Korea Institute of Public Finance, Report on 'Mid- to Long-Term Fiscal Risk Policy Directions in Response to Population Structure'
High Mandatory Spending Ratio → Low Income Redistribution Effect → Reduced Incentive for Tax Increase
[Asia Economy Sejong=Reporter Kwon Haeyoung] There has been a call for active restructuring of mandatory expenditures, which account for more than 50% of South Korea's budget. In particular, it has been pointed out that the system should be reformed to expand the government's discretion to adjust the targets or costs of mandatory expenditures according to economic conditions, thereby securing the government's fiscal capacity.
On the 8th, the National Assembly Legislative Research Office released a report titled "Mid- to Long-term Fiscal Risk Policy Directions in Response to Population Structure (Kim Hyun-ah, Senior Research Fellow at the Korea Institute of Public Finance)" containing these contents.
Mandatory expenditures in South Korea account for 53.5% of the 2023 budget proposal, exceeding half of the national budget size. Mandatory expenditures refer to budgets that the government cannot arbitrarily reduce as they are legally stipulated, such as the four major public pensions, health insurance, and local transfer expenditures. In particular, about 40% of domestic taxes (19.24%, 20.79%) are transferred as local allocation tax and local education finance grants, which are local transfer expenditures.
The problem is that mandatory expenditures, centered on social welfare spending, are expected to increase further due to rapid aging and changes in population structure. According to the report, social welfare expenditures account for 33% of South Korea's mandatory expenditures, but in advanced countries that have long experienced aging, this proportion reaches 58%.
The report suggested that while restructuring the local transfer expenditure included in mandatory expenditures, it is necessary to apply and strengthen the government's economic response function not only in discretionary expenditures but also in mandatory expenditures.
Senior Research Fellow Kim Hyun-ah stated, "Advanced countries with mature pension and health insurance systems operate mandatory expenditure fiscal management by adjusting targets and unit costs within social welfare expenditures according to economic fluctuations." She added, "In particular, for public pensions, efforts should be made to operate social welfare mandatory expenditures in an economic cycle-linked manner, enabling active spending during economic crises and slowing spending growth during booms." She also pointed out that discussions on intergenerational equity through pension system reform should be actively pursued.
She also mentioned the need to reform the local allocation tax and local education finance grant systems, which increase proportionally with tax revenues regardless of economic growth rates. Currently, South Korea transfers 40% of tax revenues to local governments and only redistributes the remaining 60% nationally. Because the scale of local transfer expenditures based on tax revenues is large, the redistribution effect of the central government budget is limited, and incentives for tax increases to prepare for aging inevitably decrease.
Senior Research Fellow Kim said, "Even if the legal distribution of local transfer expenditures is maintained, the method of transferring a certain percentage of domestic taxes, introduced about 50 years ago, needs to be restructured." She pointed out, "The current mandatory expenditure system reduces fiscal responsiveness during crises and, relying solely on discretionary expenditure-centered fiscal management, exposes limits in securing fiscal capacity, resulting in an increase in national debt."
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