Current rate abnormally low
Increasing taxes on corporations has reemerged as a political challenge as the government and National Assembly struggle to come up with funds to sustain welfare programs. Polls overwhelmingly show the public wants corporate taxes raised first, if tax increases are necessary to pay for welfare programs. But the government and business sectors worry the move could further dampen investment sentiment and slow economic recovery.
The question of whether or not we need higher corporate tax rates is wrong in the first place. We should instead examine whether current rates are reasonable from an economic standpoint.
The bottom line is our corporate rates are not normal, hovering below the maximum personal income tax rate. A self-employed businessman reporting annual income of more than 150 million won ($133,600) will pay 38 percent in taxes, the maximum rate. If the same income is reported by an incorporated entity, the tax rate drops to 22 percent. A small business with income of less than 200 million won would pay 10 percent.
After taxes, the profit of an incorporated entity should be paid out to shareholders. According to the National Tax Service, 72.1 percent of dividend income in 2012 went to country’s richest 1 percent. Income tax is levied on dividends, but the additional burden can be avoided if the largest shareholder decides not to withdraw the dividend. As a result, companies can help their main shareholders hide income from tax authorities by keeping funds in the corporate safe.
Reduced tax rates should help companies contribute to buttressing economic growth, and that contribution should exceed revenue lost from the tax cuts. Opportunity costs from policy actions need to be covered. Economic benefits from corporate tax cuts must be shared across-the-board and most of all trickle down to the lower-income group.
So have all these conditions been met? Studies show economic growth has not reached the low-income class and cuts in corporate tax rates have failed to generate new investment and jobs. In short, corporate tax cuts have not incited capital investment, economic growth or foreign investment. Because most new corporate investment goes into upgrades that reduce labor costs, low corporate tax advocates also lose the argument that it helps to generate employment.
Why doesn’t corporate investment pick up even with tax incentives? The answer is simple. Taxes account for just 1 percent of corporate expenditures. According to the 2012 White Paper on national tax data, gross revenue of local companies totaled 4,212 trillion won. Gross income was 262 trillion won and expenditures 3,950 trillion won. Tax collected from companies was 40 trillion won. If the corporate tax rate is lowered 10 percent, companies save only about 0.1 percentage point in spending. Companies would welcome a lower tax burden of any amount, but taxes don’t significantly influence investment plans. According to Chaebul.com, a website that follows the country’s large companies, cash on hand at the country’s 10 largest reached 125.4 trillion won at the end of September. The reserves grew 15.1 percent from the end of 2013. What use is lowering corporate income taxes to help boost liquidity when companies already are sitting on piles of cash instead of spending on new investment and hiring? The longstanding argument was companies should be relieved of heavy tax burdens because they contribute to generating jobs and driving economic development. But policies aimed at stimulating investment and job creation through tax cuts no longer work. Even with decreasing revenue from collecting less in taxes from companies, the savings for those companies is not big enough to encourage them to invest.
Korean companies continue to argue that their tax contribution to the gross domestic product is greater than the average for member countries of the Organization for Economic Cooperation and Development (OECD). But they omit one important fact. Corporate income against GDP is much higher than the OECD average, meaning they pay less in taxes relative to earnings.
It is also wrong to argue that tax cuts are a global trend. Countries have been shaving nominal rates since the 1980s, but the effective rates have remained more or less the same because of reduced tax deductions.
Translation by the Korea JoongAng Daily staff.
*The author is a professor of tax accounting at Hongik University Graduate School of Business Administration.
BY Kim Yoo-chan