Local finance 1

Local Finance under the First Constitution of Korea (1948 to 1961)
 
1. Overview
 
The first Constitution of Korea (1948) with its inclusion of articles on self-government (Chapter 8) enshrined local government as a key constitutional and democratic principle. But leaving fiscal policymaking to the National Budget and Accounting Act and local laws and regulations eventually led to much inconsistency and disorder in the devising and implementing of local fiscal policies, thus compelling the enactment of more consistent and effective local finance ordinances. Though the Local Government Act (LGA) was enacted to that end, its impact was short-lived since the Korean War broke out shortly after it went into effect. Moreover the military government, which later rose to power as a result of the coup of May 16, 1961, passed the Provisional Measures Act on Local Government (PMA) that largely rendered the LGA null and void (KRILA, 1998, 393).
 
(1) Supervision over Local Finance
The LGA, originally enacted in 1949, required local councils to inspect the revenue and spending of their respective local governments twice each fiscal year, and local government heads to produce reports on the settlement and execution of budgets on an annual basis and submit them to their respective local councils for review and approval. Ironically, however, the enactment of the LGA did not immediately lead to the creation of local councils. The central government, already supervising local government heads, thus came to supervise and control local finance to a great extent.

It was not until the creation of the first local councils in Korea on April 6, 1952 that local governments began to oversee and control their own finances. The first local councils were given new authority with respect to decisions on budgets, service charges and fees, public dues, local taxes, cost allocation, subscription fees, labor conscription, payments in kind, and tax collection etc. not already covered in law or presidential decrees; the imposition of non-budget-related financial obligations; and the review and approval of settlement reports (Article 19, LGA, December 15, 1949). These provisions allowed local councils to exert independent control over their own finances.
 
(2) Revenue Structure
The revenue structure of local governments during this period, for general accounting purposes, first included fee-based revenue on local taxes and other such fees or charges, as well as 11 accounts of non-tax revenue, collected by local governments on their own. The local revenue structure also included local government allocation taxes and subsidies provided from the National Treasury and provinces (KRILA, 1998, 400).

Statistics from 1951 show that Seoul and the provinces relied on the National Treasury and on local government allocation taxes (levied by the central government) from the central government for 48 percent and 10 percent of their combined budgets, respectively, while drawing only 19 percent of their budgets from local tax revenue. Local tax revenue made up only 19 percent or so of their budgets. Cities, on the other hand, drew 28 percent of their budgets from usage fees and service charges, and 25 percent from local tax revenue, while relying on subsidies and local government allocation taxes for only 9.5 percent. Districts below the level of cities or counties, known as eup, had a similarly independent revenue structure dependent on service charges for 27 percent of their budgets, local tax revenue for 22 percent, and local government allocation taxes and subsidies for only 11 percent. Myeon, another type of district below the level of city or county, relied on refunds for 37 percent, local tax revenue for 19 percent, local government allocation taxes for 13 percent, and subsidies for 7 percent of their budgets (KRILA, 1998, 401).
 
 
[Table 4∙1] Changes in Local Revenue Statistics 1951~60
(Unit: KRW 1,000,000)
 

Year	Total (A)	Fee-based revenue (B)	Subsidies and local government allocation taxes	Proportion (B/A, %)
1951	110	66	44	60.0
1952	344	193	151	56.1
1953	800	376	424	47.0
1954	2,913	1,240	1,673	42.6
1955	7,921	2,885	5,036	36.4
1957	8,524	3,432	5,092	40.3
1958	10,622	4,096	6,526	38.6
1959	12,666	4,690	7,976	37.0
1960	13,713	4,562	9,151	33.3

Source: Korea Research Institute for Local Administration (KRILA), 1998, 401
 
Note: The year 1956 has been omitted from the official fiscal history of Korea as the concept and period of the fiscal year changed. At the time of the LGA’s enactment, a fiscal year for a local government began on April 1 and ended on March 31 the next year, just as it did for the central government. The amendment of the National Finance Act (NFA) in 1954, however, changed the starting and ending dates of each fiscal year to July 1 and June 30 of the subsequent year, respectively. In June 1956, the government again amended the NFA to make each fiscal year start on January 1 and end on December 31 of the same year. In this process, the fiscal year of 1954 actually came to comprise 15 months, and the fiscal year of 1955 included 18 months, thus effectively removing 1956 as a fiscal year.

Source: Korea Institute of Public Administration. 2008. Korean Public Administration, 1948-2008, Edited by Korea Institute of Public Administration. Pajubookcity: Bobmunsa.

