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T he Ministry of Economy and Finance (MEF) recently announced a surprising package of tax incentives for investments. When MEF unveiled the directions of economic policy for the second half of 2019, one of the most eye opening and jaw dropping elements was the set of tax incentives for investment. Almost all of the media dubbed the package as a surprising tax cut, which has been for long believed exactly running counter to the principle of the Moon administration. Indeed, the current administration has been emphasizing the role of active government spending to correct social polarization as well as to vamp up economic growth, which necessitate more revenues and higher taxes.
The so-called a set of triple tax incentives was definitely introduced to stimulate chronically deficient investment activities in Korea. In fact, negative investments has undermined economic growth for more than 5 quarters, contributing –2.6 percentage points for the first quarter growth rate of 1.9 percent. In another words, the growth rate for the first quarter could have been 4.5 percent, had the investment stayed foot and not fallen by 2.6 percent. It has been that way for more than a year since early 2018.
Unlike previous policy directions where only infra-structure investments were taken into consideration, MEF this time shifts its focus to encouraging facility investments especially connected to efficiency and productivity of the Korean economy. More specifically, the set of three kinds of tax incentives are as follows: the tax exemption rate for investment is raised 1 to 3 percentage points depending upon the size of the investing firm, the scope of eligible tax exemption is broadened to include investment in the logistics industry and safety related projects among others, and finally, speedier depreciation of up to 75 percent is allowed for the first accounting year. In sum, it is clear that the government intends to encourage more investment in facility investments related to factory automation, high-tech industry, logistics industry, medical and pharmaceutical industry, as well as enhancing the safety of energy production and transportation, just to name a few.
With this great ambition of MEF at the backdrop, one of the most crucial problems of it is that it requires an amendment of the act of restraining special tax treatments (2019). If the national assembly which has been in recess for a few months because of a political tug-of-war cannot properly amend the articles pertaining to the set of the three tax incentives, then all their positive effects would be hard to expect. Fortunately, the political leaders recently agreed to open parliamentary processes and the expectation is very high as the amendment of the act would be among the top priorities without much disagreement or opposition from any political party.
Another potential problem regarding the tax incentives is how extensive the effect would be in expanding facility investments. The tax exemption incentives system was already in place and only the exemption rate was raised from 1 percent to 2 percent for big firms, 3 percent to 7 percent for medium-sized firms, and from 5 percent to 10 percent to small-sized firms. Although it looked drastic in raising the exemption rate, especially for the medium and small-sized firms, still, a 2 percent exemption rate seems quite too small for the big firms, which account for more than 50 percent of facility investment in Korea. Also, the tax benefits are strictly confined to investment related to the enhancement of productivity or safety, making general investments in other areas such as new expansion or branching out not applicable for the exemption. Therefore, it is a general belief in business that these kinds of preferential tax advantages should be extended to a variety of investment activities with drastic and audacious benefits if the government wants a real impact with tangible results.
The tax incentive set was not as ambitious perhaps because the government was not expecting a disastrous economic growth for the remainder of this year. The 2.4-2.5 percent economic growth projection for 2019 may look decent when compared to other OECD countries. But the fact is that even this new target growth rate seems very unlikely considering the 1.7 percent growth in the first quarter. Economic growth in the second half has to be over 3 percent to make the annual economic growth rate to be 2.4 percent. MEF is also considering an expansionary policy by implementing a KRW 6.7 trillion package of supplementary budget, but this won’t be sufficient to turn around the economic slowdown in domestic consumption.
Knowing that the real challenge for the future Korean economy rests upon the global competitiveness of SMEs, the government has to be more audacious in providing resources for investments, innovation and restructuring. More drastic tax exemptions have to be allowed in SME investments. Tens or even hundreds of trillions of won should be channeled into investment for newer machines and factories. They should not come solely from tax revenues or debt financing. The hundreds of trillions of won in private savings in the financial system could be mobilized for that purpose. Economic growth, income and new jobs follow only after investment, not the other way around.
By Professor Se Don Shin
Dean, Sookmyung Women’s University
The opinions expressed in this article are the author’s own and do not reflect the views of KOTRA