Calls for "Price Indexation System" Grow, but Government Faces Income Tax Dilemma [Why&Next]

Price Indexation System to Prevent "Silent Tax Increases"
Major OECD Countries Already Adjust Taxes for Inflation
Government Stance: "Requires Mid- to Long-Term Review"
Korea's Effective Income Tax Rate Remains at 6.91%
Price Indexatio

There have been increasing calls for the adoption of a "price indexation system," which would levy income tax based on real wages adjusted for inflation. However, the government maintains that immediate implementation is difficult. This is because the effective income tax rate is relatively low, and the recent significant decrease in tax revenue could increase the fiscal burden. Experts advise that, in line with the principles of taxation, the system should be introduced in the medium to long term, while also preparing measures to secure tax revenue, such as streamlining tax deductions.

Reducing the Income Tax Burden... Adopted by Many OECD Countries

According to the Ministry of Economy and Finance, the National Tax Service, and the National Assembly as of December 8, demands for the introduction of a price indexation system for income tax continue to grow. The income tax price indexation system refers to automatically adjusting tax brackets and deductions according to the rate of inflation, so that taxes are levied based on real income. The purpose is to prevent an automatic tax increase for taxpayers when wages rise due to inflation, as occurs under the current progressive tax system with fixed tax brackets.

Last month, citizens commuting near Gwanghwamun Station in Seoul. Photo by Yonhap News

Calls for the adoption of the price indexation system are especially strong regarding earned income tax. The Korea Enterprises Federation argued for its necessity on December 4, noting that the growth rate of earned income tax and social insurance premiums has outpaced that of workers' wages. While the average monthly wage for workers increased by an annual average of only 3.3% from 2020 to this year, the total amount of earned income tax and social insurance premiums withheld from monthly paychecks rose by an annual average of 5.9%.

Related discussions are also ongoing in the National Assembly. In October, Lee Inseon, a lawmaker from the People Power Party, pointed out that the proportion of all workers subject to the 6% tax rate fell from 76% in 2010 to 43.2% in 2022, while the proportion subject to the 15% tax rate rose from 20.2% to 43.4%. She called for the introduction of the price indexation system to ease the tax burden. Park Beomgye and Noh Woongrae, lawmakers from the Democratic Party of Korea, have also proposed amendments to the Income Tax Act to introduce the price indexation system.

The majority of countries in the Organisation for Economic Co-operation and Development (OECD) have already implemented a price indexation system. In the United States, income tax brackets and standard deductions are adjusted according to inflation. Canada operates an income tax system linked to the Consumer Price Index (CPI). In addition, major European countries such as the United Kingdom, France, Germany, the Netherlands, and Switzerland, as well as Australia, adjust income tax in response to inflation and other price changes.

Government: "Requires Medium- to Long-Term Review"

On the other hand, the government believes that immediate implementation is not urgent. This is because tax relief measures, such as various tax deductions, have already reduced the tax burden, and the effective income tax rate is relatively low compared to other countries. There are also institutional limitations, such as the difficulty of adjusting only earned income tax brackets for price indexation. Above all, there are concerns that introducing the price indexation system immediately could significantly reduce tax revenue, given the large-scale tax revenue shortfalls in recent years.

A government official stated, "We have eased the tax burden by adjusting tax brackets and expanding deductions," and added, "Given our circumstances, the price indexation system requires a medium- to long-term review." Another official said, "If income tax were sufficient, as in advanced countries, it should be considered, but now is not the time." Previously, in October, Lim Gwanghyeon, Commissioner of the National Tax Service, commented, "The price indexation system is a medium- to long-term task that must be accompanied by reforms to deductions and other measures."

According to actual OECD statistics, for single-person households without children, the average effective income tax rate in Korea was 6.91% last year. This is 8.48 percentage points lower than the OECD average (15.39%) and 9.21 percentage points lower than the G7 average (16.12%). It is also lower than Canada (18.92%), Australia (25.32%), and Spain (16.02%), which have similar economic scales, as well as major countries such as the United States (16.74%) and Japan (7.30%).

"Step-by-Step Approach Needed... Measures to Secure Tax Revenue Also Required"

Experts agree that, given the current tax revenue situation, it would be difficult for the Korean government to immediately introduce the price indexation system. However, they explain that to ensure fairness in real taxation and uphold the principles of taxation, the government should pursue the price indexation system as a medium- to long-term project in stages. They also suggest that, in addition to improving tax brackets, proactive measures to secure tax revenue-such as reducing the number of tax-exempt individuals and limiting special tax treatments-are necessary.

Park Hoon, President of the Korean Association of Tax Law (Professor of Taxation at the University of Seoul), said, "Looking at the U.S. example and theoretical grounds, there is a need to introduce the price indexation system," but added, "Given the burden of reduced tax revenue and the lower tax burden ratio compared to the OECD, it is not easy to implement." However, he also stated, "For the desired direction, it is ultimately right to move toward the principle of taxation based on real income," and "there could be approaches such as further adjusting brackets or changing deductions."

Ahn Changnam, President of the World Tax Association (former Professor of Taxation at Kangnam University), said, "If it is stipulated that the imposition of income tax brackets, which are currently fixed amounts, should be applied in proportion to price changes, adjustments linked to inflation would be possible without revising the tax law every year." He further explained, "Given the low effective tax rate, the government should raise tax rates and make efforts to reduce tax exemptions under the Restriction of Special Taxation Act."