15-03 Local Autonomy and Local Tax Policy

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(1). Research Paper . 15-03. Local Autonomy and Local Tax Policy in Korea. December 2015. Jongseok An.

(2) Korea Institute of Public Finance 336, Sicheong-daero, Sejong-si, Korea Tel: 82-44-414-2114 Fax: 82-44-414-2179 URL: www.kipf.re.kr ◯ C 2015 KIPF.

(3) Local Autonomy and Local Tax Policy in Korea. December 2015. Jongseok An.

(4) Local Autonomy and Local Tax Policy in Korea. 2. Contents. Ⅰ. Introduction ······························································································ 7 Ⅱ. Local Public Finance in Korea: the Size and Structures of Tax Revenue and Expenditure ····························································· 11 1. The Volume of Local Government Budget ····································· 11 2. Composition of Local Government Revenue ··································· 15 3. Composition of Local Government Expenditure ······························ 18 Ⅲ. Changes in Local Tax and Local Public Finance Systems ·············· 20 1. History of Local Autonomy ····························································· 20 2. Changes in the Local Tax System ·················································· 24 A. Local Tax Reforms in the 1980s as the Groundwork for Local Autonomy ···· 24 B. Flexible Tax Rate System ················································································ 26 C. Aggregate Real Estate Tax and the Property Tax Reform ······························· 30 D. Local Consumption Tax ··················································································· 32 E. Local Income Tax ···························································································· 38 F. Other Changes to the Local Tax System ·························································· 41 3. Fiscal Equalization Scheme ······························································ 43 A. Local Fiscal Equalization Scheme before the Introduction of Local Autonomy · 43 B. Abolishing the Local Transfer Fund and Introducing the Decentralization Grant ················································································································ 45.

(5) Contents. 3 Local Autonomy and Local Tax Policy in Korea. Ⅳ. Evaluation of Local Tax and Intergovernmental Transfer System ·· 48 1. The Frame of Evaluation ································································· 48 2. Evaluation Results ············································································· 50 Ⅴ. Policy Suggestions ················································································· 55 1. Securing Taxation Autonomy vs. Expansion of Local Tax Revenue · 55 2. Distribution of Resource Between Regions: Autonomy vs. Equality · 57 References ···································································································· 59 Appendix ········································································································ 62.

(6) Local Autonomy and Local Tax Policy in Korea. 4. List of Tables. <Table III-1>. Developments of Local Autonomy in Korea ······································· 21. <Table IV-1>. Summary of evaluation framework ······················································ 49. <Table IV-2>. Summary of evaluation result 1 ··························································· 51. <Table IV-3>. Summary of evaluation result 2 ··························································· 53. <Appendix II-1> Change of size of local finance(1980~2013) ······································· 62 <Appendix II-2> Composition of Local government revenue – general account (1980~2013) ··························································································· 63 <Appendix II-3> Composition of Local government expenditure – general account (1980~2013) ··························································································· 64 <Appendix IV-1> (Local tax/local government ravenue) ratio and Local finance independence index – general account ···························· 65 <Appendix IV-2> Local tax revenue - OECD countries ················································· 66 <Appendix IV-3> Flexible tax rate system ······································································ 67 <Appendix IV-4> Change of local government tax revenue due to increase of local tax ·························································································· 68 <Appendix IV-5> Regional distribution of local tax revenue per person ······················ 68 <Appendix IV-6> Changes in local tax revenue per person(1995～2013) ····················· 69 <Appendix IV-7> Change of fiscal capacity index due to distribution of the local grant tax(2013) ····················································································· 70 <Appendix IV-8> Distribution of local income tax revenue(2013) ································· 71 <Appendix IV-9> Flow of general grant tax calculation ················································ 72 <Appendix IV-10> Change of local government fiscal capacity index due to local grant tax ······················································································ 73.

(7) Contents. 5. List of Figures. [Figure II-1]. Each level government final expenditures as percentages of total expenditure ······························································································ 13. [Figure II-2]. Composition of General Account Revenues of Local Governments (1980~2013) ···························································································· 16. [Figure II-3]. Composition of Expenditures of Local Government General Account (1980~2013) ···························································································· 19. [Figure III-1]. Introduction of Local Income Tax and Changes to the Local Tax System ···································································································· 38. [Figure III-2]. Changes to the Local Fiscal Equalization Scheme (2005) ·················· 46.