   2. Local Tax System
 
The local tax system in the period between the liberation of Korea from Japan’s colonial rule and 1960 was modeled in large part after Japan’s system. There was quite a large number of local tax items during this period, as many as 21 at one point. The process of managing these taxes was complex, even though the amount of tax revenue generated from them was extremely low.
The local taxes introduced immediately after the Korean Republic’s foundation were mainly divided between general and earmarked taxes. General taxes, in turn, were again subdivided into provincial, municipal, eup, and myeon taxes.[1] Provincial taxes included three surtaxes on national taxes and nine independent taxes. The municipal, eup, and myeon taxes comprised of three surtaxes on national taxes, five provincial surtaxes, and five independent taxes. The earmarked taxes were comprised of elementary education taxes, house tax dues, and special dues.

The amendment of the Local Tax Act (LTA) in 1951 reduced the amounts of surtaxes and independent taxes that formed the taxes for Seoul and the provinces to one and 12 in total, and also changed the makeup of municipal, eup, and myeon taxes to include a surtax on the national tax, 10 surtaxes on provincial taxes, and seven independent taxes. Another amendment of the LTA in 1952 introduced one surtax on the national taxes and 16 independent taxes to Seoul and the provinces; as well as one surtax on the national taxes, 16 surtaxes to the provincial taxes, and one independent tax to form the new municipal, eup, and myeon taxes.

The amendment of the LTA in 1954 transferred some national tax items to local taxes and raised local tax rates. As a result, taxes in Seoul and the provinces came to comprise of two surtaxes on the national taxes and 17 independent taxes, while the municipal, eup, and myeon taxes came to include two surtaxes on the national taxes, 16 surtaxes on the provincial taxes, and three independent taxes. The new LTA also allowed earmarked taxes to introduce three new tax items in special circumstances.

The amended LTA of 1957 sought to streamline the number and diversity of local taxes, limiting taxes in Seoul and the provinces to two surtaxes on the national taxes and 10 independent taxes; and municipal, eup and myeon taxes to two surtaxes on the national taxes, 10 surtaxes on provincial taxes, and two independent taxes. The LTA was once again amended in 1958 to introduce local automobile surtaxes on the newly enacted national automobile tax. The elementary education tax was removed from the list of earmarked taxes in the meantime.
 
[Table 4∙2] Changes in the Composition of Local Tax Items: 1949 and the 1950s
 

Year	General taxes					Earmarked Taxes
	Provincial		Municipal, eup, and myeon
	Surtaxes on national taxes	Independent taxes	Surtaxes on national taxes	Surtaxes on provincial taxes	Independent taxes
1949	Land tax VAT, sales tax VAT, mining tax VAT	Household tax, house tax, special land tax on tax-exempt land, forest and fields tax, cattle slaughter tax, fishing tax, quantity-weighted tax, real estate tax, courtroom entry tax *Additional tax items in Seoul: special sales tax, advance tax, dog tax, and transportation tax	Land tax VAT, sales tax VAT, mining tax VAT	Household tax VAT, house tax VAT, VAT on special land tax on tax-exempt land, real estate tax VAT	Quantity-weighted tax, special sales tax, dog tax, advance tax, transportation tax	Elementary education tax, house tax dues, special dues
1951	Mining tax VAT	Household tax, house tax, special land tax on tax-exempt land, forest and fields tax, cattle slaughter tax, fishing tax, quantity-weighted tax, real estate tax, special action tax, hunting tax, motor tax *Additional tax items in Seoul: safe tax, transportation tax, guest tax, and liquor tax	Mining tax VAT	Household tax VAT, house tax VAT, VAT on special land tax on tax-exempt land, forest and fields tax VAT, cattle slaughter tax VAT, automobile tax VAT, real estate tax VAT, motor tax VAT	Quantity-weighted tax, safe tax, guest tax, liquor tax, transportation tax,	Same as above
1952	Same as above	Household tax, house tax, special land tax on tax-exempt land, forest and fields tax, cattle slaughter tax, fishing tax, automobile tax, property acquisition tax, special action tax, hunting tax, motor tax, ship tax, safe tax, guest tax, advertisement tax, telephone tax *Additional tax items in Seoul: transportation tax	Same as above	Household tax VAT, house tax VAT, special land tax on tax-exempt land VAT, forest and fields tax VAT, cattle slaughter tax VAT, fishing tax VAT, automobile tax VAT, property acquisition tax VAT, special action tax VAT, hunting tax VAT, motor tax VAT, ship tax VAT, safe tax VAT, guest tax VAT, advertisement tax VAT, telephone tax VAT	Transportation tax	Same as above
1954	Sales tax VAT, mining tax VAT	Household tax, house tax, special land tax on tax-exempt land, forest and fields tax, cattle slaughter tax, fishing tax, automobile tax, property acquisition tax, special action tax, hunting tax, motor tax, ship tax, license tax, safe tax, guest tax, advertisement tax, telephone tax *Additional tax items in Seoul: logging tax, transportation tax	Sales tax VAT, mining tax VAT	Household tax VAT, house tax VAT, special land tax on tax-exempt land VAT, forest and fields tax VAT, cattle slaughter tax VAT, fishing tax VAT, automobile tax VAT, property acquisition tax VAT, special action tax VAT, hunting tax VAT, motor tax VAT, ship tax VAT, license tax VAT, safe tax VAT, guest tax VAT, advertisement tax VAT, telephone tax VAT	Logging tax, transportation tax	Elementary education tax, house tax dues, special dues, dong or li (district) tax, urban planning tax, public facility tax
1957	Same as above	Household tax, house tax, forest and fields tax, cattle slaughter tax, fishing tax, automobile tax, property acquisition tax, special action tax, motor tax, ship tax, license tax *Additional tax items in Seoul: transportation tax	Same as above	Household tax VAT, house tax VAT, forest and fields tax VAT, cattle slaughter tax VAT, fishing tax VAT, automobile tax VAT, property acquisition tax VAT, special action tax VAT, motor tax VAT, ship tax VAT, license tax VAT	Transportation tax	Same as above
1958	Sales tax VAT, mining tax VAT, automobile tax VAT (automobile surtax)	Same as above	Sales tax VAT, mining tax VAT, automobile tax VAT (automobile surtax)	Same as above	Same as above	Same as above

