact on tax revenues would reach 8.7 trillion won during the period from 2014 to 2017. This estimation is 0.6 trillion won less than the 9.2 trillion won estimated by the administration. This gap in estimates is due to the difference in major programs including conversion of special deductions to tax credits and imposition of a new limit on deemed input tax credits for agricultural products, as well as the fact that the administration did not include estimations for some programs that would cause a decrease in tax revenues such as tax credits for R&D costs allowed in the service industry.
After calculating the amounts of tax expenditures for 44 tax benefit programs that face sunsetting at the end of 2013, the administration announced that it would eliminate or reduce 34 programs (77 percent): 17 programs will be eliminated and the other 17 programs will be reduced. This report, however, regards only the tax benefit programs of which deduction rates and deductible objects are reduced as programs subject to the “tax expenditure system streamlining” and determines that only 29 programs (66 percent) are actually being eliminated (16) or reduced (13).
In particular, the administration considers the program for tax reduction or exemption related to electronic tax invoicing by businesses as being eliminated, but this tax benefit program continues to apply to sole proprietorships, which in effect means that the program will only be reduced. As to reduction of value added tax for ordinary taxi transportation businesses, which was classified as a program subject to the tax expenditure system streamlining by the administration, the amount of tax expenditures is set to increase in 2014.
2. Analysis of Tax Expenditure Programs by Item
(1) Income Tax
The administration is trying to redefine the special deduction program as tax credits instead of income deductions in order to make the tax code less regressive. However, further in-depth review is needed in consideration of the public policy objectives and effectiveness of each special deduction item. One possibility is to review each special deduction item and continue to treat the deduction items accounted for as necessary expenses as income deductions and to treat the items devised for public policy goals as tax credits. If this program continues to treat all such items as income deductions, a different deduction limit and the like will need to be set for every income level in order to have the same income redistribution effect as tax credits.
The administration suggested in its tax revision plan to retain income deductions but to decrease the deduction rate on credit card spending. However, the public policy objectives have been substantially achieved; credit card spending does not constitute a necessary expense, which is a requirement for income deduction; and deducting credit card spending is likely to have a regressive effect. Given these facts, modification of the current program to adopt the tax credit method may be an option to consider.
The administration seeks to reduce only the deduction rate on credit card spending-from 15 percent to 10 percent-under the current income deduction program. However, analysis shows that per capita tax exemption would not significantly change because credit card spending is mainly used to fill up the deduction limit. In addition, as the original purpose of deductions on credit card spending was to expand the tax base by revealing the revenue sources of the self-employed, a comprehensive review is necessary rather than focusing on minor details. It seems that this program has substantially achieved its policy objectives so far. Conversion of this program into a tax credit program needs to be considered because this program was initiated mainly to serve the policy objective of expanding the tax base, credit card spending may not be incurred for necessary expenses (i.e. double deduction when paying medical expenses or education expenses with a credit card), and the program has a regressive effect.
(2) Corporation Tax
It is acknowledged that tax credit programs for investment in energy-efficient facilities and investment in environmental conservation facilities, which the administration is now moving to sunset, are necessary, but their credit rates, etc. should be adjusted in recognition of the inordinate percentage of the benefits going to large enterprises, their effectiveness, and balance with other tax credit programs.
Large enterprises accounted for over 95 percent (based on the 2011 report) of the credits granted under these programs, and the correlation coefficient between credit rate and investment amount is 0.18 for energy facilities and –0.63 for environmental conservation facilities, showing that the programs have only been of the slightest effectiveness. The administration proposed extending the sunset dates of these programs but with lower deduction rates and applying different rates according to the sizes of enterprises. More thorough evaluation is called for concerning the effectiveness of these programs.
A tax credit for improvement of the commercial paper system, which the administration also seeks to sunset, was introduced to prevent a liquidity crisis and a chain reaction of bankruptcies of small and medium enterprises. Considering the recent liquidity crunch, etc. of small and medium enterprises, measures to reduce or maintain the program including adjustment of the deduction rate need to be explored. Based on the 2011 report, out of a total of 42.2 billion won in tax reductions and exemptions, small and medium enterprises accounted for 92.6 percent, or 39.1 billion won, and the cash or cash-equivalent payment ratio rose from 58.6 percent in 2002 to 71.7 percent in 2011. The administration intends to sunset the program on the grounds that enterprises’ cash or cash-equivalent payment ratio increased. However, a more careful approach is required given that the ratio of cash or cash-equivalent payment is dropping and the volume of dishonored commercial paper is increasing as a result of the recent economic slowdown. It seems that the deduction rate needs to be lowered to a certain extent considering the rising ratio of cash and cash-equivalent payment and the improvement in the commercial paper system.
