[Q&A] Lee Bok-hyun "Financial Investment Tax Will Trigger Short-Term Trading in Funds and Stocks"

After the Market Experts Meeting on the 31st: Backbriefing
"Concerns over Domestic Capital Outflow if Financial Investment Tax is Implemented
Questions Remain on Actual Tax Effectiveness and Achievement of Objectives"

Lee Bok-hyun, Governor of the Financial Supervisory Service (FSS), expressed concerns during a back briefing after a private meeting with market experts on the 'Financial Investment Income Tax (FIIT) system' on the 31st of last month, stating that "market experts unanimously agree that investment in the Korean stock market is likely to become more short-term."

The FIIT is a system that imposes a capital gains tax of 20-25% on gains exceeding 50 million KRW annually for investors in financial investment products such as stocks, bonds, funds, and derivatives. For other financial products, the threshold is 2.5 million KRW. Although the system was established under the principle of 'taxation where income exists,' concerns have grown that it may trigger the withdrawal of major investors from the domestic stock market in the future.

Attendees at the morning meeting included representatives from securities firms, asset management companies, and academic experts in financial taxation. The meeting was organized to discuss the direct and indirect impacts of the FIIT implementation on individual investors, the financial investment industry, and the capital market.

Below is a Q&A session with Lee Bok-hyun, Governor of the FSS.

- As the head of the FSS, what are your thoughts on the direction of the FIIT, inheritance tax, and amendments to the Commercial Act?

▲ Whether it is a tax system or a corporate law issue, pollution originating upstream affects the downstream fields. Although the jurisdiction of the system itself lies with the National Assembly's Political Affairs Committee and other standing committees, there are impacts on the capital market we oversee. I understand that those concerned with the FIIT have implemented it with appropriate goals such as securing tax revenue and ensuring tax fairness and rationality. However, just as well-intentioned designs in past real estate taxation influenced market participants' behavior and triggered real estate price increases, we have concerns about possible errors in prediction. Regarding the capital market, there was a sense of problem awareness about how this system might operate, including whether it was reviewed back in 2019.

Some mentioned bond taxation, noting that bond investments have increased significantly. We believe abolition is appropriate, but if there are reasonable arguments for maintaining the FIIT, then 'fine-tuning' (specific adjustments) is necessary. The FSS and the Financial Services Commission have provided opinions within government departments. However, at this stage, the government's position is already set, and with the National Assembly situation and stakeholders such as individual investors voicing their opinions and media coverage, if this is not handled concretely, market confusion is likely to increase. Inheritance tax also has its purposes, but it is important to consider how it might affect the stock prices of medium-sized companies. There are situations where founders or previous generations can pass on management rights to successors in an appropriate manner, and such cases may become more frequent.

- The Ministry of Economy and Finance estimated in 2022 that the taxable population would be 1%, about 150,000 people. What is the current estimate, and what justification do you think is necessary to discuss abolition?

▲ It would be more appropriate for the tax authorities to respond. Broadly speaking, considering the increased portions of various investment products such as stocks and bonds and the rise in interest rates, there may be points to reconsider. If requested, we have data extracted. The issue is not only who becomes taxable but also that individuals will likely try to avoid taxation through loss offsetting. Individuals may make microeconomic decisions. If investment and buy-sell decisions are made for tax purposes, market experts unanimously agree that investment is likely to become more short-term from a long-term investment perspective. Even if one is not a taxable person, those who fear becoming taxable may make decisions not based on market supply and demand or usual purposes but on tax considerations, fearing exposure to risk. Even if not taxable themselves, if their position volatility increases, adjustments may cause concentration effects.

Another point is that even if the same interest income is taxed, there is a difference between taxing income that is predictably certain and investing in growth stocks. Income from investments in stable areas is predictable. In contrast, income from investments in volatile areas is different, even if it is the same 1 million KRW. In the past, there was a decision to tax less on income from stocks with both upside and downside risk, acknowledging the risk of losses, unlike fixed income with only upside. I respect the efforts to rationalize the FIIT system, and I believe the tax authorities have deliberated carefully. However, it seems that the psychological and motivational aspects of market participants were not sufficiently considered.

- There are concerns that general individual investors may suffer in year-end tax settlements or health insurance premiums if the FIIT is implemented. Was this discussed?

▲ There were criticisms that the exclusion from deductions for those with income over 1 million KRW was not deeply considered during initial financial planning. We are currently conducting various effect analyses. Although nothing definitive can be said yet, some market experts have expressed concerns that the number of affected people could be much larger than just a few thousand or hundreds of thousands, possibly reaching several hundred thousand. There are worries that many may continuously lose eligibility for basic deductions. We plan to analyze internally and quantify what can be quantified. Once organized, we think it is necessary to explain.

There were also concerns about health insurance premiums. Market experts, based on their contact with private banking (PB) services and regional managers within companies, have expressed worries about potential negative aspects. Due to uncertainty, some have already liquidated their domestic stock portfolios or are seriously considering doing so. Although this system exists in some advanced countries like the U.S. and Japan, if implemented as is, it may intensify the concentration on overseas stocks. Investors might recognize losses to avoid taxes while investing in domestic stocks, which could discourage long-term holding of funds and other assets, triggering short-term trading. This issue was unanimously regarded as problematic across management and other areas.

- Do you intend to communicate or persuade the political sphere directly?

▲ Regarding inheritance tax, value-up initiatives, capital market advancement, and inheritance tax, I think communicating with the National Assembly or media to hear opinions is not bad from the perspective of healthy democratic decision-making. However, since the government’s position may or may not be finalized, and although the FSS has some independence, it must align with the authorities for policy consistency. Therefore, it is cautious for the FSS to act unilaterally. If the Political Affairs Committee or other standing committees or state agencies officially or unofficially request explanations, I believe it is generally impossible not to provide them.

- Some individual investors argue that since the FIIT applies separate taxation, it is more advantageous than comprehensive taxation and claim that private equity funds are the hidden forces behind the FIIT. What is the FSS’s view?

▲ Experts related to private equity funds also attended the meeting. In private equity management, the assets managed are stocks or dividends from stocks. For example, in the case of dividends, if private equity holds them until maturity, taxation may occur, and some say the private equity market carries significant risks. Among private equity management, those heavily investing in overseas stocks might increase their overseas portfolios if the domestic stock burden rises under current regulations, and some say overseas private equity could increase. It would be better to gradually clarify excessive psychological anxiety or worries about unresolved issues. Even if the FIIT is implemented, large securities firms have prepared and are cautious, but many participants will need to organize withholding tax and other matters, which each asset management company or securities firm must develop. I believe this will cost much more than several hundred billion KRW, possibly several trillion KRW.

- If the FIIT is abolished, do you consider reverting to the previous system as an alternative?

▲ This is not something I can answer. Since it relates to a complete tax system, we have opinions, but discussing adjustments to the scope of capital gains tax might be excessive. Taxation on dividend income or other systems must consider revenue goals, but from a market perspective, the impact on the market when changes occur, whether many investors find it appropriate for domestic stocks, and the need for supervisory systems must be comprehensively considered. Currently, regarding dividends and the FIIT, long-term investment may decrease, and the possibility of capital outflow abroad seems high.

- You previously stated that 'postponing the FIIT system is cowardly.' Do you still hold the same position?

▲ When the postponement was made in 2020, these aspects were reviewed, and there was a task to consider how to improve it in 2024, whether by the National Assembly or elsewhere. If this had been reviewed then, I think productive discussions could have taken place. We really need to open a forum for discussion. I apologize if anyone felt uncomfortable with my previous expression calling postponement cowardly.