KOREAN TAX REFORMS DRAW FIRE, PASSAGE UNCERTAIN

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E.O. 12958: N/A
TAGS: EFIN ECON PGOV KS
SUBJECT: KOREAN TAX REFORMS DRAW FIRE, PASSAGE UNCERTAIN


SUMMARY
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1. (SBU) The Korean government introduced ambitious income
tax reform legislation in February, proposing to raise
certain value-added and excise taxes and tighten individual
income tax loopholes favoring the wealthy and self-employed.
But the proposals have run up against significant criticism
from the public and lawmakers, and with difficult local
elections looming on May 31 the ruling Uri Party appealed to
the Roh Administration to postpone the controversial plan.
At this stage, the National Assembly is expected to consider
the tax reform plan in the latter half of this year, at
which time the opposition Grand National Party (GNP) will
make its best efforts to scuttle the measure.


2. (SBU) Some Korean economists fear the proposed tax
reforms could dampen consumer sentiment and jeopardize
Korea's accelerating, but still fragile and uneven, economic
recovery. Self-employed professionals and small business
owners, who along with childless individuals and high-income
property owners would bear the brunt of the increases, worry
that their future income and purchasing power will decrease.
While many large business executives welcome the
government's proposal for expanded corporate tax breaks,
some are concerned the resulting gains will not be enough to
offset an anticipated contraction in domestic consumption.
In addition, some analysts are not convinced that the
proposed reductions in business taxes will spur aggressive
investment. Amid general public dissatisfaction about
economic policy, the success of the government's proposed
reforms may hinge on the ability of the Roh Administration
to clearly communicate the view that this legislation would
help institute a more fair tax regime. End Summary.

MORE TAXES, WITH FEWER EXEMPTIONS AND SMALLER DEDUCTIONS
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3. (U) After foreshadowing new measures in December 2005,
the Ministry of Finance and Economy (MOFE) unveiled its long-
term tax reform plan on February 5 as part of a plan to
raise more tax revenues to compensate for mounting spending
pressure. MOFE's proposed reforms slap a new 10-percent
value-added tax on education and medical services. In
addition, excise taxes on hard liquor with an alcohol
content of 21 percent or higher would be raised to 150
percent by 2015 from the current 75 percent. Also under
consideration are fresh taxes on top of the current high
levies on cigarettes.


4. (U) MOFE's new tax proposals also trim deductions for
Korean wage earners, especially the nation's 4.75 million
childless and unmarried taxpayers, starting in 2007. If
Korea's National Assembly endorses the MOFE proposal, single-
person households could face up to 350,000 won (USD 365)
more in taxes each year. Two-person households without
children would have to pay up to 175,000 won (USD 182)
in additional taxes. The ministry projects that it should
be able to collect a total of 2 trillion won in additional
revenue over the next four years by implementing the benefit
reduction plan. To soften the blow, government officials
also plan to increase tax refund schemes for educational and
medical spending by wage earners.


5. (U) Reflecting demands for a crackdown on tax evasion by
independent businesses and persons with well-paying jobs,
certain tax benefits would also vanish for the self-
employed, for example tax deductions for credit card use.
According to MOFE, these measures would translate into 2.16
million self-employed Koreans being saddled with roughly
345,900 won (USD 359) in additional annual taxes. With a
few exceptions, most of these revisions, as well as the
reduced deductions for childless persons, would gradually
kick in between 2008 and 2015.
HIGHER REAL ESTATE TAXES FOR THE RICH
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6. (U) In a related measure, revisions to Korea's Income Tax
Act that were enacted in December 2005 dictate that owners
of apartment units smaller than 84.8 square meters in net
area, but which are worth more than 200 million won (USD
200,000) in market value, will no longer be eligible for
mortgage and long-term housing purchase savings account tax
breaks. Moreover, starting in 2006, Koreans with more than
two houses will be required to pay income taxes on all
rental income earned. According to MOFE estimates, the
December legislation could net more than one trillion won
(USD 1 billion) in revenue.


7. (U) The December 2005 tax revisions supplemented other
measures announced on August 31, 2005 to help rein in real
estate speculation. That plan, already being implemented,
involved a drastic hike in ownership and capital gains taxes
for owners of multiple homes, with taxes for owners of two
or more houses hiked to 50 percent, up from 9 to 36 percent.
The August 2005 policy also assessed a new Property Holdings
Tax on owners of apartments or unused land in "high-rent"
areas or specially-designated speculative districts in
southern Seoul and its satellite cities. This tax, set at
0.15 percent of assessed value in 2005, will rise to one
percent by 2009. In addition, starting in 2006, all owners
of properties worth more than 600 million won (USD 600,000)
became subject to Korea's composite property tax.
Previously, the composite (or comprehensive) real estate tax
was only applied to owners of homes worth more than 900
million won (USD 900,000).


8. (U) Finally, to ensure that property owners and
speculators in higher-rate areas actually pay higher taxes,
officials are using a more accurate "fair market value"
rather than the current "assessed value" to calculate tax
rates beginning in 2006. Under the new measures, the
assessment base of the comprehensive real estate tax will be
gradually raised, up from the current 50 percent of the
standard price to 100 percent by 2009. The government has
also recently hinted that it may announce even more real
estate speculation control measures, since housing prices
have again jumped since November 2005.