Source: Local Tax Act (LTA), amended each year
Source: Korea Institute of Public Administration. 2008. Korean Public Administration, 1948-2008, Edited by Korea Institute of Public Administration. Pajubookcity: Bobmunsa.

  3. Local Finance Adjustment System
 
(1) Local Government Allocation Taxes: Temporary and Standing
The local government allocation tax (LGAT) policy was implemented on a trial basis for one year beginning in 1951 in an effort to readjust the fiscal imbalance among various local government organizations. The total amount of LGATs to be distributed to local governments was 34.68 percent of the aggregate amount of national revenue, i.e., national land and sales taxes combined, of the pertinent year, with the floor set at 12.39 percent. LGATs included three types of generation distribution fees and two types of special distribution fees. The former was set at 74 percent of the total amount of the LGATs and the latter at 26 percent (Article 3, Temporary Local Government Allocation Tax Act (TLGATA)). The allocation of general distribution fees was set as follows: 8.3 percent to Seoul and the provinces; 8.47 percent to cities; and 83.23 percent to eup and myeon (Article 4, TLGATA). The amount of the first type of general distribution fees was determined by multiplying the total number of employees working at each type of government organization by the standard amount of wages and office expenses. The amount of the second type was calculated by first determining the margin by which the target tax revenue of a given local government (in consideration of the population over which it governed) fell short of the tax amount to be borne by each person nationwide. The margin was then multiplied by the population of the local community concerned. The amount of the third type was determined in light of fiscal defects and other special circumstances. The amount reserved for each city, eup, or myeon was determined by the given province, and provided four times a year. Special distribution fees were paid in consideration of special circumstances and purposes, such as the repair of government buildings or the recovery of office tasks (Article 5, TLGATA).

The Local Government Allocation Tax Act (LGATA) fixed the total amount of LGATs to be paid each year at 15 percent of the total amount of Category-2 land acquisition taxes and sales taxes collected in a given year. Twenty percent of this amount went to Seoul and the provinces, 10 percent to cities, and 70 percent to eup and myeon. The percentages of the four types of distribution fees paid to each local government organization were 30, 15, 15, and 40 percent of the total amount of distribution fees reserved for that government. Amendments made to the LGATA in 1954 saw these ratios slightly revised and the Secretary of Interior taking over the obligation to determine the amount to be paid to each city by governors (Article 14), thereby enhancing the central government’s control over the process.

The LGATs, in the end, failed to achieve the overarching purpose of solving fiscal imbalance among local governments as they fundamentally drew upon vulnerable sources of revenue and the inconsistencies in their calculation only served to make wealthy local governments wealthier and poor ones poorer (KRILA, 1998). As a result, the Local Government Finance Adjustment Grants Act (LGFAGA) came to be enacted in 1958, expanding the scope of national revenue to be provided for local governments as grants in aid, and distributing those grants according to need instead of in a blanket manner to all local governments.
 
