What makes the income tax system so progressive? – the case of Korea

Abstract

We analyse the impact of each component of Korea's income tax system, which includes tax rates, allowance, deduction and tax credit, on overall level of progressivity, using micro-level data in 1991, 1996 and 2000. We find that Korea's income tax system has a surprisingly high level of gap between economic income and taxable income, due to remarkably generous levels of allowance and deduction. These have made nearly half of total taxpayers, specifically 47% in 2000, to pay no taxes effectively. Having analysed the impact of each component of Korea's income tax system on overall progressivity, we find that deduction policy has more impact on progressivity than tax rates and allowance. We highlight that tax credit has played an opposite role in determining the level of progressivity, which is regressive. Our recommendation is that decision makers in Korea should pay more attention to tax credit to increase the progressivity of the income tax system.

Acknowledgements

The earlier version of this article was presented at the 61st Congress of the International Institute of Public Finance in 2005, which was held in South Korea. The authors would like to express many thanks to participants for helpful comments.

Notes

¹ There are several classifications in the measurement of tax progressivity. Duclos and Tabi (1996) divide these indexes into two approaches. The first is to measure the progressivity by using the shares of total tax burden with respect to pre-tax income (for example; Kakwani, 1977). It represents that the lesser the tax burden share of the poorer, the greater the tax progressivity is. The second is to measure the redistributive effect of taxes. For a fixed distribution of pre-tax incomes, the greater the progressivity of a tax system is, the more equal the distribution of after-tax incomes is (for example; Reynolds and Smolensky, 1977). On the other hand, Lambert (2001) shows the different classification, which is disproportionality into the distribution of tax burden and a redistributive effect of the distribution of income.

² It is well-known in Korea that survey data has serious under-reporting problem for tax amounts. Our estimation shows that the effective tax rates from the reported tax amounts are 2.2% in 1991 and 1.1% in 1996, whereas our estimates from the simulated taxes are 5.3% in 1991 and 4.97% in 1996.

³ Wagstaff and van Doorslaer (2001) discuss that estimates for four terms do not always sum to the value of , because of the interpolation problem. Our estimates show the same case.

⁴ Hyun and Lim (2005) shows the comprehensive estimates for the impact of Korea's financial crisis on the level of income distribution in details.