SEOUL (Wall Street Journal) — Despite a global recession, the South Korean economy posted 0.1% and 2.3% growth in the first and second quarters respectively. Improving consumer sentiment and the rising stock market index imply the Korean economy is well on its way out of the recession.

Yet it is premature to breathe a sigh of relief. Private-sector investment is still sluggish, and tackling 3.7% unemployment remains a daunting task for a nation accustomed to rapid economic growth and relatively low unemployment rates. Korea must redouble its efforts to increase its competitiveness. Tax reforms like those we have announced this week will be central to this effort.
Korea will stick to its commitment to introduce a business-friendly environment for domestic and foreign investors. The government has already slashed corporate income tax rates to promote companies' competitiveness and job creation. The corporate tax rate has been reduced to 22% from 25% this year and will be further lowered to 20% from 2010 onwards. The top income tax rate will also be cut to 33% from 35% next year. Cutting these rates has been pursued on schedule as part of President Lee Myung-bak's tax policy proposal, part of his campaign platform, despite sometimes fierce opposition.
The Lee government believes we must do more, hence yesterday's additional tax reforms. The government will introduce next year tax measures to support corporate research and development and to encourage low-carbon green growth. Tax deductibility for research and development on developing new growth engines and ground-breaking technology will increase from around 3% to 6%, to 20% and 25% for large enterprises and from 25% to 30% and 35% for small and mid-sized companies. This is one of the most generous R&D incentives in the world.
In line with President Lee's Green New Deal stimulus program, Seoul also will cut taxes on interest and dividends from green financial products such as mutual funds that invest more than 60% of their portfolios in green-technology companies. Developing technology to such effect will be one of main driving forces for the Korean economy.
The government also has to provide a tax shield for the vulnerable in these turbulent times. And the government will strengthen tax incentives for the self-employed and the working class. Measures will include providing tax breaks to the self-employed attempting to rebuild their businesses from bankruptcy.
All these measures could justifiably bring a degree of skepticism about fiscal sustainability. Korea has so far maintained a relatively sound government debt-to-GDP ratio among OECD members. Acting upon the proposed measures above will cause the nation's overall fiscal conditions to spiral downward for a short time.
To cope with this effect, the government will gradually phase out tax incentives that either are no longer relevant to economic development or that have already achieved their purpose. These include the ""temporary investment tax credit"" favoring investments in the manufacturing sector and non-Seoul metropolitan region. Last year, the total amount of tax revenue forgone as a result of these discriminatory tax incentives represented a whopping 18% of the total tax revenue. Phasing out these incentives will increase tax revenues substantially. The government will also impose a 5% consumption tax on carbon-emitting home electronic appliances.
Korea will embark upon a path to introduce a smaller government by attracting private capital to public projects as well as introduce zero-based budgeting—in which departments must justify their full budgets each year, as opposed to only the increase over the previous year—to help streamline the government budget. The government will also seek ways to improve compliance of taxpayers—the self-employed in particular—to provide a level playing field for all taxpayers.
These proposals are easier said than done. Vested interest groups will resist any attempt to take away the tax incentives that they have taken for granted and to which they now feel entitled. However, this is a task that should be accomplished to render the tax regime more equitable and in line with global standards. Broadening the revenue base, coupled with the ongoing efforts to reduce the role of government in the realm of public finance, will hopefully more than offset the dwindling national coffer due to the expansionary fiscal policies since the onset of the global economic crisis.
Mr. Hur is vice minister at the Ministry of Strategy and Finance of the Republic of Korea.
Photo: South Korean Minister Hur Kyung-wook joins other International Monetary and Financial Committee delegates at International Monetary Fund headquarters for the Spring meetings of the IMF and World Bank in Washington, Saturday, April 25, 2009. (AP photo