Economic Policy of Incumbent Administration at Watershed

The Presidential House, the Ministry of Strategy and Finance and the ruling Grand National Party held a consultative meeting on September 7 and agreed to call off plans to lower top corporate and income tax rates, which were scheduled to be implemented from next year.

Tax cuts have been the linchpin of the Lee Myung-bak administration’s laissez-faire economic policy since its inception. The government has pursued its ambitious goals -- economic growth of 7%, per capita income of US$40,000 and the title as one of the seven global economic powerhouses - through the medium of, above all things, lower taxation. Now, however, the government is feeling constrained to change the tack with the ruling party putting the brakes on it.

For the past three years or so, whenever the government’s taxation policy has been criticized as favoring those better-off, the government has refuted it, stating that tax cuts engender a will to work and invest, while giving rise to further entrepreneurship, economic vitality and leeway for consumption. The government has also argued that tax reduction has a positive trickle-down effect in the long-term regarding aspects of tax revenue and fiscal soundness.

Nevertheless, during a recent meeting, the government could not remain firm against the ruling party, which insisted tax incentives be halted for more welfare benefits. This means that at least some damage has been done to the government’s policy consistency.

Kang Man-soo, the first Minister of Strategy and Finance under the incumbent administration, spearheaded the reduction of corporate and income taxes from 2008. In the following year, the corporate tax base for the higher rate was adjusted upwardly, from over 0.1 billion won to over 0.2 billion. The tax rate itself also went down, falling from 25% to 22%, with a substantial tax cut following. The top rates under the current corporate and income tax laws were supposed to be lowered starting 2012, and thus it can be interpreted as if the government came up with a bill for tax raise at this time. In short, the three year-long tax cut drive has proven to be somewhat half-done in the end.

The government announced that appr-oximately 2.8 trillion won in prospective tax revenues will be spent on fiscal soundness and public welfare. The announcement implies that it is shifting its policy focus from growth to distribution. How-ever, the government is remarking that it does not signify any change in the fundamental policy direction.

“Even when we were putting forth the concept of business-friendliness back in the early days, we were still oriented to the middle class and ordinary people,” said a government official. The former minister Kang also commented at an interview that the Lee Myung-bak administration, thou-gh based on pragmatism and market economic principles, rejects a winner-takes-all approach and guarantees fair and free competition along with a helping hand to the underprivileged and economically vulnerable.

High Income Earners and Large Corporations Subject to Increased Tax Burden

Worried at this point of time is discontent on the part of high income earners and major enterprises. Down the road, their tax burden is expected to increase by approximately 3.8 trillion won. The income tax rate for taxable income higher than 88 million won remains at 35%, instead of being reduced to 33%. As far as corporate tax is concerned, the top rate for the amount exceeding 50 billion won is maintained at 22%. However, a new bracket a middle tax rate is applied to is going to be created through negotiations.

For those turning small, yet long-lasting businesses, over to their children, the inheritance tax will be fully exempt. At the same time, temporary investment tax credits will be abolished, while job-creation investment tax credits are shored up. Those firms increasing employment without any layoffs are subject to a deduction rate of 5% to 6%.

Additionally, a 14% interest income tax is to be imposed on Kimchi bonds from next year. The upper limit of household income eligible for the earned income subsidy has been adjusted upwards to 25 million won, with the size of the grant increasing by up to 600,000 won.

The tax deduction on credit card spending is to be extended, with the deduction rates to rise in certain circumstances. For example, the rate for debit and check cards will rise to 30% next year from the current 25%. The same rate is to be applied to expenses made by credit, cash and debit cards at traditional markets.

Government’s Hidden Card: Special Deduction for Long-term Holdings

In the meantime, a special deduction for long-term holdings is to be reinstated. The measure is likely to relieve multiple home owners of the burden of transfer taxes. The abolishment of the heavier transfer tax was taken out of the revision bill due to public opinion against a tax break for the sake of the rich.

Real estate industry experts, though sorry for the maintenance of the surcharge, are hoping that the special deduction will be a great boon and revitalize the market now in the doldrums. Currently, anyone in possession of a house for three years or longer can have their transfer gains deducted in part. Though currently only applicable to single home owners, multiple home owners will also be able to enjoy the benefit from 2012. The deduction rate is determined by the duration of possession, with the maximum estimated at 30% of the transfer gain.

“The reduction rate has been set relatively high and it will be helpful for those who have owned two or more houses, for an extended period of time,” said Ham Yeong-jin of Real Estate Serve, a local realty service provider. He added, “The expanded special deduction for long-term holdings will be of significant help to those temporarily owning two houses and those about to buy their homes in the wake of the recent increase in Jeonse deposit amount.”

Furthermore, multiple house owners are now able to enjoy substantial tax cut effects by renting their assets. Under such circumstances, it is expected that some cash-rich investors will buy houses for lease purposes, helping the government cope with the current shortage in the supply of national rental houses.

Meanwhile, some are pointing out that it could lead to some confusion among market participants since the point of time of non-taxation has been nailed down by the Strategy and Finance Ministry and collides with the government’s own real estate policy announced on August 18 to rejuvenate the supply of rental houses.

The ministry is forecasting that the tax law revision will generate approximately 3.5 trillion won in increased revenue. It breaks down as follows: 2.4 trillion won from the new, middle-rate corporate tax bracket; 600 billion from the maintenance of the top income tax rate; 1 trillion won from job-creation investment tax credits; 100 billion from the imposition of gift taxes on conglomerates resorting to favoritism in outsourcing and subcontracting; -200 billion from the expanded Earned Income Tax Credit; -100 billion from income tax deduction for youths finding jobs at small businesses, etc.