LOCAL ECONOMISTS AND STAKEHOLDERS GIVE MIXED REVIEWS
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9. (SBU) Many Korean economists and tax policy experts have
welcomed MOFE's proposed combination of higher "sin" taxes,
social engineering in favor of families with children, and
fewer loopholes for the self-employed, as a reasonable
approach to bringing in more revenue to help deal with
Korea's troubling demographic future. Some economists,
however, worry that significantly increased taxes may lead
to a reduction in disposable household income, further
weakening domestic consumption.


10. (SBU) Korean small business owners and self-employed
persons have also spoken out against the February tax
proposals, saying they are puzzled by the changing stance of
the tax authorities, who lowered value-added tax (VAT) rates
last year only to suggest selective increases to the VAT in

2006. Independent businessmen are even more distressed by
MOFE's announced measures to improve its methods for
identifying the income levels of self-employed business
owners and professionals, while refusing to renew certain
tax reduction schemes expiring in 2006. With the February
tax measures still pending at the National Assembly, it is
possible that small business owners may defer investments
this year, while awaiting the outcome of parliamentary
debate over the new tax plans.


11. (SBU) Opponents of Korea's 2005 real estate tax
revisions are the most vocal critics of the Roh
Administration's tax policies -- although their arguments
tend to be partisan and politically-loaded. Such opponents
assert that real estate investors are usually high income
earners, who serve as significant consumers. Putting a
break on real estate investment, therefore, could force the
country into a severe liquidity crunch, they argue. Many
rich Korean property owners, fearing heavy capital gains
taxes, may become reluctant to sell their extra houses or
property, instead adopting a wait-and-see attitude to
observe whether the government actually implements the new
tax policies as scheduled. Others are likely to look for
loopholes to pass on (or donate) property to relatives,
paying an as-yet-unchanged inheritance tax.

PASSAGE UNCERTAIN, AS PROPOSALS STIR POLITICAL DEBATE
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12. (SBU) The main part of MOFE's income and VAT tax reform
plans will probably be submitted to the National Assembly in
September 2006, following discussions between the Finance
Ministry and ruling Uri party that will take place as early
as June, after the May 31 regional elections. However, easy
approval of MOFE's plans is far from guaranteed. In fact,
fierce National Assembly debate and politicking between the
legislative and executive branches appears highly likely.


13. (SBU) In defending its tax recommendations, MOFE noted
that "considering strong requests for a government role in
improving Korea's social safety net, the government has no
other option but to raise taxes." MOFE Vice Minister Baik
Byung-Won explained that the government had little choice
but to increase some taxes to avoid growing fiscal deficits.
Heo Chan-gook, a director at the Korea Economic Research
Institute, observes that the new tax measures may indicate
that officials -- following 2004's poor revenue-gathering
performance -- may have lost their confidence in the ability
of an early economic revival to top off government coffers.


14. (SBU) Despite MOFE's strong stance, many Koreans who
paid attention to President Roh Moo-hyun's January 25 pledge
of "no tax hikes" doubt that government officials have in
fact explored all other options to raising taxpayer's rates.
Salaried Koreans, whose full income is easily known and
easily taxed, feel particularly aggrieved, and are likely to
try to hold the President to his "no tax hikes" promise
unless MOFE can clearly demonstrate that the new tax schemes
will work to their advantage. In 2004, when the National
Tax Service (NTS) failed to meet its overall tax collection
goal, the NTS made up for this shortfall by zealously
collecting 18.9 percent more than planned from non-self-
employed Koreans, who lack the ability of professionals and
self-employed Koreans to shield their true income from the
taxman.


15. (SBU) Over the Internet and on the country's hyperactive
"blog" network, Korean "netizens" are complaining vigorously
about the tax reform plan, using postings to government and
lawmaker websites to make their views known. The opposition
Grand National Party (GNP) has taken advantage of the
situation to roundly criticize the tax plans, saying,
"Without any effort to reduce its spending, the government
is passing the burden of its tax revenue shortfalls onto the
general public, especially middle-income families." GNP
leaders, in fact, recently declared a "war on tax hikes,"
accusing the Roh Administration of trying to pass tax
reforms "in order to cover-up its failed economic policies."


16. (SBU) Amid the criticism, some in the ruling Uri Party
are also becoming uncomfortable with the rising public
criticism of the Administration tax measures, although it
remains unclear whether large numbers of Uri members will
rebel when the new tax bills come up for a vote. With an
eye on the May 31 election, however, the Uri Party prevailed
on the government to remain silent about its tax plans until
June. The ruling Uri Party did faithfully pass the
government's eight real estate tax reform bills in late
December 2005, garnering support from three minor opposition
parties at the National Assembly despite a boycott from the
opposition GNP.

COMMENT
--------------


17. (SBU) Serious public discord and scant political support
in the National Assembly may yet scuttle Korean government
attempts to modernize the tax code in 2006. The main
problem is one of public communication: Officials have not
yet been able to convince a majority of citizens that its
proposed tax measures will advance economic recovery,
stabilize the real estate market, or increase fairness in
taxation. The task is made more difficult by the fact that,
due to the ambitious and wide-ranging nature of MOFE's
reforms, they contain a little something to hate for just
about every voter. Failure to pass the 2006 tax bills will
send government economic planners back to the drawing board
to come up with new ideas to address Korea's growing (if
still manageable by international standards) revenue
shortfalls. In that event, tax reform will likely become a
major project for President Roh's successor, regardless of
party affiliation.

VERSHBOW