The Diplomat
Overview
The South Korean Government’s Proposal for Tax Reform
Depositphotos
Northeast Asia

The South Korean Government’s Proposal for Tax Reform

The opposition Democratic Party is surprisingly open to some major tax cuts.

By Eunwoo Lee

In late July, the South Korea government unveiled its plan for tax reform, the scope of which is considered the largest in 25 years. The changes are especially huge for the well-off: the government wants to curtail inheritance and gift taxes and abolish the financial investment income tax. It also wants to end the practice of pegging shareholders’ stock value higher than the market value in cases of companies’ ownership changing hands through stock inheritance or gifting.

At the same time, the administration is fiddling with the possibility of scrapping the comprehensive real estate tax – the so-called wealth tax because people with expensive property pay this on top of already having paid regular property tax.

The proposed reform will not raise a single dime in additional government revenue. Instead, it conforms to President Yoon Suk-yeol’s belief in trickle-down economics. He has frequently aired out the importance of letting corporations and high-income individuals save more on taxes so that they eventually splurge more. Benefits will then “trickle down” from their loose purses onto people on lower economic rungs.

The opposition Democratic Party (DP) is usually against such tax cuts. Last year, the government ran a tax revenue shortfall of more than $41 billion – 8.7 percent of the government’s 2023 budget, or equivalent to South Korea’s annual defense budget. It was the single largest budget deficit in South Korean history. The outlook for this year isn’t too optimistic, either; the deficit might be around $14 billion.

Tidying up the fiscal balance is a simple plus-minus calculation. Yet the DP has found itself in a quandary, as a fair number of middle-class voters and almost all upper- and high-class voters welcome the government’s tax cuts, especially the financial investment income tax and some changes in the inheritance and gift taxes.

Let’s look into the details, then. The most contentious aspect of the reform is to remove the uppermost inheritance and gift tax bracket of 50 percent imposed on real estate or securities worth more than 3 billion Korean won, or $2.2 million. The reform also intends to increase the exemption threshold for inheritance income from 50 million won to 500 million won. Also, this exemption is applicable to every offspring. For instance, if you happen to have six kids, you could avoid any inheritance tax over a house worth 3 billion won by equally dividing and bequeathing your property.

The thing is, even the existing inheritance tax has touched only a select few. In 2022, beneficiaries had to pay inheritance tax on just 4.5 percent of all estates. With the baseline exemption of 200 million won, which the reform still keeps, and a spousal exemption of 500 million won, not a lot of people had a net worth over 700 million won that required their beneficiaries to pay the inheritance tax. Even among some 15,000 people that had the honor of paying the inheritance tax last year, the lion’s share of the 2023 inheritance revenue was from the mega rich. Lowering the highest inheritance and gift tax rate from 50 to 40 percent will set the government back by some $13.5 billion in the short term, while only benefiting a tiny proportion of the population.

The government argues that the new reform is meant to encourage and facilitate transfer of wealth from baby boomers – people aged over 60 – to the next generation. It is true that most businesses and property are owned by the baby boomers. It is also true that due to increasing housing values, more and more middle-class people will end up having to pay inheritance tax without the new exemption threshold, which is why the government says it’s all for the middle class.

However, instituting the 500 million won exemption threshold for gifting – handing down wealth before death – would have made more sense, rather than applying this only to inheritance tax. It could be some 20 years before the baby boomers start passing away in large numbers and thus before their descendants benefit from the increased exemption threshold. Under the proposed reform, baby boomers have all the more reason to hold onto their possessions until death, because gifting offers less of a tax break.

As for the change to the highest tax bracket, it’s purely for property owners in Seoul or those with pricy buildings in the countryside. The DP, in its struggle to win over upper middle-class voters, is open to increasing the exemption threshold, but opposed to lowering the highest inheritance and gift tax rate.

