government coffers, even after the previous tax became an independent local tax. However, critics point out that the local income tax faces limitations as an independent tax because it still follows the same taxation system that was created when it was a piggy-back tax(An and Joo, 2012; Joo and Choi, 2012).
For now, the tax burden of the local income tax is not large, because it is similar to that of residence tax. In addition, local income tax rates are the same across regions, thus presenting no major problems. Still, these issues can pose obstacles if the role of local income taxes is to increase to being pivotal to enhancing the taxation autonomy of local governments.
This study examines and evaluates the changes in the local tax system that took place when introducing and implementing local autonomy. These changes include the increases in local taxes, the expanded base of taxpayers subject to elastic tax rates, the introduction and expansion of local consumption taxes, and the reform of local income tax into an independent tax, rather than being a surtax. Finally, this study discusses possible future directions for local tax policies.
Recently, studies and symposiums have been used to assess Korea's local autonomy and the financial conditions of local governments, as well as to establish the policy direction for local autonomy, as it marked its 20th anniversary. The study reviews the policy changes over the past 20 years, since the inception of local autonomy, and suggests future steps to be taken. In its 20th year since its implementation, Korea's local tax policy has come to a turning point where local taxes are expected to assume a greater role, becoming a major source of self-supporting finance for local governments. This will occur as the policy gains fresh momentum from the introduction of local consumption taxes and local income taxes as new independent taxes. Therefore, this is a good time to thoroughly assess the policies that have been implemented and to offer policy recommendations.
Policy changes were tracked through literary reviews in order to examine their background and goals, how they have been revised, and what the outcomes
Local Autonomy and Local Tax Policy in Korea
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were. Policies were evaluated from three major perspectives: decentralization of public finance, distribution of tax revenue across regions, and basic principles of taxation.
The discussion on policy direction, which is based on the results of this study, includes local tax policies and the steps required to improve the local finance equalization scheme. Specifically, this study attempts to find ways to improve the local tax system in a way that advances the self-rule of local governments and increases the efficiency of national policies. Furthermore, it discusses how the local finance equalization scheme can be revised.
Ⅱ
Local Public Finance in Korea: the Size and Structures of Tax Revenue and Expenditure
1 The Volume of Local Government Budget
[Figure II-1] shows the proportion of combined public finance taken up by the central government, local governments, and autonomous educational authorities. The Figure includes expenditures by each group, net of fiscal interactions between the central government and local governments for the period 1980 to 2013. Data prior to the introduction of local autonomy are also included for comparative purposes. Fiscal interactions include local subsidies and subsidies from the national treasury that the central government provides to local governments, and local education grants and subsidies distributed by the central government to local educational authorities.
Education grants accounted for 19.4% of the total public finance that combines the finances of the central and local governments in 1980. This rose to 19.7% in 1981, before decreasing to 15.5% in 1982, remaining at around 15%, with a margin of ±%p, until 2013 when it reached 16%.
Two major changes that had an impact on the size of local education grants occurred in 1982. One was the introduction of an education tax, and the other was the reinstating of legal rates for grants. The Local Education Grant Act was established in 1971, with 12.98% of national tax revenue earmarked for the local education budget, starting in 1972. However, the legal rates ceased to have effect after the 8.3 measure taken on August 3, 1972,4) and the amount
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of the local education budget was determined within the government budget.
At the end of 1981, the government decided to introduce an education tax in order to raise funds for local education, and began to levy the tax in 1982.
In April 1982, the Local Education Grant Act was revised to reinstate legal rates for grants. At that time, legal rates for general grants were around 11.8%
of internal tax revenue, which was similar to the rates that were effective before the legal rates for grants became invalid. Special grants were not subject to legal rates and, instead, were allocated within the national budget. In reality, however, no special grant has been provided since 1983. Surprisingly, the local education budget as a ratio of the total national budget decreased, in spite of the critical legal changes, including imposing the education tax and reinstating the legal rates for grants, both of which were intended to ensure a stable source of funding for local education. Thus, the increases in the sources of revenue and the actual size of revenue did not match. The majority of the local education budget comes from local education grants and education tax revenue.