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(9) Ⅰ Introduction. It has been approximately 20 years since the leaders of local governments were first elected directly by local residents, in 1995. Although the introduction of direct elections of local government leaders marked a political watershed, it brought about few changes to the public finance of the local governments because they merely inherited the existing public finance systems. Ahead of the implementation of local autonomy, attempts were made to increase the sources of local tax revenue. This was to ensure the financial independence of local governments. In addition, the flexible tax rate system was expanded to enhance taxation rights of local governments immediately after the election of local government leaders. The expanded flexible tax rate system provided the symbolic effect of strengthening the local governments' autonomous right to tax. However, local governments failed to take advantage of their enhanced taxation right, which remained nominal, apart from a handful of tax items. Fifteen years after the implementation of local autonomy system, changes began to take place.1) As local governments managed their own finance, they began to raise issues, demanding greater local financial autonomy and more sources of local tax revenue. In response to these demands, the local consumption tax was introduced in 2010. In 2014, the local income tax changed to an. 1) Korea’s local autonomy system can be defined in a multitude of angles. Following Korea’s liberation, the local autonomy system was initiated until 1962, when the local assembly dissolved. Later, the system was adopted again and the local assembly was established since 1991. Moreover, in 1995, direct election for the head of local government took place. In this study, the ‘initiation of local autonomy system’ refers to the initiation of direct election for the head of local government in 1995 for convenience sake.

(10) Local Autonomy and Local Tax Policy in Korea. 8 independent tax, levied on the income of individuals and corporations. Before the change, the local income tax was treated as a surtax that piggy-backed on income tax and corporate tax, both of which were national taxes. These changes indicate the desire that local governments function as fully independent authorities, empowered with the right to impose major taxes, and the expectation that local taxes will steadily expand, with income and consumption being the key sources of tax revenue for local governments. In 2015, the tobacco consumption tax rate was raised and a new national specific consumption tax was levied on tobacco. A fire safety subsidy, partly financed by the revenue from the national specific consumption tax, was subsequently introduced. These changes can be viewed from different perspectives. From a positive point of view, revenue from local taxes increased and local governments now had a secure a foundation from which to expand tax revenue(Lee, 2012). This was the view adopted by most scholars studying issues in the public finance of local governments. These scholars argued that revenue from the local consumption tax and the local income tax should be increased further in order to change the 8:2 tax revenue ratio of national to local taxes, which had remained largely unchanged, even after the implementation of local autonomy system.2) On the other hand, critics contend that while the local consumption tax did add to the local tax revenue, this did not necessarily translate into increased autonomous rights of taxation for local governments, in a qualitative sense.3) Critics also argue that there was little effect in terms of distributing tax revenue in proportion to local economic activities, one of the most critical issues discussed in connection with the introduction of local consumption taxes (Joo and Choi, 2012). Critics maintain that it is not desirable to increase local consumption taxes under the current circumstances. However, they are not opposed to the concept of increasing local consumption tax. Rather, they emphasize that it is not feasible to strengthen the autonomous right of local governments to tax by merely increasing the local consumption tax, given the diverse restrictions that. 2) Yu et al.(2014) 3) Problems related to local consumption tax are well-organized in An and Won(2009) which was written during the process of debate on adoption of local consumption tax..

(11) Introduction. 9 exist in reality. Furthermore, they believe that the policy goal of distributing tax revenue in proportion to local economic activities is not feasible either. The criticisms outlined above do not apply to the local income tax, because no substantial amount of national tax revenue has been redirected to the local 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.

(12) Local Autonomy and Local Tax Policy in Korea. 10 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..

(13) 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.

(14) Local Autonomy and Local Tax Policy in Korea. 12 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..

(15) Local Public Finance in Korea: the Size and Structures of Tax Revenue and Expenditure. 13. [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.

(16) Local Autonomy and Local Tax Policy in Korea. 14 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.

(17) Local Public Finance in Korea: the Size and Structures of Tax Revenue and Expenditure. 15 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..

(18) Local Autonomy and Local Tax Policy in Korea. 16 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. Sources: the Ministry of the Interior, Yearbook of Local Public Finance for Each Year. local bonds.

(19) Local Public Finance in Korea: the Size and Structures of Tax Revenue and Expenditure. 17 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%.

(20) Local Autonomy and Local Tax Policy in Korea. 18 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..

(21) Local Public Finance in Korea: the Size and Structures of Tax Revenue and Expenditure. 19. [Figure II-3] Composition of Expenditures of Local Government General Account (1980~2013) (Unit: %). general administration and other expenses. social development. economic development. Source: the Ministry of the Interior, Yearbook of Local Public Finance for each year. civil defense.

(22) 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.

(23) Changes in Local Tax and Local Public Finance Systems. 21 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. 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. Content. Temporary measures for - Heads of basic administrative units shall be appointed. local autonomy enacted. Dec. 14, 1963. The above measures amended. - Direct election of heads of metropolitan cities shall be superseded by appointment.. Dec. 27, 1972. The Constitution amended. - Establishment of local assemblies shall be postponed until after the unification of South and North Korea.. Oct. 27, 1980. The Constitution amended. - Local assemblies shall be organized consecutively in 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 direct vote, but they shall be appointed by the central government until provisions on direct election shall be set forth by law.. Dec. 30, 1989. Local Autonomy Act amended. - The timetable for local elections were determined. ․ Election of local assembly members: by June 30, 1990 ․ Election of heads of local governments: by June 30, 1991.

