What if the government loses fiscal maneuvering?

A small open market like South Korea can be easily shaken by external shock waves. The country’s fiscal strength serves as a fortress against external contingencies. Korea has long argued for fiscal integrity as its last resort. But it is turning into wishful thinking.

Public finance became wobbly during the last government under which fiscal spending stretched beyond revenue throughout the five-year term of Moon Jae-in’s presidency. At the time, the Covid-19 pandemic could be attributed to the overexpansion of government spending. Under the Yoon Suk Yeol presidency, the government is set to incur a deficit for the second straight year after a record shortfall of tax revenue of over 56 trillion won ($40.5 billion) last year. The tax revenue from January through May is 9.1 trillion won less than that of a year-ago period — largely due to a decline in corporate taxes from poor earnings. The tax shortfall for this year is estimated to top 10 trillion won to 20 trillion won.

If the tax collection falls below the estimate, the government usually would have to issue debt or find other means to finance its spending plan. Such options would go against the government’s restrictive stance. Some of these spending plans may have to be reserved. It would be great if the budget is “unspent,” but withholding the spending scheme due to a lack of money is another matter. The action can worsen the ongoing slump. The legislature also can protest the disregard of its approved budgetary plan.

The economic data has also turned downbeat. Industrial output, consumption and investment all fell against a year-ago period in May in the first triple decline in 10 months. The economy may not pick up in the second half as hoped. When the economy deteriorates, the monetary and fiscal policy should turn loose, but that option cannot be easy. If the Bank of Korea cuts the benchmark rate before the U.S. Federal Reserve does, debt and the foreign exchange market can become unsettled. Authorities cannot risk worsening the environment in managing fiscal deficit, as it can further narrow fiscal and monetary maneuvering room. Deepening the fiscal deficit on top of the deteriorating economy can entrench the economic slump.

Yet the government and politicians are vying for a tax cut. The government promised to scrap the plan of taxing capital gains from all financial investment incomes and plans to include easing in inheritance and comprehensive property ownership taxes in next year’s tax code. The outdated tax system needs revisiting, but it must take place in light of the ramifications on tax revenue. Predatory and speculative capital that leverages on the sovereignty bonds of governments with weak public finance go after countries with weak confidence in public policy and penchant for populist moves.