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.
For example, flexible rates were imposed on container taxes in Busan, taxes on water for power generation in the Gangwon and Chungcheong Provinces,11) underground water on Jeju Island, and underground resources in the Gangwon and Chungcheong Provinces. The regional development tax was later replaced by the regional resources facilities tax.
Flexible rates were used more often for regional development tax than for other types of tax because the tax burden was likely to fall upon residents of other regions as it was on residents of the taxable area. In other words, a regional development tax creates a tax-exporting effect of transferring the tax burden to residents of other regions and, thus, heads of local governments can increase tax revenue while minimizing political pressure from tax increases. However, applying flexible rates does not have a significant impact on the decentralization of public finance because a regional development tax does not add much to tax revenue.
Furthermore, increasing a regional development tax is not necessarily desirable, because inefficiency arises if excessive tax exporting occurs. This
11) An(2001), Kim(2008)
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creates a large gap between taxpayers and voters, and sources of regional development tax revenue can be concentrated in particular regions.
Second, flexible rates were imposed on resident taxes. Until 1998, the standard resident tax ranged between 1,000 won and 4,500 won per person, depending on the local government, who could adjust the rate within 50% of the standard tax amount. In 1999, mayors and county heads were given the discretion to determine a resident tax within the limit of 10,000 won. Initially, local governments were cautious, adhering to the former standard tax amount rather than actively exercising their autonomous right of taxation. Later, Seoul City took the lead and raised the tax by 300 won to 4,800 won, and other cities and provinces imposed a tax of 5,000 won. Eventually, most local governments kept their resident tax at 5,000 won or lower. Only four counties levied a resident tax of 10,000 won in 2014. However, in 2015, 37 local municipalities imposed a resident tax of 10,000 won, and a significant number of other municipalities raised their rates as well. These increases in resident taxes seem to have resulted from the government encouraging local governments to use flexible rates to increase the tax burden. When calculating the base amount of local fiscal revenue to distribute the local government tax, incentives are provided for local governments to increase revenue, including applying elastic rates to resident taxes and regional development taxes. The government considered raising the standard tax from 10,000 won to 20,000 won in 2014, but abandoned the plan after strong opposition from the public.12)
Third, flexible rates were used for property taxes, following the introduction of an aggregate real estate tax.The imposition of the aggregate real estate tax and the property tax reform in 2015 under the Roh Moo-hyeon administration significantly increased the property holding tax burden for residents of certain areas. These included a relatively large number of rich people, which will be discussed in more detail in the review of the aggregate real estate tax. In this section, the discussion is restricted to flexible rates. Gangnam-gu cut the tax rate by 50% by applying flexible rates to property tax, because residents were expected to face an increased tax burden. A considerable number of other
12) Lee(2015), Enforcement Regulations on Local Subsidy Law, Attachment 6.
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autonomous districts later followed suit. In response to these moves by local governments, the central government took actions to limit the use of flexible rates for property tax. Now, property tax rates could be adjusted within the 50% limit of the standard tax rate, in accordance with provisions of ordinances, only when the adjustment was deemed inevitable owing to extraordinary fiscal needs or disasters, and the adjusted rate only applied to the one year.13) As a result, elastic rates were used for property taxes in 2006 only, and the standard tax rate was applied from 2007 onwards.14)