Ⅱ. Local Public Finance in Korea: the Size and Structures of
3. Composition of Local Government Expenditure
[Figure II-4] and <Appendix II-3> in the Appendix show how the composition of the expenditure of the local general account has changed over time. From the mid-1980s to 1995, general administration expenses and other expenses declined as a percentage of total expenditure, while the portion of social development costs increased. Overall, economic development costs exhibited little change, although it varied from year to year. The ratio of general administration expenses and other expenses rose from 37.4% in 1980 to 41.3%
in 1985, before the downward trend began, pulling it down to 30.1% in 1995.
Social development costs continued to increase to 15.4% in 1980, 16.8% in 1985, 22.5% in 1990, and 24.2% in 1993. Economic development costs stood at 45.6% in 1980 and 45.9% in 1995.
During the 10 years after local autonomy was adopted in 1995, the portion of economic development costs and general administration and other expenses quickly declined, while that of social development expenditures expanded at a fast rate. General administration and other expenses represented 30.1% of the total expenditure in 1995, dropping to 24.1% in 2005. Expenditures for economic development comprised 45.9% of the total expenditure in 1995, but decreased to 31.2% in 2005. Social development expenditures made up 21.4% of the total expenditure in 1995, before jumping to 42% in 2005. The trend of falling economic development expenditures and rising social development expenditures as a percentage of total expenditure continued beyond 2005, albeit at a slower pace. The ratio of economic development expenditures dropped from 31.2% in 2005 to 28% in 2013, while the ratio of social development expenditures climbed from 42% to 43.8% during the same period. General administration and other expenses comprised 24.1% of the total expenditure in 2005 and 25.6% in 2014, reversing the downward trend and actually expanding.
Local Public Finance in Korea: the Size and Structures of Tax Revenue and Expenditure
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[Figure II-3] Composition of Expenditures of Local Government General Account (1980~2013)
(Unit: %)
general administration and
other expenses social
development economic
development civil defense
Source: the Ministry of the Interior, Yearbook of Local Public Finance for each year
Ⅲ
Changes in Local Tax and Local Public Finance Systems
1 History of Local Autonomy
The Constitution enacted after Korea became an independent country in 1945 proclaimed the approval of local autonomy by prescribing that “local governments manage their properties in order to handle administrative matters pertaining to local autonomy and administrative matters delegated by the state within the limit of relevant Acts. Local governments can enact provisions relating to local autonomy within the limit permitted by relevant Acts.”6) Under the Local Autonomy Act enacted in 1949, the heads of the local governments were elected by local assemblies, and the direct elections of the heads of provincial governments by their resident voters began in 1960.
However, the May 16 military coup broke out less than one year after the direct election of local government heads was introduced, and local assemblies were dissolved by the Revolution Committee. Those behind the military coup needed to control channels through which diverse views were voiced in order to rationalize the coup and manipulate public views.
Following the coup, the heads of local governments, who were previously elected, were appointed. After the military regime came to power through the
6) Article 96 of the Constitution
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coup, local governments in the 1960s, which were controlled by public officials appointed by the central government, acted as agents for the central government, rather than functioning as organizations with their own provisions and rules, and dealt with administrative affairs. This phenomenon continued in the 1970s.
The revised Constitution of 1972, also known as the so-called Yusin Constitution or the Revitalizing Reforms Constitution, practically abandoned local autonomy by prescribing that “local assemblies shall not be set up until after the unification of South and North Korea.”
〈Table III-1〉Developments of Local Autonomy in Korea Date of
Amendment Act Content
Jul. 4, 1949 Local Autonomy Act
amended - Local assemblies shall elect heads of local governments.
Feb. 13, 1956 Local Autonomy Act amended
- Heads of city and other basic administrative units (eup and myeon) shall be elected by direct vote of residents.
Dec. 26, 1958 Local Autonomy Act amended
- Heads of city, eup, and myeon shall be appointed instead of directly elected by residents.
