[Lee Jong-woo's Economic Reading] Biden-Initiated Tax Increase Wave... Unavoidable for Korea, Need to Prepare Rational Measures

Global Fiscal Deficit Ratios Rise Amid Severe Wealth Gap
US Administration Proposes Infrastructure Investment and Corporate Tax Increase from 21% to 28%
South Korea Also Sees 850 Trillion Won Increase in Deficit Bonds

The framework of U.S. economic policy consists of two main approaches. One is the New Deal policy initiated by President Franklin Roosevelt in the mid-1930s. This approach centers on the government building social infrastructure, including roads, investing in future key industries, and addressing welfare. Because the government must take on many responsibilities, its size inevitably grows. The other is Reaganomics, started by President Ronald Reagan in the early 1980s. This approach aims for a smaller government by managing the economy primarily through businesses and markets rather than the government.

The New Deal approach began during the Great Depression. The government directly stepped in as the main agent to resolve the crisis. This policy was implemented for nearly 40 years until the late 1970s and still forms the foundation of the Democratic Party's economic policy. During the 48 years when the New Deal approach was in effect, the Democrats were in power for 32 years, and the Republicans for 16 years.

The New Deal approach began to collapse starting in 1968. Throughout the 1960s, the U.S. enjoyed its greatest economic boom. Encouraged by this, the U.S. government planned to build a welfare society under the goal of the "Great Society" and strengthened government-led economic management. The necessary funds were raised through taxes, with the corporate tax rate raised from 48% in 1967 to a historically high 52.8% the following year. Unfortunately, 10 months after the tax increase was implemented, the U.S. economy began to slow down, and combined with the Vietnam War and the 1971 suspension of gold convertibility, the recession period extended to 10 years. Because the policy orientation favored a large government, it was difficult to reduce spending even when the economy worsened, and the fiscal deficit, which was only about 0.2% of GDP in 1965, increased to 2.8% in 1968. The New Deal approach had become unsustainable.

The alternative that emerged was Reaganomics. Its goal was to revive the economy and rebuild a "Great America by strength." It aimed to cut spending, drastically reduce income taxes, and ease government regulations on businesses. For the past 40 years, this approach has become the framework for economic management not only in the U.S. but also in major countries worldwide. However, the small government policy has recently revealed many problems due to widening income inequality.

The Biden administration announced an infrastructure investment plan along with a tax increase proposal. The main point is raising the corporate tax rate from 21% to 28%, including a plan to raise the global minimum corporate tax rate from 13% to 21% to standardize corporate taxes among countries. There is also a possibility of raising the top individual income tax rate from the current 37% to 39.6% soon. This will be the first significant tax increase since 1968, and it is thought that this tax hike might mark a shift from a small government to a large government.

This judgment starts from the inevitability of tax increases. Last year, the U.S. fiscal deficit ratio to GDP was 16.1%. This year, it is expected to be similar at 15.4%. The UK is at 16.7%, and Japan exceeds 10%. Many advanced countries are recording double-digit fiscal deficits, which has never happened outside of special circumstances like wars or financial crises. Since many countries are in a state where issuing additional deficit bonds is difficult, tax increases are the only option for governments to carry out projects. Perhaps because of this, France and Germany have supported raising the minimum corporate tax rate, and by July, the number of countries agreeing is expected to increase to 140.

Severe income inequality is also accelerating tax increases. Since the outbreak of COVID-19, poverty due to unemployment has increased in all countries. Meanwhile, the wealthy have seen their asset values rise thanks to increases in real estate and stock prices. This has resulted in the widest income gap ever, and if it is not narrowed, social conflicts will intensify. The logical framework for increasing the tax burden on the wealthy has thus been completed.

Our country is no exception in tax increase discussions. At the end of last year, the domestic deficit bond amount and national debt ratio were 850 trillion won and 43.9%, respectively. Both have increased significantly compared to before, largely due to strengthened fiscal policies such as disaster relief payments. Even if last year's spending was largely one-off and unavoidable due to the lack of other means to defend against economic slowdown besides fiscal input, the future remains problematic.

The biggest issue in next year's presidential election will likely be welfare, including basic income. Due to the nature of the issue, spending will inevitably continue, and there is no way to cover this other than raising taxes. Continuous spending cannot be sustained through bond issuance. Although the government currently says it will resolve this through spending restructuring and expanding the tax base rather than tax increases, that will not be enough. Tax increases are the only alternative, and the introduction of a wealth tax and corporate tax hikes are likely to be the first items under consideration. Currently, our country's top corporate tax rate is 25%, which is above the international minimum standard of 21% proposed by the U.S. government. Even if international cooperation is achieved, we will not be immediately affected, but since most G20 countries are likely to support corporate tax increases, raising corporate taxes will inevitably be the first target for expanding tax revenue.

The impact of tax increases on the economy has been a topic of long-standing debate, but no definitive conclusion has been reached yet. The effect varies depending on the economic situation.

Proponents of tax increases argue that when the government invests, businesses follow, leading to increased employment and a virtuous economic cycle. On the other hand, opponents claim that with limited investment funds, if the government takes a large share, the private sector's investment capacity inevitably decreases. Traditionally, the government is less efficient than the private sector, and because many resources flow to inefficient areas, the overall economic efficiency declines. Historically, the U.S. experienced its greatest prosperity in the 1960s when it pursued a large government, and also recorded the longest economic expansion in the 1990s when a small government was established, so historical experience does not clearly favor either side.

Looking at history, tax issues have often been at the root of a dynasty's collapse. The terms "disorder in the tax collection system" and "harsh and excessive taxation" originated from this, and no one likes taxes. Still, taxes are essential for the government to fulfill the roles that citizens expect. Showing how rationally taxes are collected and well spent may be the key to solving the tax increase issue.