KDI criticizes efficacy of corporate tax policy

The logo of the Korea Development Institute (KDI) Courtesy of KDI

By Lee Kyung-min

The government policy of imposing an additional tax of 20 percent on up to 35 percent of corporate net income retained in the form of reserves should be abolished or undergo a major revision due to its clear lack of efficacy, a state think tank said Wednesday.

Little of the intended outcome will be drawn from the policy, the Korea Development Institute (KDI) said, recommending that the key policy objective ― economic vibrancy defined by greater private investment and job creation ― be achieved via greater tax incentives instead of what businesses consider a punitive tax that disincentivizes entrepreneurship. The policy first implemented in 2015 was revised in 2018 to exclude dividends and land investments as deductibles.

Despite the recommendation, however, the Ministry of Economy and Finance submitted a bill to the National Assembly seeking to extend the policy for two more years, with the minimum amount deductible decreased further to 30 percent from the current 35 percent, starting 2021.

The policy led to a combined 853 billion won ($736 million) in additional tax revenue from 969 firms that had either total assets over 10 trillion won or capital over 50 billion won in 2019, accounting for 1.2 percent of the corporate tax total of 72.1 trillion won.

Businesses say that “unilateral railroading” will hamper autonomy of corporate activities at the expense of their growth opportunity, saying an increase in the number of profit-oriented entities sapped of motivation will result in a loss of the country's growth momentum as a whole.

In a report commissioned by the KDI at the request of the ministry, the state think tank said the additional tax will only lead to a further reduction in corporate investment, the exact opposite outcome drawn for failing to recognize that the core corporate activity must be determined by businesses thorough review of long-term growth prospects and profit.

Investment is by nature highly difficult to withdraw or cancel once initiated, a reason why the hefty spending should be put in place after carefully weighing pros and cons not to mention exit strategies.

“Let's say a business decides to build a manufacturing plant as part of an investment,” KDI report author Kim Hag-soo said. “What should be in the picture also is how the additional subsequent costs would be paid for maintenance thereafter. This is why any corporate entities would not dare make investment risks just to avoid tax.”

The policy in his view should be abolished, because it has failed to help corporate profit shared in the form of private investment and wage increases.

The number of firms subject to the policy increased to 969 in 2019, up from 159 in 2016. Yet corporate investment and employee wages in the same period dropped 1 percent and 3.9 percent, respectively.

“Corporate tax rate will be raised up by a full 0.5 percentage points due to the additional tax, although the amount shouldered by individual firms would vary,” he added.

“This increases the burden for the businesses already under severe pressure brought on by the COVID-19 pandemic exacerbated by the drawn-out U.S.-China dispute.”

Korea's corporate tax of 27.5 percent is the ninth-highest among OECD countries, well above the OECD average of 23.5 percent. The figure is up 10 in only about four years under the Moon Jae-in administration, from 19th-highest in 2016 when the rate was 24.2 percent. The rapid jump followed creation of a new tax bracket for firms making over 300 billion won in annual income in 2018.

“We need more time for the policy to have its desired outcome,” a ministry official said.