[Initial Insight] Implementation of Financial Investment Income Tax: More Drawbacks Than Benefits

Unprecedented Boom in 2020 After Financial Investment Tax Passed
Current Capital Market Is a Powder Keg Filled with Oil
Small Sparks Could Lead to Explosions

[Asia Economy Reporter Ji Yeon-jin] The ruling and opposition parties continue to struggle over the two-year postponement plan for the financial investment income tax. If no agreement is reached between the parties within this year, the financial investment income tax will be implemented as scheduled from January next year. The financial investment income tax is a system that levies a 20% tax (25% for amounts exceeding 300 million KRW) on profits exceeding 50 million KRW earned from stock, bond, and fund investments, established to ensure tax fairness by "taxing where income exists." It also aimed to replenish the government's empty coffers as public finances were mobilized to overcome the unprecedented COVID-19 pandemic.

Let’s go back to 2020 when the financial investment income tax was legislated. After the massive stock market crash in March of that year due to COVID-19, a stock investment craze centered on individual investors, known as the ‘Donghak Ant Movement,’ took place in the domestic stock market. As a result, the KOSPI, which had fallen below 1,400 points, soared to 2,800 points by the end of the year when the bill was passed, more than doubling. The policy funds released worldwide in response to the COVID-19 pandemic drove up asset prices indiscriminately, including stocks and real estate. Stories of FIRE (Financial Independence, Retire Early) enthusiasts who made a fortune through stock investments flooded YouTube, and people of all ages and genders, from university students to office workers, jumped into investing. Those who did not invest at all were considered ‘lightning beggars.’ The public opinion that ‘unearned income’ from stock investments should also be taxed seemed reasonable.

However, it was like a sandcastle. The stock market, built up by COVID-19 liquidity, quickly collapsed as countries began tightening monetary policies. In May last year, the KOSPI surpassed 3,300 points but then declined, breaking below 3,000 points at the beginning of the year and plunging to 2,200 points by last June. Most individual investors’ stock accounts were bruised badly. Moreover, many investors resorted to ‘debt investing’ this summer to recover losses during the rebound. Last month, when the KOSPI fell again to the 2,100 level, many individual investors suffered painful forced sales.

There is an old saying that generosity comes when the granary is full. In 2020, when the financial investment income tax was passed during an unprecedented boom, it would have been generous to tax 20% of investment profits. However, now that the index has fallen to historic lows, fear of further losses is widespread. According to data released early last month by Yoo Dong-su, a member of the National Assembly’s Planning and Finance Committee from the Democratic Party, only 200,000 individual investors, or 0.9%, are subject to the financial investment income tax. Since most investors are currently in a loss position this year, there is no real tax increase effect. If the financial investment income tax is implemented next year, the rationale of tax fairness can be maintained.

On the other hand, there are significant concerns that large individual investors who earn more than 50 million KRW from stock investments may withdraw funds from the domestic stock market. Although these major investors are unlikely to stop investing due to tax burdens, it could dampen investment sentiment. The recently released Beige Book, a report on economic conditions by the U.S. Federal Reserve (Fed), mentioned recession for the first time, stating that “economic outlooks are becoming more pessimistic amid growing concerns about weakening demand.” The Bank of Korea also slowed its pace on the 24th by implementing a baby step (a 0.25 percentage point increase in the base interest rate) due to concerns about tightening liquidity.

Currently, the domestic capital market is like a ‘powder keg filled with oil.’ There are concerns that a ‘small spark’ could lead to an explosion, as seen when Legoland in Gangwon Province failed to repay approximately 200 billion KRW in asset-backed commercial paper (ABCP), causing about 100 trillion KRW in capital outflows in the bond market.