ed Real-name system failed to cut untaxed economy
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By Lee Chang-sup
This year marks the 20th anniversary of the real-name system for financial transactions. However, as the latest slush fund scandal involving conglomerate CJ Group shows, the system has not reduced the untaxed economy significantly.
An initial investigation by prosecutors shows CJ’s owners, including its chairman, Lee Jay-hyun, have bypassed laws in managing personal wealth. Prosecutors’ initial findings suggest the owners hid undocumented assets, estimated to be more than $500 million, under borrowed names of CJ’s executives and retirees. Should this allegation be proven, Chairman Lee and two of his siblings will be indicted for breaking the real-name financial transaction system.
In addition to prosecutors, financial regulators are looking into CJ owners’ alleged manipulation of CJ stock prices. They suspect the Lee family has used undocumented funds in tax havens including the Virgin Islands to invest in CJ stocks. Such investment is technically foreign investment and would have artificially boosted CJ stocks.
Other government agencies are looking into further allegations against CJ owners. Tax offices are reportedly looking into whether the CJ family raked in enormous capital gains but underreported taxable income. Fair trading enforcers are checking whether the Lee family used a secret fund to subsidize CJ’s affiliates. This practice, if confirmed, is also a violation of the law that bans a conglomerate from subsidizing subsidiaries.
Conglomerates like CJ are not alone in exploiting the real-name system — politicians have been caught doing it too. For instance, former authoritarian leader Chun Doo-hwan was convicted for hiding multi-billion dollars in borrowed-name accounts in 1995. The court had ordered him to pay $200 million, but so far, he has paid only $50 million. He is also accused of hiding his wealth in unregistered bonds. Prosecutors are still verifying this allegation.
The court had also ordered Chun’s successor Roh Tae-woo to pay back $260 million of the funds he had illegally acquired during his five-year presidency. So far, Roh has paid 90 percent of the amount. However, prosecutors are still tracing other potentially hidden assets for confiscation.
Ordinary persons have also broken the real-name system. Many parents reportedly buy gold bars and withdraw bundles of 50,000-won banknotes, labeling them as inheritance for their children so they won’t have to pay tax. In an extreme case, police found an unlicensed casino operator and his colleagues keeping $10 million in Korean banknotes in a garlic field two years ago.
Former President Kim Young-sam had introduced the real-name system in 1993 to reduce the untaxed economy. However, according to Kim Min-jung, a research fellow at Hyundai Research Institute (HRI), the untaxed economy has not decreased noticeably since then. As of last year, Korea’s untaxed economy is equal to 23 percent of the economy, 10 percentage points above the OECD average but 5 percentage points below that in 1993.
She says significant bribery is a reason Korea has a relatively larger untaxed economy. Transparency International, a nongovernmental organization tracking global corruption trends, ranked Korea at 45 in the 2012 corruption perception index, well below Japan at 17 and Taiwan at 37 but above Italy at 72 and China at 80.
The growing tax burden is another reason for the higher untaxed economy. Taxpayers underreport income to reduce tax payments. The Organisation for Economic Co-operation and Development (OECD) reported Korea’s tax-to-GDP ratio was 25.5 percent, higher than the U.S.’ 24.4 percent. In addition, Korea, together with Mexico, Iceland, Ireland and Turkey, has seen its tax burden rise by more than 1 percentage point in 2012, according to the OECD.
Also responsible for the larger untaxed economy are the self-employed and the undocumented workers, HRI reports. A National Tax Service survey shows that the self-employed underreported 48 percent of their income in the years 2005–2009. This is a significant problem because the self-employed represent 28.8 percent of the total number of workers, more than four times that in the U.S. Meanwhile, small companies prefer undocumented workers over documented ones to save on costs, the institute says.
President Park Geun-hye has vowed to reduce the untaxed economy. Instead of hiking taxes, she seeks to collect lost revenue from tax evaders to increase the welfare budget.
This campaign gets a wide public support, except from the rich, including owners of conglomerates. Business organizations, including the Federation of Korean Industries worry that the ongoing CJ probe has political motives. The probe aims to tame conglomerates, according to a tycoon, who wants to remain anonymous. He said the widening probe would dent the entrepreneurial spirit, which is vital for stimulating the anemic economy.
A recent USA Today article reported that the U.S. underground economy, estimated at 8 percent of the GDP, is ironically helping recovery. This is because many American firms save on labor costs by hiring illegal immigrants, who do not pay taxes. In the article, Peter McHenry, an assistant professor of economics at the College of William & Mary, was quoted as saying: “They are going to do everything they can to keep costs down, and if that means paying people off the books, they will do it. The government does not really have the resources to track down every business that does this.”
However, that the untaxed economy helps recovery is not a mainstream view. Korea must still reduce the untaxed economy. To do so, Korea must remove loopholes in the real-name system and legalize the untaxed economy.
Lee Chang-sup is the executive managing director of The Korea Times. Contact him at editorial@ktimes.co.kr.