4) ‘Government’ that is mentioned without the level of government such as ‘central government’ or ‘local government’ refers to the central government in this study.
Local Public Finance in Korea: the Size and Structures of Tax Revenue and Expenditure
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[Figure II-1] Each level government final expenditures as percentages of total expenditure
(Unit: %)
the central
government local
governments local education authorities
Source: Ministry of Strategy and Planning, Appendix to Budget Overview, Ministry of the Interior, Yearbook of Local Public Finance for each year
While the ratio of the local education budget to the national budget remained much the same, the ratio of the local government budget to the national budget increased consistently from 1980, and that of the central government budget continued to decrease. The central government budget made up over 50% of the national budget in the early 1980s, but fell to around 40% in the late 1980s and then to below 40% in the early 1990s. This trend continued until after 1995.
The central government budget ratio rose back above 40% only during the period of the financial crisis(1998~2001), and remained at 35% to 40% beyond 2001.
Then, in 2010, when the economy was again hit by a crisis, the ratio of the local government budget declined, while that of the central government increased.
More major institutional changes that affected the size of local government finance took place in the process of designing and formulating the local autonomy system than after the system was implemented. Specifically, the local subsidy and legal rates for local education grants, which had practically ceased to have an effect after the 8.3 measure of 1972, were restored. Furthermore, local tax
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revenue increased with the introduction of a tobacco consumption tax and other measures in the late 1980s. In the early 1990s, an aggregate land tax and local grant were introduced.
In 2013, the budget was allocated among the central government, local governments, and autonomous educational authorities in the ratio of 39:45:16.
Compared with the ratio of 40:44:16 in 1995, after local autonomy was introduced, there is little change in how the budget was allocated among the three groups. The ratio stood at 51:33:16 in 1985. The portion national budget allocated to the central government shrank significantly, while the share of local governments grew from 1985 to 1995. In 1980, the budget was distributed among the three groups in the ratio of 53:28:19.
The budget of local governments, including educational authorities, represented around 9% of GDP in the 1980s. This figure rose to around 11%
in the 1990s and steadily increased to approximately 12% in 1996. The upward trend continued. It climbed up to 14.8% in 2003 and remained between 13.5%
and 14.5% in the years that followed, reaching 14.4% in 2013. In summary, the budget of local governments as a percentage of GDP decreased from 1980 to 1988, then reversed, and continued increasing until early 2000s. The figure has remained much the same during the past 10 years (see <Appendix II-1>).
The changes to the ratios of the central government, local government, and educational authorities to the national budget are shown in [Figure II-1]. The changes to the shares of local governments' expenditures as a percentage of GDP are shown in <Appendix II-1>. We can draw the following conclusions from these figures.
First, local public finance as a percentage of the national budget increased at a fast rate, even though local public expenditure as a percentage of GDP exhibited a downward trend throughout the 1980s. During the same period, the government budget generally remained on a declining trend, but local public finance as a percentage of GDP contracted at a slower rate than in the case of the central government's finance because more funds were transferred from the central government to local governments.
Second, there was no significant change in the budget allocation between the central government, local governments, and educational authorities after local autonomy was adopted, but local public expenditure as a percentage of GDP
Local Public Finance in Korea: the Size and Structures of Tax Revenue and Expenditure
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continued to expand. Thus, the expanded local expenditure during this period is attributed more to the increase in the overall national expenditure than to the changing flows of funds from the central government to local governments.
The changes in local public finance, including the revised local subsidy rates, in the same period only altered the ratio of the budget allocation between the central government and local governments.
2 Composition of Local Government Revenue
[Figure II-2] and <Appendix II-2> in the Appendix show the changes in the makeup of the general account revenue of local governments. Local autonomous governments in Korea can be classified into two types: local governments that deal with general administration, and autonomous educational authorities that handle local educational affairs. Revenue from local taxes reverts to the general account of local governments. Therefore, the review below of the composition of local government revenue focuses on this general account, followed by a review of expenditure from the account.5)
The revenue of the general account comprises local taxes, non-tax revenue, dependent sources, and municipal bonds. Dependent sources consist of a general grants (the local grant tax) and specific grants from the national treasury (central government subsidies). In addition to these two types of subsidy, a block grants (the local transfer fund) were provided to local governments from 1991 to 2004.