[Table 4-3] Overview of the TLGATA, LGATA, and LGFAGA
 

	TLGATA (April 1, 1951)	LGATA (September 12, 1952)	New LGATA (April 14, 1954)	LGFAGA (March 11, 1958)
Sources of finance	Up to 34.68% of national land and sales taxes combined (12.39% minimum)	15% of Category-2 land acquisition tax and sales tax	8.8% of Category-1 land acquisition tax, 50% of land acquisition tax, and 30% of entertainment and food and beverages tax	Source 1: 40% of entertainment and food and beverages tax, entry tax, and electricity/gas tax combined Source 2: 8.8% of Category-1 land acquisition tax, 50% of Category-2 land acquisition tax Source 3: supplementary sources
General distribution fees and grants-in-aid	74% of total LGAT Type 1: 80% Type 2: 10% Type 3: 10%	Type 1: 30% Type 2: 15% Type 3: 15%	Type 1: 20% Type 2: 10% Type 3: 30%	Provided to compensate the margin by which a local government’s reference financial revenue fell short of its reference financial demand
Special distribution fees and grants-in-aid	26% of total LGAT	Type 4: 50%	Type 4: 40%	30% or less of general distribution fees and grants-in-aid
Distribution of general fees and grants-in-aid by local government type	8.3% to Seoul and the provinces combined, 8.47% to all other cities, and 82.33% to all eup	20% to Seoul and the provinces combined, 10% to all other cities, and 70% to all eup	15% to Seoul and the provinces combined, 10% to all other cities, and 75% to all eup	None
Modes of distributing general fees and grants-in-aid	Type 1: Total designate number of employees at given local government, multiplied by standard amount of wages and office expenses, and distributed proportionally   Type 2: Target local tax revenue of 1951, divided by tax amount per capita nationwide, then multiplied by local population, and finally distributed proportionally   Type 3: To be distributed according to financial need and other special circumstances within proportion. Amount for each city to be determined by given province.	Type 1: Margin by which Category-1 tax revenue falls short of target Category-1 tax revenue, and multiplied by local population, and distributed proportionally   Type 2: Margin by which Category-2 tax revenue falls short of target Category-2 tax revenue, and multiplied by local population, and distributed proportionally   Type 3: To be distributed according to financial need and other special circumstances, within proportion. Amount for each city or eup to be determined by Secretary of Interior.	Same as column on the left. However, amount for each city now to be determined by Secretary of Interior.	Amount of grants-in-aid for each local government in need to be determined based on the margin by which that government’s yearly reference revenue fell short of yearly financial demand. Grants to be provided for only local governments in need.
Modes of distributing special fees and grants-in-aid	To be paid according to need, such as repair and maintenance of facilities, equipment, etc.	To be paid according to need, such as repair and maintenance of facilities, equipment, etc.	To be paid according to need, such as repair and maintenance of facilities, equipment, etc.	To be paid according to need, including not only repair and maintenance of facilities and equipment, but also recovery of natural disasters or other such circumstances increasing financial demand.

Source: TLGATA, LGATA, and LGFAGA
 
(2) Government Subsidies
The amount of subsidies provided by the central government for local government organizations each year multiplied rapidly from KRW 30 million in 1951 to KRW 7.7 billion in 1961, a 257-time increase. The rate at which government subsidies grew in amount is all the more astonishing when one considers that the total amount of national revenue increased by 85 times and local revenue by 132 times over the same period.

A breakdown of local revenue during this period shows that local governments relied heavily on central government subsidies, not the least because the tax system in effect at the time was designed almost exclusively with an eye to national revenue. More specifically, Seoul and the provinces overwhelmingly relied on subsidies for 47.8 percent of their combined revenue of KRW 63.407 million, with some 90 percent or so of the entire amount of central government subsidies concentrated in Seoul and the provinces. Cities, eup, and myeon, on the other hand, required central government subsidies for only fractions of their budgets, ranging between 4 and 7 percent, and mainly drew upon local taxes and grants-in-aid instead. Central government subsidies were heavily directed at Seoul and the provinces in this period because the administrative structure of the nation back then was centered on the provinces, which directly executed the major public works of national reconstruction efforts after the Korean War (KRILA, 1998, 435).
 
[Table 4-5] Central Government Subsidies: 1951 to 1961
(Unit: KRW 100 million)
 

Year	Amount (a)	Budget structure		Proportion
		National (b)	Local (c)	a/b	a/c
1951	0.3	6.1	1.1	4.9	30.0
1952	1.1	22.1	.4	5.0	32.4
1953	3.2	31.6	8.0	10.1	40.0
1954	14.5	67.0	29.1	21.6	49.8
1955	47.4	139.9	79.2	33.9	59.8
1957	47.0	196.0	85.0	24.0	55.3
1958	59.0	280.0	106.0	21.1	55.7
1959	54.0	319.0	127.0	16.9	42.5
1960	61.0	370.0	137.0	6.5	44.5
1961	77.0	520.0	145.0	14.8	53.1

Source: KRILA, 1998, 435

Source: Korea Institute of Public Administration. 2008. Korean Public Administration, 1948-2008, Edited by Korea Institute of Public Administration. Pajubookcity: Bobmunsa.