The divisive debate on tax cuts has resurfaced in the ruling Grand National Party following the election on Friday of Rep. Hwang Woo-yea, a neutral four-term lawmaker, as the party’s new floor leader.
Hwang pledged to scrap the planned tax cuts for the companies and individuals in the highest corporate and personal income tax brackets, saying he would use the money for low-income people who suffer from high university tuition fees, rising child care costs and excessive costs from renting their homes.
Hwang’s plan is a direct challenge to President Lee Myung-bak’s macroeconomic policy, called “MBnomics.” In Lee’s economic strategy, tax cuts are the starting point for a virtuous circle of investment and consumption growth, output expansion, job creation and increased tax revenue.
Under this vision, the government undertook a tax reform in 2008. It lowered the personal income tax rates by 2 percentage points for each income bracket. But the rate adjustment for the top income bracket exceeding 88 million won was delayed twice due to the demands from opposition parties ― first to 2010 and again to 2012.
The tax reform also called for lowering corporate taxes. The government cut the rate applied to small firms with a taxable income of less than 200 million won from 13 percent to 11 percent in 2008 and further to 10 percent in 2010. For bigger firms, the rate was first cut from 25 percent to 22 percent in 2009, but the planned additional cut down to 20 percent was delayed from 2010 to 2012.
The debate on tax cuts started last fall when Rep. Chung Doo-un called for an outright cancellation of the deferred personal and corporate income tax cuts, saying the tax cut scheme led people to paint the GNP as a party for big firms and the rich.
With such a negative image, Chung asserted, the GNP would lose the next general and presidential elections, both slated for 2012. Hence he urged the party leadership to kill, rather than delay, the planned tax cuts for affluent individuals and large companies.
Chung’s argument completely missed the logic behind MBnomics. But it resonated with lawmakers who feared they would lose their parliamentary seats. The debate subsided after Rep. Park Geun-hye, the frontrunner among the party’s presidential hopefuls, proposed a compromise ― retracting the personal income tax cut for the rich but implementing the scheme for big corporations as scheduled.
The compromise, however, was not set in stone. Last week, Chung submitted a bill to divide corporations into three income brackets instead of the present two. His plan called for applying a 22 percent tax rate for firms with a taxable income exceeding 10 billion won, 20 percent for firms in the middle bracket and 10 percent for the lower bracket with an income below 200 million won.
Chung’s campaign to kick the legs out from under President Lee’s tax policy is gaining traction following the election of Hwang as the new floor leader. Many GNP lawmakers who previously banged the drum for Lee’s MBnomics are withdrawing their support, reflecting the power shift in the party.
Any decision regarding taxation is up to lawmakers. If the GNP lawmakers choose to pull the plug on Lee’s tax cut policy, so be it. But they need to remember that tax changes have significant consequences on economic growth.
According Chrisina Romer and David Romer, both professors of economics at the University of California, Berkeley, “tax cuts have very large and persistent positive output effects.” The magnitude of the effects can be surmised from their finding that a tax increase of 1 percent of GDP lowers real GDP by almost 3 percent.
The finding should serve as a warning that any attempts to promote tax changes for short-term political gain could undermine long-term economic growth.