Local taxes made up 39.5% of the general account revenue in 1980 and the figure hovered between 36.3% and 39.7% until 1988, without ever reaching 40%. However, it then rose to 43.5% in 1989 and, over the following four years, increased to 46.5% in 1993. Local taxes as a percentage of general account revenue increased sharply because sources of local tax revenue expanded with the imposition of the tobacco tax and the aggregate land tax. In addition, cyclical effects in the real estate market added to the local tax revenue. This trend reversed and the ratio of local taxes declined to below 35% in many of the following
5) If no further explanation, local expenditure is hereinafter referred to as general accounting.
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years. In particular, in 1998 and 1999, the figure fell to below 35% amid the repercussions of the financial crisis, and plunged to 31.1% 10 years later in 2009 when the economy was struck by another financial crisis. It then rose to 37.1% in 2010 when the local consumption tax was introduced. However, the persistently sluggish real estate market dragged the figure down to 33.2%
in 2013.
Transfers or dependent sources (i.e., subsidies from the central government) accounted for 37.9% of the general account revenue in 1980, but fell to as low as 26.2% in 1993. The fall in the portion of transfers began to accelerate in 1988 when the ratio of local taxes increased sharply. Transfers as a share of total revenue were reduced further in 1991 and beyond as the local transfer fund was introduced, while the central government subsidies were scaled down.
The ratio of transfers began to rise with the expansion of the local transfer fund in 1994, and the upward trend has continued until recently.
[Figure II-2] Composition of General Account Revenues of Local Governments (1980~2013)
(Unit: %)
local tax non-tax
revenue local grant tax local transfer
fund Central govern
–ment subsidies local bonds Sources: the Ministry of the Interior, Yearbook of Local Public Finance for Each Year
Local Public Finance in Korea: the Size and Structures of Tax Revenue and Expenditure
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It is noteworthy that the ratio of transfers increased quickly after local autonomy was implemented, and the rise was driven by central government subsidies. Subsidies from the national treasury or central government subsidies accounted for 8.8% of the general account revenue in 1995, rising to 13.8%
10 years later in 2005. Then, it stood at 19% in 2013. The local transfer fund was abolished in the meantime, but most of the financial sources were integrated into the local grant tax.
When compared to the period prior to the introduction of local autonomy, central government subsidies comprised 16.8% of the general account revenue in 1980, but then decreased. In contrast, the share of local taxes increased as a result of a series of policy measures designed to expand the local tax base and to scale down some of the subsidies for local public finance ahead of the implementation of local autonomy. However, once the system was implemented, not much was added to the sum of local taxes collected, which are an independent source, or to the local grant tax, a transferred source for local governments.
However, central government subsidies, directly controlled by the central government, became a major tool to expand local public finances.
For the sake of local autonomy, it is not a step in the right direction that local public finances were expanded by central government subsidies. Central government subsidies will likely compromise the autonomy of local governments in terms of both tax revenue and expenditure. The same view was reflected in the changes in the composition of local public finances. As a result, the ratio of the local transfer tax and of central government subsidies increased. In 2005, the local transfer fund was abolished, and projects previously financed by the fund were funded by the local grant tax and central government subsidies, the combined amount of which was greater than the sum of the previous fund. The local grant tax represented 14.7% of the general account revenue in 2004, and rose to 20.1% in 2005, before remaining at around 20% until 2010.
Local tax revenue expanded further in 2010. Scholars and policymakers shared the growing concern that transfers that included mainly the local grant tax and central government subsidies continued to play a major role in the expansion of local public finances. Various alternatives, including a local consumption tax, were presented and discussed as ways to expand the source of local tax revenue. Under the local consumption tax introduced in 2010, 5%
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of the value-added tax revenue was to be transferred to the treasuries of local governments. As a result, the ratio of local taxes to total local government revenue increased from 31.1% in 2009 to 37.1% in 2010.
3 Composition of Local Government Expenditures
[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.
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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
Changes in Local Tax and Local Public Finance Systems
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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
〈Table III-1〉Developments of Local Autonomy in Korea