Tax Cuts Without Spending Restraint Are an Illusion

They say it will revive livelihoods and lead an economic recovery,

but it only worsens the fiscal condition amid inflation concerns,

and leads to a greater tax burden on future generations.

Tax cuts are being put forward by presidential candidates as major campaign pledges. Kim Munsu of the People Power Party has promised cuts to the corporate tax and inheritance tax, an increase in the basic income deduction, reform of the comprehensive real estate holding tax, and the abolition of heavy capital gains tax rates. Lee Jaemyung of the Democratic Party of Korea has pledged bold tax benefits, including income tax and corporate tax reductions for investment in advanced industries, as well as expanded tax credits for monthly rent, communication expenses, and education expenses. The intention is to invigorate people’s livelihoods and revive the sluggish economy through tax cuts. However, for tax cuts to produce their intended effects, they must be accompanied by reductions in government spending. Otherwise, not only do the positive effects of tax cuts disappear, but fiscal conditions deteriorate and negatively affect the economy.

A look at the candidates’ presidential pledges shows that it is difficult to find any mention of reducing government spending. Rather, most of the plans involve increasing spending. Lee Jaemyung has proposed expanding child allowances to all children under 18, introducing a basic income for farmers and fishers, and expanding local currency programs. These pledges would require tens of trillions of won in fiscal spending. Kim Munsu, too, has made no mention of any plan to reduce government spending.

Tax cuts increase taxpayers’ disposable income. Taxpayers whose income rises will spend part of it on goods and services, which in turn increases corporate sales and contributes to economic revitalization. More importantly, the increase in income resulting from tax cuts also increases savings. As income rises, time preference declines—in other words, people come to prefer future goods relatively more than present goods—and savings increase. Savings are the source of increased production of goods and services. In order to produce more goods and services, capital goods such as new tools and machinery are needed, and this is possible only through capital accumulation made possible by savings. Therefore, tax cuts promote economic growth by increasing savings, enabling more capital goods, and making it possible to produce more goods and services in the future.

However, while tax cuts increase taxpayers’ disposable income, they reduce the funds available to the government. If government spending is not reduced in line with the reduced funds, the government must either issue government bonds and borrow to cover the shortfall or finance it through new money creation.

Borrowing money from the public means that those lending to the government either reduce their spending on goods and services or have less money to lend to others. This offsets the spending effect of taxpayers resulting from the tax cut. For example, if taxpayers use the entire amount gained from a tax cut to buy government bonds, then instead of holding the funds from the tax cut, they simply hold government bonds. On the surface, this may seem no different, but that is an illusion. In order to repay the interest and principal on its borrowing, the government must impose taxes on the public in the future. Therefore, the bonds held by taxpayers can be regarded as tax bills received in advance for taxes to be imposed in the future.

In reality, taxpayers do not lend the entire amount gained from tax cuts to the government. The amount the government borrows is the amount left after taxpayers have spent part of it. This comes at the expense of private borrowers. The government borrows funds that would otherwise be used by builders constructing houses, factories, and the like. As a result, taxpayers’ consumer spending increases, but spending on private capital formation declines. Consequently, employment and production rise in the consumption sector, while employment and production fall in the investment sector, causing distortions in the structure of production. The consumption and investment sectors offset each other, so there is no short-term stimulus effect, and because the investment sector contracts, the economy declines in the long run.

If the tax cut is instead financed through new money creation, the situation becomes even worse. Inflation occurs, making people’s livelihoods even more difficult. If the government does not reduce spending and only cuts taxes, it will not revive livelihoods or restore the economy through tax cuts; it will only worsen the fiscal condition.

Korea’s fiscal situation is growing worse by the day. Because of a shortfall in tax revenue this year, the government had to urgently borrow as much as 71 trillion won from the Bank of Korea by April. As annual fiscal deficits of tens of trillions of won have accumulated, national debt came close to 1,196 trillion won at the end of last year, exceeding 47% of gross domestic product (GDP). The National Assembly Budget Office forecasts that the consolidated fiscal balance deficit will reach 25.7 trillion won this year, while national debt will rise to 1,270.4 trillion won. If public finances are mismanaged, not only will the country’s creditworthiness decline, but future generations will suffer from a heavier tax burden. A tax-cut policy without reducing government spending is nothing more than an illusion.

Ahn Jaewook, Chairman, Center for Free Enterprise (CFE)

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Original title: 정부지출 줄이지 않는 감세정책은 환상일 뿐

Author: Jae-wook Ahn

Date: 2025-05-27

Source: https://www.cfe.org/bbs/bbsDetail.php?cid=press&idx=27756