On Cutting the Corporate Tax Rate

- 2003.8.5. Bill introduced by member of the National Assembly Naoyeon Na

Bill No. 162518: Partial Amendment to the Corporate Tax Act -

1. Introduction of the corporate tax rate amendment bill

On August 5, a bill to amend the Corporate Tax Act was introduced by 58 members of the National Assembly. As domestic firms are suffering from sluggish investment and foreign firms’ investment in Korea is declining, this amendment seeks to ease business difficulties and promote economic growth and recovery by lowering the corporate tax rate. Specifically, it would reduce the corporate tax rate on taxable income of 100 million won or less from the current 15% to 13%, and lower the rate on taxable income exceeding 100 million won from the current 27% to 26%.

Although the introduction of this tax cut in the National Assembly falls short of the preferable alternative of abolishing the corporate tax altogether and reducing government spending by the same amount as the lost corporate tax revenue, and although the cut itself is only modest, it is nevertheless welcome in that it suggests that revisions to the corporate tax are moving in the direction of abolition. In contrast to the daily news of strikes, the introduction of this amendment also carries the significance of sending a signal to domestic and foreign investors that Korea intends to create a business-friendly environment, making it especially welcome news at a time when the economic downturn is deepening.

Some oppose cutting the corporate tax rate, arguing that such a reduction benefits capitalists and therefore runs counter to tax justice, or that it would undermine fiscal soundness at a time when public funds were injected during the foreign exchange crisis and when government spending on the four major public pension programs is expected to rise in the future due to population aging. In reality, however, the most desirable approach is to abolish the corporate income tax while simultaneously reducing government spending by the amount made unnecessary by its elimination. If that is difficult because of the challenges of abruptly cutting government spending, then it is necessary to reduce the tax gradually, as now, while steadily reducing government expenditures. Thus, the reasons for abolishing the corporate income tax also become reasons for reducing it in stages while cutting government spending when real-world constraints exist.

2. The need to abolish (or reduce) the corporate income tax

Even when we say that a “company” has decided to invest in a certain business, what we really mean is that the company’s managers have made that decision. In the same way, the “income” of a “corporation” is in fact simply another way of referring to the income of the corporation’s shareholders. Therefore, imposing a corporate income tax and then taxing dividends again ultimately creates, more precisely speaking, a problem of double taxation: taxing the income of the corporation’s shareholders once through the corporate income tax and then taxing dividend income again. This problem is already well known. That is why most countries, including Korea, have tried to integrate the income tax and the corporate tax, and have sought to mitigate this problem by allowing deductions for a portion of dividend income.

Contrary to common perception, the corporate income tax should in fact be abolished in the name of tax justice as well. The belief that abolishing the corporate income tax runs counter to tax justice is itself a mistaken conventional notion. First, if “tax justice” means taxing the same amount of income at the same rate, then the corporate tax is not only an unnecessary form of double taxation, but also applies different rates to the same amount of income. In that sense, imposing the corporate tax is itself contrary to justice.

Second, even if “tax justice” is taken to mean progressive taxation in pursuit of the ideal of “income redistribution,” a concept made familiar to us through the vague notion of social justice, it is far from simple to determine who ultimately bears the burden of the corporate tax and how. For example, when a value-added tax is imposed on a product, the price rises accordingly, and consumers buy less of the now more expensive product than before, losing consumer surplus; consumers therefore bear part of the tax burden. At the same time, producers also usually bear part of the tax burden because reduced consumer purchases lead to reduced production, marginal firms that would have remained in the market before the tax may go bankrupt, and even profitable firms may see their earnings decline. Even if the tobacco excise tax is raised, habitual smokers who cannot easily quit despite higher cigarette prices end up bearing most of the tax burden. Likewise, the freer the movement of capital becomes, the more the ultimate burden of the corporate income tax generally falls not on shareholders but on workers, who cannot move easily across borders.

Even if we concede, for the sake of argument, that the burden falls only on shareholders, the net effect is still not simple, because workers’ income is saved through insurance, pensions, and investment banks and then indirectly invested in the stock market, making workers indirect shareholders as well. Moreover, the issue becomes even more complex when one considers the possibility that reducing the corporate income tax could increase employment and wages by increasing demand for labor through direct investment from abroad. It is no accident that OECD countries have competitively cut corporate taxes in an effort to attract foreign direct investment, and it is worth recalling that in the United States as well, Treasury Secretary O’Neill attempted to abolish the corporate tax with the intention of attracting such foreign direct investment to the United States.

It is only natural that imposing a corporate income tax, which constitutes double taxation, distorts investment incentives. Once such a double tax is imposed, investment itself declines relative to what it otherwise would have been. Since rental income from real estate and interest income are taxed only once, while stock investment is subject to double taxation, stock investment is bound to decline relatively. Not only does investment decrease, but the composition of investment also changes in a way that creates a stronger incentive to rely on borrowing, since borrowing is treated as a cost.

Of course, it may not be particularly desirable for a government responsible for maintaining fiscal soundness to promise a corporate tax cut too easily. Given that Korea’s corporate income tax accounted for as much as 18.2% of total tax revenue in 2000, a large-scale cut or abolition of the corporate tax may be difficult in practice. That is why there may be a need for phased implementation, along with efforts to identify areas where government spending can be reduced as much as possible. However, while the need for fiscal soundness may justify a gradual reduction, it cannot serve as a reason not to reduce the corporate income tax at all.

3. Conclusion: Expectations for economic recovery

Rather than having the reduction of the corporate tax justified merely as a short-term stimulus measure, I hope it will more fundamentally serve, as indicated in the legislators’ proposal, as a stepping stone toward expanding our growth potential as part of a broader reform process in which the public sector is gradually replaced by the market sector through privatization and other measures.

At the same time, timing also matters in implementing policy. At present, in addition to the global economic slowdown caused by the Iraq War and SARS, investment sentiment has further deteriorated due to the North Korean nuclear issue and nationwide strikes. It is therefore all the more desirable that members of the National Assembly have introduced this corporate income tax rate cut at this moment. If domestic and foreign investors take it as an expression of the government’s and the National Assembly’s determination to create a business-friendly environment, and if investment actually increases and the economy recovers as a result, nothing could be better. Concerns about fiscal soundness would then decline accordingly.

Some people respond to calls for reducing or abolishing the corporate income tax by saying that other countries also impose such a tax, or that Korea’s tax rate is lower than the OECD average. But just because the man next door, whose house is bigger than ours, thinks something may be worth doing yet hesitates, there is no reason for us to hesitate as he does. What really matters is whether it is truly a good policy, and if it is, then we should act on it before others do.

Iseok Kim (Senior Research Fellow, Institute for International Affairs)

Wiki:

https://www.cfe.org/w/bbsDetail.php?idx=66

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Original title: 법인세율 인하에 대하여

Author: I-seok Kim

Date: 2003-09-01

Source: https://www.cfe.org/bbs/bbsDetail.php?cid=bill&pn=4&idx=25823