(24) Local Autonomy and Local Tax Policy in Korea. 22 〈Table III-1〉Continue Date of Amendment. Act. Content. Dec. 31, 1990. Local Autonomy Act amended. - The election timetable was revised. ․ Election of local assembly members: by June 30, 1991 ․ Election of heads of local governments: by June 30, 1992. Mar.~Jun. 1991. Members of local assemblies elected. - Basic local administrative units: March 26 ․ Metropolitan city governments: June 20. Mar. 16, 1994. Local Autonomy Act amended. - Heads of local governments shall be elected by no later than June 30, 1995. Jun. 27, 1995. Heads of local 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..

(25) Changes in Local Tax and Local Public Finance Systems. 23 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..

(26) Local Autonomy and Local Tax Policy in Korea. 24 <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.

(27) Changes in Local Tax and Local Public Finance Systems. 25 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..

(28) Local Autonomy and Local Tax Policy in Korea. 26 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).

(29) Changes in Local Tax and Local Public Finance Systems. 27 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).

(30) Local Autonomy and Local Tax Policy in Korea. 28 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).

(31) Changes in Local Tax and Local Public Finance Systems. 29 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..

(32) Local Autonomy and Local Tax Policy in Korea. 30 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) C. Aggregate Real Estate Tax and the Property Tax Reform The local tax system went through a major change in 2005, namely the introduction of aggregate real estate taxes and other real estate tax reform measures. The property tax system was criticized for its radically progressive rate and, in some cases, causing owners of homes with higher market values to pay less tax, because the tax base was determined based on the acquisition cost, not the market price. In addition, the gaps in the acquisition tax and registration tax, both of which are transaction taxes, are often too large between first-time buyers and those who purchase from them. Critics also argue that the transaction tax burden from acquisition and registration taxes is excessively heavy when compared with holding taxes, including property taxes. A reform package was prepared in 2004 to overhaul the property tax system, including the introduction of an aggregate real estate tax. The aims were to fundamentally address the above problems and to enhance the role of property tax in income redistribution by increasing the tax burden on high-priced properties. The package was implemented in 2005. Specifically, the aggregate land tax and property tax were consolidated, and the holding taxes on land and buildings were reorganized into a property tax and an aggregate real estate tax. The property tax functioned purely as a local. 13) Article 111 (3) of the Local Tax Act 14) Kim (2007).

(33) Changes in Local Tax and Local Public Finance Systems. 31 tax that raised funds for local governments, while the aggregate real estate tax, which is a national tax, served as a policy tool. The aggregate real estate tax was able to redistribute income because high progressive rates, ranging between 1% and 3% were imposed when the combined value of the real estate owned by individual households exceeded predetermined limits (i.e., 900 million won in 2005 and 600 million won in 2006). Because it is a national tax, the aggregate real estate tax is collected by the central government, but all revenue is distributed to local governments as a real estate grant tax. Revenue from the aggregate real estate tax is allocated first to local governments whose tax revenue decreased because of the tax reforms in 2005. The remaining amount is distributed to different regions, depending on their fiscal conditions in order to promote balanced regional development. Buildings and land are combined as a single taxable item, and assessed as such when determining the aggregate real estate tax and property tax amounts. The tax base is determined based on the market price instead of the previously used acquisition cost. Benchmark prices published by the National Tax Service are used for apartments, and prices published by the Ministry of Construction and Transportation are used for single houses for which benchmark prices were not available in order to rationalize the tax base. Benchmark prices or reference prices are increased gradually to prevent the tax burden from increasing rapidly as a result of the rationalization of the tax base. The registration tax rate was decreased from 3% to 2% to partly offset the increased tax burden. The property holding tax reform, including the introduction of the aggregate real estate tax, increased the tax burden for residents in certain areas. The heads of some local governments reduced the tax burden by applying flexible rates to property tax with a view to easing the excessive tax burden on their local residents. The central government responded to this move by restricting the use of flexible rates on property tax. As explained earlier, local governments were allowed to adjust property tax rates within a limit of 50% of the standard tax rate, in accordance with the provisions of ordinances, only when the adjustment was deemed inevitable owing to extraordinary fiscal needs or disasters. In addition, the adjusted rate applied only to a particular year. Critics pointed out that the aggregate real estate tax placed an excessive tax burden on a certain class of taxpayers, and their tax-bearing capacity was.