(3) Value Added Tax
The administration is planning to reduce the rates of deemed input tax credits (waste resources 6/106→3/103, used vehicles 9/109→5/105). Considering such facts as distortion of the value added tax system and abuse for fraudulent granting of tax credits, measures to reduce and abolish the deemed input tax credit program in phases need to be explored, but a separate measure is also required to support petty waste resource collectors, etc. to take into account their poor business conditions. This program is acknowledged for having substantially helped achieve its public policy purposes, such as raising the recycling rate of waste materials (as of 2010, 60.5 percent for residential wastes, 72.5 percent for business wastes), but it may be abused to take advantage of the taxation structure of value added tax and to evade taxes through fraudulent granting of tax credits.
In consideration of this program’s ineffectiveness at achieving the policy purposes for corporations that are obligated to issue electronic tax invoices, and the tax compliance costs of sole proprietorships for whom electronic tax invoicing is not yet mandatory, the administration is trying to limit tax benefits to sole proprietorships. However, as sole proprietorships will also be subject to mandatory electronic tax invoicing in the future, reduction of the scope of tax benefits needs to be reviewed. This program was introduced in 2009 in order to help make electronic tax invoicing standard practice as quickly as possible. It became mandatory for corporations in 2011 and for sole proprietorships whose revenues totaled at least one billion won in 2012. In July 2014, the system will expand to include sole proprietorships with at least 300 million won in revenues, so reduction of tax benefits for sole proprietorships should also be reviewed.
The administration’s plan to expire the special input tax deductions for scrap gold is plausible in that this special taxation program was not very effective. Even after the program was implemented, more than half of all gold trades were conducted unofficially. A government-controlled gold exchange is set to open soon, and the tax base needs to be further expanded. The gold exchange will block trading of gold without records (60 percent of current gold trades) and retailers of gold bullion will be obligated to issue cash receipts starting in July 2014 to help expand the tax base, which will render this program completely ineffective.
3. Issues and Measures for Improvement Concerning Preparation of Tax Expenditure Proposal
The 2014 Tax Expenditure Proposal presented some improvements concerning some issues that had been criticized in the past. However, further efforts at rectification and improvement are called for to deal with persistent issues such as lack of consistency in preparing the Tax Expenditure Proposal, appropriation of earned income tax credits in the budget and their management, and extension of the scope of preparation of the Tax Expenditure Proposal.
Out of ten new programs planned under the 2013 tax revision plan, only three were added to the 2014 Tax Expenditure Proposal. Use of the term “memorandum” account to refer to tax expenditures under individual tax laws in the 2013 Tax Expenditure Proposal was excluded, showing inconsistency in preparing the proposal. The earned income tax credit, which is being managed as a tax expenditure, is rather a spending program as the subsidies are granted directly, and is to be expanded to a great extent. In the United States, it is accounted for as an appropriation. In this light, it seems necessary to convert the program from a tax expenditure to an appropriation and manage it as such. In addition, under the Restriction of Special Taxation Act, tax expenditure proposals are prepared for a three-year period including the previous and the following year of the year of preparation. To identify the continued tax revenue effect, it would be necessary to discuss ways to extend the subject period of an expenditure proposal to five years or longer.
4. Ways to Improve Tax Expenditure Budget System
Principles should be established for streamlining of major tax expenditures programs in the 2014 Tax Expenditure Proposal in recognition of the effectiveness of the programs, equity in taxation, and securing tax revenues, and the preliminary evaluation and post implementation evaluation system for the tax expenditure budget system needs to be improved.
First, it is deemed appropriate that in setting up the principles for system streamlining, tax reductions or exemptions for economic activities which do not require strong tax incentives should be excluded in principle; for tax expenditures that effectively serve as subsidies since tax reductions or exemptions are granted to anyone who qualifies for them, the recipients of such tax reductions or exemptions should be limited; and the tax expenditures should not overlap with appropriations. Furthermore, for sunsetting programs, sunsetting should be allowed in principle. However, depending on the findings of detailed performance evaluation, the programs need to be supplemented by such means as redesign or reintroduction.
Second, preliminary evaluation of tax expenditures needs to compare tax expenditures with fiscal programs in order to minimize overlapping with fiscal expenditures. If it is determined that a certain tax expenditure prevails over a fiscal expenditure in terms of effectiveness, practicality, and administrative cost in support of policy, the tax expenditure needs to be allowed, and double support from tax expenditure and fiscal expenditure may be applied as an extraordinary case only when it is clearly effective for policy implementation.
Third, the central administrative agency currently prepares tax reduction or exemption recommendations and evaluation reports for preliminary and follow-up management of special taxation cases under the Restriction of Special Taxation Act, but it is hard to recognize whether such recommendations and evaluation results are adopted. Therefore, it is necessary to seek ways to improve the feedback process for the tax expenditure system, by such means as disclosing the evaluation information and submitting it to the National Assembly
Lastly, for local tax expenditures, which accounted for approximately 60 percent (17.3 trillion won) of total tax expenditures (29.6 trillion won) as of 2011, it is hard to examine the current state of local tax expenditures and their preliminary or follow-up control is inadequate. Accordingly, measures to strengthen the control over non-taxation and over reductions or exemptions of local taxes should be pursued, including mandatory submission of reports on local tax expenditures as well as evaluation reports of and recommendations for reductions or exemptions of local taxes to the National Assembly.