Reconsidering tax cuts

The tax debate is dominating politics again. President Lee Myung-bak has reopened the issue, saying that he wants to pursue his campaign promise of tax cuts for high-income individuals and large firms in particular. But he added that the timing of the cuts could be pushed back by a year or two than he initially suggested, depending on economic circumstances.

The government has already lowered income taxes by 2 percentage points, but it has delayed the cuts for residents who earn more than 88 million won ($77,935) a year. Park Geun-hye, President Lee’s former rival and the de facto leader of a marginal faction within the ruling party, offered up a different idea. She proposed that income taxes remain at current levels but that the government lower corporate taxes.

Grand National Party Chairman Ahn Sang-soo suggested a neutral alternative, proposing a 35 percent tax rate for a new income bracket of individuals who make more than 100 million won or 120 million won per year. The opposition parties, meanwhile, are enjoying the wrangling over tax policies in the ruling camp.

In principle, the tax cuts should be implemented as promised. The National Assembly, while endorsing the tax cut last year, suspended the 2-percentage-point break for individuals earning more than 88 million won and companies earning more than 200 million won until 2013, conceding to demands by the opposition.

But any tax breaks for the wealthy are bound to be controversial. Unlike two years ago, the world is grappling with large fiscal deficits and related problems. Economists have long debated the effectiveness of tax cuts in helping the economy over the long run. Tax cuts can help increase consumer spending and prop up the economy in the near term, but they are hardly a panacea.

To avoid criticism of providing tax breaks for the rich, the government needs to differentiate its approach to individuals and companies. A corporate tax cut, for instance, can benefit the overall economy. The government must provide a carrot to spur corporate investment. But we need to deliberate on whether individuals making 88 million won to 100 million won should really be considered as high-income earners or the middle class.

If politicians are concerned about fiscal health, they should focus on broadening tax sources. Overdue taxes amount to 37 trillion won ($32.75 billion), while the underground economy is as large as 300 trillion won ($265.5 billion) by some estimates. If we can reduce both figures, our deficit problems may be solved.