Nov. 1, 1960 Local Autonomy Act amended
- Provincial governors and mayor of Seoul Metropolitan City shall be elected by direct vote of residents.
May 16, 1961 The Revolution
Commission declared - Local assemblies shall be dissolved.
Sept. 1, 1961 Temporary measures for
local autonomy enacted - Heads of basic administrative units shall be appointed.
Dec. 14, 1963 The above measures amended
- Direct election of heads of metropolitan cities shall be superseded by appointment.
Dec. 27, 1972 The Constitution consideration of fiscal self-reliance of individual local governments.
Apr. 6, 1988 Local Autonomy Act amended
- Provisions pertaining to organization of local assemblies and other provisions relating to local autonomy were established.
- In principle, heads of local government shall be elected by
Local Autonomy and Local Tax Policy in Korea
governments elected - Election of heads of local governments Aug. 31, 1999 Local Autonomy Act
amended
- Residents are allowed to propose and revise local ordinances, and to request audits by residents.
Jan. 29, 2004 Local Autonomy Act amended
- Prescribed details of residents' votes, including what calls for a residents' vote, requirements, and procedures.
Jan. 27, 2005 Local Autonomy Act
amended - Residents' suit was introduced.
Jan. 11, 2006 Local Autonomy Act amended
- Special Self-Governing Province was introduced, and Jeju Island was designated as such.
May 24, 2006 Local Autonomy Act
amended - Matters pertaining to residential recall were prescribed.
Dec. 20. 2006 Local Autonomy Act amended
- Partially amended according to the revised Local Education Autonomy Act
․ Education Commission was changed to permanent commission under local assemblies of cities and provinces.
․ Superintendents were elected directly by residents.
Sources: the Ministry of the Interior, The Chronology of Local Autonomous Act, December 2000.
Website of the Ministry of Government Legislation (www.moleg.go.kr) Replicated from An(2010)
Korea remained under the same military dictatorship in the 1980s, although signs of changes began to emerge. In the 1980s, an era of political turbulence, the Constitution was revised to express the intention of reintroducing local autonomy by prescribing that local assemblies shall be organized in a consecutive manner in consideration of the fiscal self-reliance of individual local governments. Studies and in-depth discussions were conducted on the organization of local assemblies and the introduction of local autonomy. Then, the Local Autonomy Act was amended in 1988 with a view to reinstating local autonomy.
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The revised Constitution clearly declared the government's intention to restore local autonomy by providing a specific timetable for the organization of local assemblies. According to the timetable, local assemblies of cities, counties, and autonomous local districts were to be formed within one year from the date that the revised Constitution came into effect. Then, the assemblies of metropolitan cities and provinces were to be set up within two years of the latter local assemblies being organized. On the other hand, the revised Constitution provided that the timetable for the election of the heads of local governments would be determined by relevant Acts, thus leaving the release of a specific timetable undecided.
The revised Local Autonomy Act of 1988 formed the backbone of what is the system of local autonomy today. However, a series of obstacles had to be overcome in the years that followed, before local autonomy was restored.
The first election of local assembly members was finally held three years later in 1991, after extending the deadline twice. The first election of local government leaders took an additional four years, finally taking place in 1995.
Key changes were made to the revised Local Autonomy Act to do with the direct election of local government leaders in the first half of 2015. These changes focused on keeping intact the framework of the local autonomy system established in the late 1980s, and making necessary improvements to strengthen local autonomy. Special emphasis was placed upon encouraging residents to become more actively involved in local affairs, one of the critical issues revealed in the course of operating local governments led by leaders elected by popular vote.
Residents were allowed to propose amendments to local ordinances and to demand audits in 1999. In addition, provisions were established in 2004 to empower residents to vote on major resolutions by local governments. In 2005, residents were allowed to file lawsuits against local governments suspected of being involved in illegal acts or having violated laws. A legal basis for residents' recall was laid in 2006 in order to tighten residents' supervision of elected public officials serving for local governments. Local education committees became permanent committees under the local assemblies of cities and provinces in December 2006. There have been no amendments to the Local Autonomy Act since 2007 that have had a significant impact on local autonomy.