In a rare instance of the DP and the ruling People Power Party (PPP) seeing eye to eye, they both see benefits in postponing or abolishing the financial investment income tax slated to take effect as of 2025. It is a 22 percent tax on those making profits of more than $36,000 from stock investments. It has long been considered redundant since all investors pay taxes on each and every transaction – whether that comes at a loss or with a profit. It has also been estimated that the investment tax will scare away large-scale investors, making them invest abroad and contracting the South Korean stock market.

The total value of stocks being handled by South Korean retail investors is around $500 billion, and there are some 14 million such investors in South Korea. It’s not an exaggeration to say that stock investment has become a middle-class hobby, and the DP seems amenable to closing their gaps with the PPP on the financial investment income tax.

But the DP draws the line against the government’s proposal to do away with an extra appraisal of stock value, designed to make majority stockholders pay more taxes upon passing on their stocks so that their children can inherit their companies. In South Korea, this taxation is called “executive premium.”

South Korea has a chaebol system, where ownership and management of conglomerates stay within families. When a grandpa retires and hands down his corporation to his children or grandchildren, people usually expect healthier management of the company. The company market cap tends to go up. Current tax policy reflects the expectation of a jacked-up company value by pegging the stock value 20 percent higher than the market value when calculating taxes on these shares.

The Yoon government says this practice is too punitive and that the reform is supposed to benefit every stock investor and the South Korean economy overall. Before a company changes hands, the largest shareholder and the company management tacitly embark on a process of undermining the company market cap. Otherwise, they end up paying too much in taxes. This tax handicap, as argued by the government and some financial wonks, has frequently hurt unassuming retail investors.

Everyone thinks such underhanded devaluation practices exist. The problem is that there’s no concrete proof as to whether, or to what degree, the “executive premium” affects this deliberate devaluation, much less overall stock market volatility. It’s entirely possible that the same trend would exist even absent the extra tax, as incoming owners would still benefit from a depreciated stock value even if their taxes are calculated using only the market rate. All this aside, the DP isn’t likely to let the chaebols off the hook so easily.

Last but not least, there’s the comprehensive real estate tax. Introduced in 2005, it is levied on those owning super expensive property or multiple properties and then distributed by the government to local governments in an effort to level up financially struggling parts of the country. Unlike the regular property tax, which lapped up directly by the local governments, this comprehensive real estate tax is an extra taxation; people with pricy property have complained that it’s a punitive double tax. Most of the revenue comes from residents in Seoul.

Last year this revenue was around $3 billion, a 37 percent decrease from 2022. (In 2023, the Yoon administration lowered the highest rate from 6 percent to 5 percent.) The government wants to dump this tax entirely, but doing so would further strain the budget for the countryside with no alternative in sight as of yet.

Although the DP is against eliminating this tax altogether, it has voiced its willingness to amend it so that those with multiple yet cheaper properties don’t end up paying more than those with one overpriced property. It’s also open to kiboshing the tax on those who own one expensive property that serves as their primary residence.

With executive orders, Yoon can tweak the tax rates for financial investment all he wants. But for changes to other tax systems, especially ones involving complete abolishment, he needs parliamentary approval. Although the comprehensive real estate tax and extra stock appraisal are likely to stay on due to the DP’s opposition, the DP will agree to most cuts, albeit by lesser degrees.

One salient change in the DP’s tax policy from the previous liberal Moon Jae-in administration is that, as property value in South Korea keeps going up and more and more people end up footing the tax bill, the DP is trying to capture some of those high-end votes.

Want to read more?
Subscribe for full access.

Subscribe
Already a subscriber?

The Authors

Eunwoo Lee writes on politics, society and history of Europe and East Asia. Based in Paris and Seoul, he is also a non-resident research fellow at the ROK Forum for Nuclear Strategy.

Northeast Asia
Okinawa’s Rocky Relationship With the U.S. Military Flares Up Over Sex Offenses
Northeast Asia
The Significance and Implications of North Korea’s Garbage Balloon Tactics