By Kim Tong-hyung
Park Geun-hye punched her ticket to Cheong Wa Dae on the promise that Koreans could both be showered with benefits but exempt from increased taxes.
Whether the Saenuri Party veteran puts her money where her mouth is might depend on pulling up the country’s immense underground economy from beneath the tax radar.
More than 370 trillion won (about $344 billion) of income is believed to go undeclared each year, accounting for about 24 percent of annual gross domestic product (GDP), according to broad-brush estimates.
Austrian economist Friedrich Schneider believes the proportion of Korea’s shadow economy to be significantly larger at 27.6 percent of GDP than levels in the United States (7.9 percent), Japan (8.8 percent), Britain (10.3 percent) and France (13.2 percent).
The underground economy refers to practices such as those often found in construction and services sectors where taxes are withheld or not paid as well as illegal activities like drug dealing and prostitution.
The culture of tax-dodging took deeper root in the past two decades as growth began to rely more on the expansion of credit than improvement in industrial competitiveness.
The dramatically high number of self-employed people, who reflect an economy beginning to lose its ability to create jobs, and strong tax resistance of high-income earners, whose wealth are often tied to less liquid items like real estate, are driving the underground economy. So are the high levels of cash transactions, corruption and the ubiquity of non-institutional loans.
``While no one is exited to pay tax, it could be said that the tax resistance here is higher than most other developed economies. This probably has something to do with the high proportion of real estate in private assets,’’ said a Bank of Korea (BOK) official.
``A person owning an apartment in southern Seoul may have as much money on paper as an American who lives in Beverly Hills. But since his wealth is tied to property he doesn’t intend to convert it into cash, and as he probably has much less value than when he bought it, he ends up lining up at discount malls for cheap fried chicken instead of living the high life. Of course he will react very sensitively to any tax raise.’’
By beating the tax evaders, Park plans to create a financial cushion of 15 trillion won in the next five years. The calculation is that by dragging just 6 percent of the underground economy into the light, her government could create an additional 1.6 trillion won in annual internal revenue. Another yearly 1.4 trillion won bump would come from clamping down on tax dodging by rich households and firms.
Good luck with that. Since the Kim Young-sam government of the early 1990s, policymakers have been putting in Herculean efforts to reduce wealth that goes unaccounted for, most notably through the introduction of the ``real name’’ system for holding bank accounts in 1992. However, the difference shown in tax revenue has been underwhelming.
Park’s margin for error would be small when her package of economic plans for the next five years includes strengthened state welfare programs and an ambitious promise to increase the proportion of middle class families to include 70 percent of all households.
This would obviously require improving the living standards of families on the wrong side of the widening wealth gap. However, Park claims her government will be able to provide a financial jolt of 135 trillion won, or 27 trillion won per year, to smooth the process.
It doesn’t take an economics degree to see that Park’s plans run against the limits of plausibility, especially when she is reluctant to touch tax rates aside of a marginal hike in some indirect items like value added taxes. It’s plain as a pikestaff that she couldn’t manage to let the underground economy be as big as it is.
Some critics argue that the emergence of the underground economy should be blamed on bad government policies, which have yet to provide a dependable tax framework for financial transactions. Korea’s tax authorities measure the annual trade of real goods at 4 quadrillion won a year, compared to 60 quadrillion won in financial transactions, roughly translating to 25.5 billion won per day.
``The current tax infrastructure, which is built around the trading of real goods, is ill-equipped to detect traditional tax-avoiding behavior such as not reporting cash transactions, let alone more sophisticated activities,’’ said Kim Jae-jin, a researcher from the Korea Institute of Public Finance.
Some believe that the National Tax Service should be provided better access to information kept by the Financial Services Commission’s financial intelligence unit (FIU) for tax purposes. Currently, the data can only be used for investigating suspected or exposed irregularities.
Some lawmakers last year pushed for a bill to revise the law to allow the NTS more freedom to use FIU information for taxation but the discussions were put on hold due to privacy protection concerns.