OECD Warns of 'Aging Debt Bomb': "Korea Must Raise VAT to Fund National Pension"

OECD Releases 'Korean Economic Report 2022'
Japan Raised Consumption Tax by 5%P from 2012 to 2019 to Cover Pension Expenditures

On the 5th, as the heatwave intensifies, elderly people are waiting to receive free meals at Tapgol Park in Jongno-gu, Seoul. Photo by Mun Honam munonam@

[Asia Economy Sejong=Reporter Kwon Haeyoung] As national debt rapidly increases due to expenditures related to population aging, the Organisation for Economic Co-operation and Development (OECD) has recommended that the South Korean government consider raising the value-added tax rate to secure pension funds.

On the 20th, the OECD released the "Korean Economic Report 2022," which included this recommendation. The report also covered Japan's pension reform case, a country that faced population aging earlier than South Korea.

According to the report, Japan gradually raised its consumption tax by 5 percentage points from 2012 to 2019 to cover aging-related costs, including pension expenditures. Currently, South Korea's value-added tax rate is 10%, which is much lower than the OECD member average of 19.2% (2020). The OECD recommended referencing Japan's case to secure funding for the National Pension Service and other pensions. This is because the National Pension Service's fiscal balance is expected to turn into a deficit in 2043, with the deficit projected to increase to approximately 213 trillion won by 2070, raising concerns about fiscal deterioration (based on the National Assembly Budget Office). In the case of the Basic Pension, funding is currently 100% covered through taxes.

The OECD stated, "The South Korean government should consider financing public pensions, which serve a redistributive function, through general taxation," adding, "This could strengthen the link between pension premiums and benefit amounts."

The OECD also suggested introducing an automatic life expectancy linkage system applied to pension schemes in some OECD member countries such as Japan and Germany. In Japan, pension benefits are linked to life expectancy under the condition that the income replacement rate does not fall below 50%. This approach can enhance fiscal sustainability and improve the predictability of future pension benefits.

Furthermore, the OECD recommended raising the National Pension eligibility age, currently scheduled to increase to 65 in 2033, earlier to 68 in 2034, and more than doubling the current National Pension contribution rate from 9%. The OECD analyzed that if the pension eligibility age is raised earlier, the expenditure pressure, which accounts for 2% of the gross domestic product (GDP) by 2060, would be reduced.

The OECD emphasized pension reform because South Korea's government debt ratio is expected to exceed 140% of GDP by 2060, up from the current level of about 50%, due to rapid population aging. With fast aging, the elderly population ratio in South Korea is expected to exceed 20% by 2050, and social spending, currently about 12% of GDP, is projected to nearly double by 2060.

The OECD stated, "Considering the rapid population aging and the urgent tasks to expand the social safety net, South Korea will face greater long-term expenditure pressures compared to most other OECD countries," and forecasted, "To stabilize debt, additional revenue or expenditure cuts equivalent to 10% of GDP will be required by 2060."