Korea's Corporate Tax Hike Results in 20 Tril. Won Reduction in Domestic Investment

As the Moon Jae-in government raised the maximum corporate tax rate from 24.2 percent to 27.5 percent, domestic investment has shrunk by approximately 20 trillion won (US$16.77 billion).

The hike in corporate tax rates is the main factor in the country’s decline in employment and household income and the economic growth rate, according to a report on corporate tax expenses released by the Korea Economic Research Institute (KERI) on Aug. 1. KERI borrowed the analysis method from the U.S. President’s Council of Economic Advisers (CEA) which analyzed the economic effects of the corporate tax rate cut from 35 percent to 21 percent.

KERI said in the study, “If corporate taxes increase, the user costs of capital rise and investment shrinks. If investment shrinks, the capital equipment ratio goes down, leading to a decline in labor productivity and earned income.” In fact, the CEA found out that investment is reduced by 10 percent if the user costs of capital grows 10 percent based on document surveys. When the top corporate tax rate in South Korea is raised 3.3 percentage points, the user costs of capital rise 3.65 percent. As a result, the report said that companies are estimated to cut back 20.9 trillion won (US$17.51 billion) in investment in South Korea as of 2018.

KERI also estimated that foreign investment in South Korea shrinks 3.72 percent annually when the corporate tax rate is raised 1 percentage point. With the 3.3 percentage point increase in the top corporate tax rate, it said, South Korea’s overseas investments grew 6.70 trillion won (US$5.61 billion), while foreign investment in South Korea fell 3.60 trillion won (US$3.02 billion). When the decrease in investment in South Korea and the increase in investment abroad are combined, South Korea has missed 10.30 trillion won (US$8.63 billion) in investment opportunities, it concluded.
 

KERI said, “With the tax hike, 49 percent of the total domestic investment reduction went abroad. The increase in corporate tax rates has a significant effect on the latest trend of capital exodus from South Korea.”

KERI also expected that the 20.9 trillion won decline in local investment from the tax hike would reduce South Korea’s gross domestic product (GDP) by 0.31 percent in the short term based on the CEA’s growth accounting pattern. GDP is forecast to drop by a 2.34 percent in the long term.

KERI said, “Based on the CEA analysis, the total amount of income given to all employed Koreans will shrink between 12.80 trillion won to 14.60 trillion won (US$10.72 billion to 12.23 billion) due to the hike in corporate taxes. When the sum of the gross labor incomes and the incomes transferred to overseas is divided by a total of 19,673,000 households, the annual average incomes per household will shrink from 750,000 (US$629) to 840,000 won (US$704).”