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<Table III-1> shows how Korea's local autonomy has evolved. Based on this table, we can determine the specific time when “the implementation of the local autonomy system,” which is not clearly defined, is mentioned. Local autonomy was first introduced in the 1950s. After a hiatus, local autonomy was reintroduced in two steps: the establishment of local assemblies in 1991, and the direct election of heads of local governments in 1995. Of the three events that can be considered as marking the implementation of local autonomy, we view the 1995 direct election of local government leaders as the beginning of local autonomy in the truer sense. Local assemblies launched in the 1950s were made null and void, even before they began to function properly. The establishment of local assemblies in 1991 was clearly an important step forward in terms of local autonomy, but the local governments were led by heads appointed by the central government. The mere existence of local assemblies that consist of members elected by popular vote cannot suffice as a true embodiment of local autonomy.
2 Changes in the Local Tax System
A. Local Tax Reforms in the 1980s as the Groundwork for Local Autonomy
The Tobacco tax is considered the most significant element of the local tax reforms in the 1980s that were carried out to lay the groundwork for the introduction of local autonomy. The existing tobacco sales tax was reformed into the broader-ranging concept of a tobacco tax. The government overhauled the farmland tax system at the end of 1984 and created tobacco sales tax. In 1987, the tobacco sales tax rate, which was 2% in cities and 22% in counties, increased to 22% and 55%, respectively. In 1989, the tobacco sales tax was replaced by the more encompassing tobacco tax, which consolidated all national taxes levied on tobacco. As a result, VAT, customs duty, education tax, defense tax, and state monopoly payments were all integrated into the tobacco tax.
The 1984 introduction of the tobacco sales tax had no bearing on local autonomy, because it was intended to offset the reduction in tax revenue under the new farmland tax system. However, the 1989 restructuring of tobacco sales
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tax into the tobacco tax is viewed as part of the preparation for the implementation of local autonomy. The government clearly expressed its intention to reinstate local autonomy by amending the Local Autonomy Act in 1988. According to the government’s timetable, local assemblies of cities, counties, and autonomous districts were to be organized within one year of the date that the Act came into effect. Then, the local assemblies of cities and provinces had to be set up within two years of this latter date. As the plans for local autonomy crystallized, it became necessary to increase local taxes and improve the fiscal self-reliance of local governments.
The introduction and expansion of the tobacco sales tax resulted in significant increases in local tax revenue, and part of the revenue was allocated to Seoul Metropolitan City, as well as cities under the direct control of the central government that did not have any revenue from tobacco sales tax. The local tax revenue increased 1.6 times in 1989, and local taxes comprised a higher share of the total tax revenue, increasing the ratio of national taxes and local taxes from 86:14 in 1988 to 81:19 in 1989. Since then, the ratio has remained at 8:2, indicating that there was no major transfer of national taxes to local governments after the tobacco tax was imposed.
Another important change in the local tax system at the end of the 1980s was the introduction of the aggregate land tax. The aggregate land tax was introduced in 1989 and began to take effect in 1990. The tax is levied on the combined value of land that an individual owns across the country. Unlike most other taxes, which are levied on individual taxable items, the aggregate land tax is imposed on individual taxpayers. The tax was created by combining property tax on land and the excessive land holding tax, introduced in 1986, and began to be levied in 1988. The major purpose of the aggregate land tax was to prohibit individuals from owning an excessively large area of land and to increase the effect of income redistribution by taxing property. The aggregated land tax was unlikely to contribute to the development of local tax systems, because the tax is levied on individuals based on the combined value of their land across the entire country. Therefore, it cannot be considered a local tax, which is intended to grant local governments the autonomous right to tax. The aggregated land tax laid the logical foundation for the subsequent introduction of the aggregate real estate holding tax.
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In 1991, a regional development tax was newly introduced as an earmarked tax to add to the revenue of provincial governments. A regional development tax is imposed on water used for power generation, underground water, underground resources, and containers that use ports to raise funds for balanced regional development. The regional development tax was a new source of local tax revenue that was created before the implementation of local autonomy, instead of being transferred from the national to the local treasury. Conceptually, the tax had a significant meaning for the development of local autonomy.
