COVID Crisis Drives Economy to Worst Point ... Cutting the Top Corporate Tax Rate Is Urgent

The COVID-19 crisis shocks corporate management

Maintaining the top corporate tax rate will act as a negative factor for economic recovery

Korea is now engaged in a difficult fight against the invisible COVID-19 virus. Contrary to initial expectations, as COVID-19 infections have spread throughout society, the entire nation has been experiencing not only social distancing—that is, restrictions on social activities—but even a kind of depression referred to as “COVID blue.”

In particular, the COVID-19 crisis is a major external shock to the Korean economy, casting a very dark shadow over this year’s economic outlook. It is unclear when the current downturn will begin to ease, but one thing is certain: in a prolonged slump, corporate investment activity contracts and production declines. If companies’ operating profits fall, the tax base may erode over the long term, resulting in lower tax revenue and placing major constraints on the government’s ability to carry out necessary fiscal spending.

According to the Ministry of Economy and Finance, annual corporate tax revenue was 59.1766 trillion won (actual) in 2017 → 70.9374 trillion won (actual) in 2018 → 72.1743 trillion won (actual) in 2019 → 64.4192 trillion won (budgeted) in 2020. In other words, corporate tax revenue rose sharply in 2018 and then increased only modestly the following year.

This year, however, it is projected to decline significantly. Moreover, given the COVID-19 crisis, which was not reflected in this year’s revenue budget, corporate tax revenue may fall much more than expected.

What is noteworthy here is that, due to the 2018 tax law revision, the top corporate tax rate was raised from 22% to 25% (or from 24.2% to 27.5% including local taxes). As a result, corporate tax revenue surged in 2018, the year of the revision, but has shown a declining tendency in subsequent years.

If we think of tax revenue as “tax revenue = tax rate × tax base,” then in the short run, if the tax base does not change, higher tax rates may increase revenue. In the medium to long run, however, the tax base may actually shrink, reducing tax revenue. In other words, if the corporate tax rate is raised, corporate operating profits—the tax base for corporate taxation—may remain unchanged in the short term, allowing corporate tax revenue to increase due to the higher rate.

In the medium to long term, however, the higher tax rate may suppress corporate investment and reduce production, lowering operating profits and ultimately causing corporate tax revenue to decline.

In addition, corporate investment and production are highly sensitive to economic conditions. During an economic downturn, corporate investment becomes more difficult, and falling production can reduce operating profits. As a result, corporate tax revenue may decline even further.

According to the Korea Economic Research Institute (KERI), a regression analysis of listed Korean firms over the 1998–2012 period found that a 1%p increase in the top corporate tax rate reduced corporate tax payments by an average of 4.2–4.9%. This is interpreted to mean that an increase in the top corporate tax rate has an overall negative effect on corporate tax payments, because rather than directly increasing tax payments, it reduces corporate production and earnings, thereby shrinking the corporate tax base itself.

The analysis also found that, as an indicator of economic conditions, a 1%p decline in Korea’s real economic growth rate reduced corporate tax payments by an average of 3.60–3.66%. This means that during an economic slowdown, corporate production and profits decrease, shrinking the corporate tax base itself and thereby reducing corporate tax payments.

Therefore, the anticipated decline in corporate tax revenue going forward will be heavily affected by the economic downturn, and the increase in the top corporate tax rate under the 2018 tax law revision, which has been maintained to this day, will instead act as a negative factor for stimulating corporate investment and promoting economic recovery.

At present, it is impossible to predict how long the economic downturn caused by the COVID-19 crisis will last. Therefore, what is most important is ultimately to lower the top corporate tax rate in order to promote corporate investment → spur economic growth → expand the revenue base → increase tax revenue, thereby securing the necessary fiscal resources in a stable manner.

Sanghyun Hwang, Professor, Division of Economics and Finance, Sangmyung University

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Original title: '코로나 사태'로 최악의 경제 ... '최고세율' 법인세 인하 절실

Author: Sang-hyeon Hwang

Date: 2020-03-23

Source: https://www.cfe.org/bbs/bbsDetail.php?cid=press&pn=22&idx=23376