Experts Discuss Do's and Dont's of Tax Reform at KIPF-IMF Seminar

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Press Release No. 13/505
December 13, 2013

On December 6, Korea Institute of Public Finance (KIPF) and the International Monetary Fund (IMF) co-hosted a seminar in Seoul on cross country experiences and prospects for tax reform. The seminar comprised a presentation by Ms. Martine Guerguil, Deputy Director of the IMF's Fiscal Affairs Department, on the October 2013 Fiscal Monitor “Taxing Times: The Revenue Side of Fiscal Consolidation,” followed by a discussion of its findings by Korean experts from academia (Messrs. Lee Manwoo, Park Jong-Su and Shim Tae Sup), the private sector (Ms. Chung Younsung and Mr. Lee Kyung Geun) and the government (Mr. Moon Chang Yong). The session was moderated by KIPF director Kim Jae Jin and chaired by KIPF President Oak Dong Suk, who delivered opening remarks stressing the relevance for Korea of learning from the experience of a broad spectrum of other advanced countries.

Ms. Isabelle Mateos y Lago, IMF mission chief for Korea, noted in her introduction that the issue of tax reform is highly relevant for Korea at this juncture given the need to create fiscal space and re-energize domestic growth.

Ms. Guerguil highlighted that fiscal consolidation in most advanced countries since the global financial crisis had relied on tax increases more than it was initially intended. Unfortunately, these tax increases have not always sought to minimize the potential adverse impact on growth: for example, payroll taxes, that have often been found to be detrimental to employment growth, have been raised more often than property taxes, that tend to be more “growth friendly.”

Ms. Guerguil argued that there is scope for countries to raise even more revenue from taxes. She says even after controlling for country-specific characteristics such as demographics or trade openness, tax ratios differ significantly across countries, with some countries like Korea, having a negative "tax gap," or its tax revenue is sizably lower than its peers with similar economic structure, while many European economies register positive tax gaps. In addition, Korea relies much less than other countries on relatively more growth friendly taxes, experts noted, and could benefit from rebalancing its tax revenue sources toward consumption tax and recurrent property taxes, as opposed to taxes on financial and real estate transactions.

Ms. Guerguil explained that the main drivers of the tax gaps in advanced countries tend to come from two main sources: low tax rates--definitely an issue for Korea as far as VAT is concerned--and a large number of tax exemptions, which reduce the tax base. These low rates or exemptions are often motivated on equity grounds, or to promote one economic activity or another. But she pointed out that exemptions can in fact reduce the progressivity of the tax system if, as is most often the case, they mostly benefit high income households. Here too Korea stands out, with one of the least redistributive tax and transfer system among OECD members.

Another issue highlighted by Ms. Guerguil was how large multinational companies and high income individuals can take advantage of loopholes in national tax legislations to minimize their tax payments. In Korea, the authorities have taken forceful action against tax evasion. But much underground economic activity remains, noted the experts.

Lastly, Ms. Guerguil offered some lessons from cross-country experience on the implementation of tax reform, which is politically challenging in any country. Long lasting tax reforms have most often been implemented in “good” times, when buoyant tax revenue can be used to compensate “losers,” but a few elements have led to successful implementation even in less favorable circumstances. Key among them is a carefully prepared communication strategy and extensive consensus-building efforts. Another important ingredient can be to package reforms--for example, combining the elimination of exemptions with a reduction of the rate. And confidence that the additional revenue will be used appropriately also goes a long way in ensuring acceptability of the reform.

Mr. Moon, Changyong, Director General for Taxation at the Ministry of Strategy and Finance, noted that Korea's tax system has been under reform for some time, and the government's strategy is generally in line with the recommendations outlined by the experts. However tax reform is difficult, and some recent proposals faced major backlash. More effort is therefore needed to communicate the benefits of reform.

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