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