Study needed on tax regime in unified Korea

On the closing day of the 2014 Incheon Asian Games, three of North Korea's top officials made a surprise visit to South Korea. Their visit was made amid a variety of rumors about a coup attempt in North Korea triggered by the disappearance of Kim Jung-un from public view for almost a month. Although those rumors turned out to be bogus, this highlighted concerns that unification might take place suddenly after the collapse of North Korea, increasing the risk of an abrupt and imminent unification in the absence of planning and preparation.

In her first press conference of 2014, President Park Geun-hye said that "Korean unification would be a bonanza." It is anticipated that a combination of South Korea's capital and technology and North Korea's abundant labor and natural resources would create an explosive synergy to provide momentum for a quantum jump in Korean economic growth.

On July 15, 2014, a committee was formed under the direct control of President Park to take initiatives to prepare for Korea's unification. Led by Park, the Presidential Committee of Reunification Preparation consists of 50 members from all levels of society, including 30 members from the private sector, two lawmakers, 11 government officials and heads of six state-run think tanks.

Ironically, however, there is no tax expert among the economic experts on the committee even though it is clear that the cost of unification will be funded through increasing tax revenue. Due to the huge gap between South and North Korea's socioeconomic systems, the way North Korea's tax regime is managed after reunification will provide a tremendous impact on the fiscal soundness of a unified Korean government. Without the participation of any tax experts on the committee, it feels like something important is missing.

Based on a recent amendment to the Basic National Tax Act, a five-year or longer-term tax policy plan should be submitted to the National Assembly this year. In April 2014, the Ministry of Strategy and Finance formed a mid- and long-term tax policy review committee.

The committee allows experts in such things as population and demographic structure, environment and unification to participate on the committee. Learning from experiences of the German reunification in 1990 which resulted in a 2 percent increase in its total tax revenue to GDP, a significant amount of cost will be needed to rebuild infrastructure in North Korea after the reunification.

It is cited that one of the most urgent needs in the path toward unification will be securing financial resources.

Korea needs to consider an increase in the value-added tax (VAT) rate to be compatible with soaring unification costs. At the same time, there will be a need for study on an innovative tax regime in North Korea to prepare for the abrupt increase in fiscal needs after unification.

Since the land in North Korea is owned by the North Korean government, it seems the land value tax of Hong Kong could offer a good template when a more innovative and efficient tax system is being sought.

According to an analysis on successful factors of the land value tax system in Hong Kong, the Hong Kong government retains proprietary interest on all land and it clearly stipulates the permitted usage when leasing land. Hong Kong land value tax revenue is quite stable and became a core element of the total tax revenue. It accounts for approximately 16 percent of total tax revenue and made it possible to retain a simple low-rate tax system. As a result, the Hong Kong government can supply low-cost, but high-quality public rental houses, public transport, hospitals and educational institutions by utilizing land value tax revenue from redevelopment of land as well as leasing land.

It is a desirable development that the economic planning team for unification under the finance ministry has taken steps to review the German experiences and lessons about the financial costs of unification.

It is also ideally recommended to include an in-depth review of unification issues from a tax perspective as one of the earliest priority items for the preparation and planning.

A study of Goldman Sachs Group suggests that the cost of Korean unification will be prohibitively high, but a united Korea could become the world's second-largest economy by 2050 after the United States in terms of per capita GDP.

When there are signs that national discussions are created about the preparation for reunification, now is a great time to recall the West German President saying that, "Unification should take place certainly and it would take place sooner than we think. Whatever happens with unification preparation, the sooner, the better."

The writer is tax knowledge management leader at Samil PwC.

By Lee Dong-keon
The Korea Times