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[INSIGHT]A simple but misunderstood idea

Mar 10,2003
If the tax rate were 0 percent, taxpayers would be happy but there would be no tax revenue to run the country. If the tax rate were 100 percent, everything earned would be collected as tax and nobody would be willing to work. The government’s job is to find the optimal tax rate, taking into consideration the productive incentive and stability of tax revenue. It is on this point that the economist Arthur Laffer said something interesting. He said the tax rate in the United States in the 1970s was beyond the optimal rate, so that any increase in the rate would lead to a decline in revenue and a decrease in the rate would result in revenue increase.
Laffer scratched this thought on a napkin in a Washington restaurant. The Laffer Curve, as the idea became known, was a concept easy enough for politicians to grasp in three seconds. The idea soon became what The Wall Street Journal began promoting as supply-side economics in a campaign against expanding government budget deficits. The theory would be adopted in Reaganomics.
The participatory government of President Roh Moo-hyun is showing a particular zeal for tax reform. Mr. Roh promised during his campaign to introduce an all-inclusive inheritance taxation. The Blue House policy planning director, Lee Joung-woo, talks about the importance of reforming taxes on income and real estate. The deputy prime minister for economic affairs, Kim Jin-pyo, is forecasting a cut in the corporate income tax. The ideas of Mr. Roh and Mr. Lee are geared toward improving social justice and relieving income disparity. But Mr. Kim’s proposal is perhaps an economic stimulus policy plan. Mr. Kim’s plan for a 1 percentage point cut in the corporate income tax each year for the duration of the administration comes with considerable credibility, especially for the business community, considering his specialty in taxation.
There is a mix of hope and concern on this proposal. The positive aspect of the plan is that Mr. Kim’s proposal would shift the focus of government economic policy to fiscal policy and give the central bank more control over its inherent territory in monetary policy. It also highlights the need to lower our tax rates to a level more in line with those of neighboring countries that are trying to attract international business investment. For example, our corporate tax rate is 27 percent; Hong Kong’s is 16 percent.
Another benefit of Mr. Kim’s idea to cut the corporate tax rate is that it would respond to the urgent need to repair our tax system, which is riddled with exemptions, deductions and credits. Yet another is the elimination of discrimination against domestic businesses. There are differences based on industry and the size of the business, but foreign-invested companies have the benefit of an exemption from corporate income tax for the first seven years of operation and a 50-percent deduction for the next three.
The deputy prime minister’s plan is not without some questionable elements. The first is whether the government’s drive to cut direct spending and transfer resources to the private sector is really compatible with its ideology on reform. Tax cuts are the staple of the conservatives. When the monetarist economist, Milton Friedman, rallied behind supply-side economics, it was not because he had faith in the fundamentals of the theory but because he thought its tax-cut element would help reduce government intervention in the U.S. economy.
It may be difficult to meddle with a revenue source that provides the government with 22 trillion won ($18.5 billion) -- 19 percent of total government revenue. The administration has a bag full of promises already with not enough resources, including the proposal to move the administrative capital outside of Seoul.
The third concern is that tax cuts may contribute to the government deficit without achieving very much. It was the blind belief in the benefits of tax cuts that drove President Ronald Reagan to leave office with the greatest government debt in the history of the United States, which brought the demise of Reaganomics. The boost to spending and investment through tax cuts is still largely unproven. Investment is a variable in economics, but it is also an important variable in the world of politics. Also, it is a concept simple enough for our representatives to understand and for the media to get all excited about.

* The writer is an editorial writer of the JoongAng Ilbo.


by Joseph W. Chung


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