However, in reality, it did not add much to local public finance because the tax rate was low. Only 1 won was levied for 10m3 of water used for power generation, 10 won for 1m3 of underground water used, 1/1000 of the value of mined underground resources, and 15,000 won per TEU of containers.7)
In addition, the fixed rate for the registration tax, the resident tax rate for corporations, the automobile tax, and the business place tax rate increased. These measures, together with the aggregate land tax, increased local tax revenue, with local taxes accounting for over 21% of the total tax revenue in the early 1990s.
B. Flexible Tax Rate System
Under the principle of no taxation without law, local tax rates and the tax base are determined by laws enacted and implemented at the central government level. In order to give local governments greater discretion over taxation, they can use ordinances to adjust the tax rates on certain taxable items, within limits permitted by laws. This flexibility is called the flexible tax rate system. Until 1991, local governments were required to obtain the approval of the Minister of the Interior when they wanted to apply flexible tax rates. According to Article 105-2 of the Enforcement Rules of the Local Tax Act, mayors or county heads were required to state the following information in an application of flexible tax rates: ① taxable item and tax rate; ② reasons for applying different tax rates; ③ details of the area taxed; ④ details of the business plan; ⑤ the changes
7) Lee(2012)
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in tax revenue as a result of imposing the elastic tax, as well as the impact on public finance; and ⑥ other matters, as necessary. In reality, local governments had little discretion in the application of flexible tax rates until 1991 because it required approval from the central government, as mentioned earlier.8)
However, the requirement of approval was lifted after implementing local autonomy and local assemblies were reinstated in order to give local governments greater discretion. On December 4, 1991, the Local Tax Act was amended and the Enforcement Rules of the Local Tax Act were revised to abolish the requirement of central government approval. This granted the heads of local governments some discretion in applying flexible tax rates based on ordinances.9)
Immediately after the heads of local governments were first elected by popular vote in 1997, the number of elastic tax-applicable items increased from 7 to 10 in order to enhance local governments autonomous right of taxation.
Specifically, flexible tax rates were applicable to acquisition tax, registration tax, property tax, automobile tax, public facility tax, urban planning tax, butchery tax, regional development tax, resident tax, and business place tax. A flexible tax rate system was also applicable to tobacco tax, but the right to adjust the rate lay with the central government, leaving local governments with little discretion. Of the 10 elastic rate-applicable taxes, the flexible tax rate systems for acquisition tax, registration tax, and property tax, which comprise the bulk of local tax revenue, were introduced in 1997. Following the application of flexible rates to these major taxes, flexible rates could be used for most of the major taxes. As a result, local governments secured a tool to increase or decrease their local tax revenue by around 40%, if they used their full discretion to adjust tax rates.10) Under the flexible tax rate system, local governments can determine the tax rate within a range of 50〜150% of the standard tax rate set by law, and the rates can be adjusted lower or higher than the standard rate for certain taxes.
8) Lee(2001) 9) Lee(2001) 10) An(2001)
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Being able to apply flexible tax rates was a significant event for the development of local autonomy, at least conceptually. In order for true local autonomy to be established, local governments should be able to collect taxes from local residents and be held accountable by the residents for how the taxes are spent. To this end, local governments should be allowed discretion in implementing their own local tax policy. The flexible tax rate is a critical tool for local governments to exercise their autonomous right to tax under the current constitutional system of Korea that adheres to the principle of no taxation without law. For this reason, the implementation of local autonomy and the subsequent expansion of flexible tax rates to include most major taxes are significant developments.
However, in the years that followed, flexible tax rates were rarely applied, to the point where they can no longer be considered important policy instruments that promote decentralization. Flexible tax rates were used in three categories.
First, unlike other taxes, regional development taxes often used flexible rates.
First, unlike other taxes, regional development taxes often used flexible rates.