"Fiscal Rules Incorporating Plans for Efficient Spending and Tax Increases Must Be Introduced" [Issue Interview]

In 10 years, social welfare expenditures are expected to approach 28% of the domestic gross product (GDP), prompting calls for the introduction of fiscal rules containing concrete measures to streamline fiscal spending. As the financial burden increases daily due to the combined effects of aging and ultra-low birth rates, it is argued that a detailed long-term outlook scenario for at least 10 years ahead should be drawn up and fiscal efficiency measures to respond to it should be included in the rules.

Professor Hong Seok-cheol of the Department of Economics at Seoul National University recently stated in an interview with Asia Economy, "At minimum, fiscal rules should be established that include future fiscal projections of over 10 years and scenarios to reduce the increasing burden." He emphasized the need to create a long-term fiscal blueprint and include solutions for the state to cope with the growing fiscal expenditure demands. In his report titled "Social Welfare Expenditure Outlook and the Necessity of Introducing Fiscal Rules" in the December 2024 issue of the Fiscal Forum, Professor Hong argued that to gain acceptance from future generations for the rapidly increasing welfare expenditure burden amid demographic changes, it is essential to have principles that ensure efficient use of fiscal resources.

For example, the rules should include plans on how demographic changes will affect revenues and expenditures in 10 years, the pace at which expenditure increases should be adjusted, the appropriate range for managing the national burden rate, which tax items should be increased if tax hikes are necessary, and how to manage debt if it needs to be increased. Professor Hong predicted that fiscal rules containing such efficiency measures must operate with binding force to persuade future generations even when tax increases become necessary.

Professor Hong Seok-cheol, Department of Economics, Seoul National University

- He argued that fiscal rules should be enacted as soon as possible.

▲ This is because the super-aged society has already begun. Based on the Statistics Korea's future population projections for the elderly population ratio, the welfare burden for about the next 10 years was estimated. By 2035, social welfare expenditure will reach 28% of GDP, ranking among the highest levels among OECD member countries. It was 15.5% last year, nearly doubling in just over a decade.

Preparation is necessary. We must start preparing now on how to secure fiscal resources and respond to expenditures. Hence, binding fiscal rules are needed. Such rules have never been legislated before. As time passes, aging intensifies, making it harder to gain support for saving or reducing expenditures. Even now, we must at least estimate how fiscal conditions will be in the long term after 10 years and create binding proposals on how to manage them.

- The Ministry of Economy and Finance also includes fiscal projections for periods exceeding five years in the National Fiscal Management Plan. In 2020, it made long-term fiscal projections up to 2060. (However, long-term fiscal projections are not regularly published like periodic fiscal forecasts.)

▲ The Ministry of Economy and Finance regularly issues projections every five years through the National Fiscal Management Plan. But five years is too short because the pace of population aging in Korea is extremely rapid. Currently, about 20% of Korea's population is aged 65 or older, but in 10 years, it will be 30%. By 2035, Korea will be almost the only country exceeding 40%, due to unprecedentedly low birth rates.

In other words, fiscal rules that provide a long-term fiscal blueprint for about 10 years and include how to manage it are necessary. Discussions on how to secure fiscal resources to meet increasing expenditure demands are urgent.

- How should the fiscal rules the government plans to introduce differ? The government announced a plan to introduce fiscal rules in September 2022 to maintain fiscal sustainability, and a revision bill to the National Finance Act for legislating fiscal rules was submitted to the National Assembly in September. (The fiscal rules proposal sets a limit of -3% on the management fiscal balance when preparing the budget, but if the national debt ratio exceeds 60%, the deficit limit is reduced to -2%. However, exceptions allow exemption from the rules during war, disasters, or economic recessions to enable fiscal roles during crises.)

▲ The current fiscal rules are number-focused. They set a principle limiting the deficit to -3%. However, simply setting an upper limit has limitations in guaranteeing fiscal sustainability. It becomes a kind of promise that cannot be kept.

It is necessary to establish comprehensive principles that rigorously assess the impact of demographic changes on revenues and expenditures, determine the pace at which expenditure increases should be adjusted, define the appropriate range for managing the national burden rate, and include necessary fiscal resource securing measures. Principles should be set on when tax increases should occur under various scenarios, which tax items should be raised, and how debt should be managed. Detailed forecasts and corresponding plans must be guaranteed along with overall principles.

- What changes are needed to structure fiscal expenditures to be manageable?

▲ First, considerations about health insurance and basic pension finances are necessary. Measures to reform the health insurance system to prevent so-called "medical shopping" (the act of repeatedly visiting multiple hospitals for the same symptoms or illnesses, often occurring when out-of-pocket costs are low or health insurance benefits are favorable) should be explored. Reforms to the basic pension system, which currently provides pensions to 70% of all elderly, should be considered. Fiscal expenditures can be reduced by focusing pension benefits more intensively on vulnerable elderly populations.

- Is tax increase a difficult alternative?

▲ Tax increases are not an easy political choice. Younger generations will resist. Nevertheless, the only way to persuade them is to first ensure sufficient expenditure efficiency. Who would agree to pay more taxes without adequate restructuring of fiscal expenditures? Expenditure efficiency must be achieved first, then tax increases can be chosen and justified.

Japan, which experienced low birth rates and rapid population aging like Korea, responded to increased government spending by raising national debt. In 2021, Japan's social welfare expenditure exceeded 25% of GDP, 12 percentage points higher than the OECD average. Japan's national burden rate was 32%, 6.3 percentage points lower than the OECD average. Although costs for economic stimulus and social welfare increased, securing tax revenues became difficult.

As a result, as of 2023, Japan's national debt ratio to GDP stood at 255%, the highest among OECD countries. Korea will soon face difficult choices between national debt and tax increases like Japan. Tax revenue conditions are worsening while expenditure demands are growing. It will become increasingly difficult to reach consensus on tax hikes during election seasons.

By 2045, Korea's elderly population ratio will exceed 37%, surpassing Japan, the country with the oldest population. We must establish fiscal rules and reasonable standards now. Only then can we alleviate the burden on future generations who will bear welfare expenditure in a super-aged society.