Tax reform for capital market urgent to foster stock market

By Hwang Sei-woon

Hwang Sei-woon, research fellow at Korea Capital Market Institute / Courtesy of Korea Capital Market Institute

The election for the 21st National Assembly is finally over. In this election, which was held in the midst of the coronavirus pandemic, a super majority, which had never been seen before, has emerged. The financial markets are looking forward to this with both positive expectations and concerns.

Human beings, who have high social inter-dependence, have adjusted their interests through politics. As a result, the history of mankind is the history of politics. The definition of politics will vary from member to member, and when it comes to the economic perspective, it can be seen as an act of deciding how much money to collect from whom and how much to give out to whom. Therefore, politics eventually leads to the matter of money collection, which is taxation.

Views on taxes have been largely divided into those that emphasize market efficiency and those that accentuate government intervention. The side emphasizing market efficiency has pointed out that tax imposition can reduce both industrial activity and consumption through price increases and raise inefficiencies such as dead-weight losses.

In contrast, the other side highlighting government intervention justifies strengthening taxation for the purpose of alleviating social imbalances through the redistribution of wealth.

Taxes are important in the stock market, which is a key area of the financial market. The taxes imposed on the Korean stock market consist of capital gains tax and transaction tax. The capital gains tax on the domestic stock market is currently widening, and the transaction tax stays at a relatively high level for a long period of time compared with the foreign stock market. This implies that the current tax policies for the domestic stock market is clearly skewed toward the side underscoring government intervention.

Looking into foreign countries which have long history of stock markets, we can find that they deliberately try to keep the balance between market efficiency and government intervention. Most of the developed countries have adopted capital gains taxes for their stock markets.

Both the general principle of “taxing where income occurs” and the ability-to-pay principle apply to the tax policies on capital gains with a progressive tax rate schedule. The need for government intervention clearly obtains universal consent. However, they do not disregard the considerations on market efficiency.

A comprehensive loss deduction over different types of financial products along with loss carry-forward are allowed. It is also common to apply preferential tax rates to capital gains from long-term investments.

The foreign governments seek to expand their roles by imposing capital gains tax on the stock market, but they also prepare institutional supplements for market enhancement. It is noteworthy that the securities transaction taxes are either abolished or imposed at a very low level in many countries.

A well-functioning stock market, which plays a crucial role in the supply of funds to companies, can have significant impacts for economic growth. Tax reform for the Korean capital market is one of the most urgent tasks to complete. And the reform will have to include items such as comprehensive loss deduction, loss carry-forward, incentives for long-term investments along with the abolition of the transaction tax.