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Governance

Local finance 2

I. Local Finance under the Constitution of the Third Republic (1962 to 1971)
 
1. Overview
 
A more modern local finance regulatory system came into being in the era of the Third Republic, starting with the enactment of the Local Finance Act (LFA, Law No. 1443) on November 11, 1963, and continuing with the creation of the Enforcement Ordinance (Presidential Decree No. 1605) for the LFA on January 15, 1964, and the implementation of the Financial Accounting Regulations on January 19, 1964, which provided detailed guidelines for the implementation of the Enforcement Ordinance.
 
(1) Supervision of Local Finance
The Local Government Act (LGA) and the LFA in the Third Republic, as in the previous Republics, continued to require local councils’ input in determining local fiscal policies and measures. However, despite the requirement in the Constitution for the creation of local councils subject to a separate statute, the Third Republic refused to legislate such a statute. As a result, the central government maintained and strengthened its control over local governments via the local government heads it appointed.

Article 62 of the LFA of 1963 required the Secretary of Interior to decide the basic principles and rules by which local government organizations were to prepare their budgets. Moreover, cities and counties intent on installing municipal safes were required to seek the approval of governors in advance. Busan and the provinces were likewise required to seek the approval of the Secretary of Interior and the Prime Minister, according to Article 41 of the LFA.

Article 103, moreover, obligated local government heads to appoint central government employees to their respective local governments to oversee tasks related to the revenue and spending of the given governments. Article 70 of the amended LFA of 1966 authorized the central government to appoint central government employees to accounting positions in local government organizations, subject to the consent of the heads of those governments, thus reinforcing the central government’s direct control over local fiscal policies.
 
(2) Revenue Structure
The amendment of the Local Tax Act (LTA) in the 1960s introduced a series of new measures regarding local finance, including the abolition of surtaxes on value-added taxes on national taxes as well as tax refunds, and the replacement of the Local Government Allocation Tax Act (LGATA) by the Local Subsidy Act (LSA). Local governments during the 1960s mainly drew upon local taxes, non-tax revenue, local subsidies, and central government subsidies for their budgets. Non-tax revenue included such items as income on properties, usage fees, service charges, balances carried over from previous fiscal periods, donations, transfers from other accounts, income generated in the preceding fiscal period, local government bonds, and other miscellaneous sources.

Local subsidies, on average, made up 31.1 percent of municipal revenue, which was greater than the amount provided by local taxes (28.1 percent). Counties, on the contrary, relied on local taxes for 48.5 percent of their revenue, and on local subsidies for only 28.3 percent. Counties collected greater income in local taxes than their urban counterparts thanks to the relatively high proportion of farmland taxes.

Overall, local finance in the 1960s accounted for only 30 percent or so of entire national finance, which was far less than the 110 percent of Japan (KRILA, 1998, 404).
 
[Table 4-5] Changes in Local Revenue: 1962 to 1970
(Units: KRW 100 million and percentage)
 
Year Total revenue Local taxes Percentage (%) Non-tax revenue Percentage (%) Local subsidies Percentage (%) Central subsidies Percentage (%)
1962 118 52 44.1 22 18.6 15 12.7 29 24.6
1963 160 74 46.3 27 16.9 21 13.1 38 23.7
1964 180 88 48.9 35 19.4 22 12.2 35 19.5
1965 233 114 48.9 38 16.3 28 12.0 53 22.8
1966 347 162 46.7 52 15.0 83 23.9 50 14.4
1967 464 141 30.4 72 15.5 156 33.6 95 20.5
1968 663 194 29.3 100 15.1 251 37.8 118 17.8
1969 1,027 266 25.9 229 22.3 369 35.9 163 15.9
1970 1,261 332 26.3 213 16.9 503 39.9 213 16.9
Source: KRILA, 1998, 403 and 118
 
[Table 4-6] Comparison of National and Local Finances: 1962 to 1970
(Unit: KRW 100 million)
 
Year National finance (A) Local finance (B) B/A (%)
Amount Index Amount Index
1962 756 100 118 100 15.6
1963 608 80 160 114 26.3
1964 632 84 180 126 28.5
1965 1,055 140 233 167 22.1
1966 1,538 203 347 266 22.6
1967 1,990 263 464 363 23.3
1968 2,757 365 663 457 24.0
1969 3,760 497 1,027 715 27.3
1970 4,459 590 1,261 846 28.3
Source: KRILA, 1998, 403 and 118

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

  ##PAGE## 2. Local Tax System
The local tax system underwent a major overhaul in the 1960s, which involved far-reaching reforms that were intended to simplify the local tax system, increase local revenue, and promote national economic development projects effectively. First, farmland, automobile, entertainment and food and beverages, mine lot, and horserace taxes, formerly in the national purview but more local in scope and nature, were converted into local tax items. On the other hand, local taxes such as fishing, special action, and transportation taxes were converted into national ones. Second, separate tax items imposed on the basis of income, such as the national education tax, local education and household taxes, and the like were either abolished or merged with the national income tax. Now local governments could levy surtaxes and value-added taxes on national income, corporate, and sales taxes. Third, the farmland tax was reintroduced as an independent tax to be levied by cities and counties (KRILA, 1998, 467, 470-471). This local tax system structure remained more or less intact throughout the decade.
 
[Table 4-7] Changes in Local Tax Items: 1961 and 1962
 
Year General taxes Earmarked taxes
Provincial Municipal (levied cities and counties)
Surtaxes on national taxes Independent taxes Surtaxes on national taxes Surtaxes on provincial taxes Independent taxes
1961 VATs on income, corporate, and sales taxes Property acquisition tax, automobile tax, entertainment and food and beverages tax, cattle slaughter tax, property tax, and license tax
* Additional tax items for Seoul: property and farmland taxes
VATs on income, corporate, and sales taxes VATs on property acquisition, automobile, entertainment and food and beverages, cattle slaughter, and license taxes Property and farmland taxes Urban planning and public facility taxes (excepting provinces)
1962 Same as above Same as above
* Additional tax items for Seoul and Busan: property and farmland taxes
Same as above Same as above Same as above Same as above
Source: LTA, amended yearly

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

  ##PAGE## 3. Local Finance Adjustment System
 
(1) Local Subsidy Act (LSA)
The LSA, enacted in 1961, replaced the previous grants-in-aid for local government organizations. The LSA marks a significant advancement in the history of local finance in Korea, by, (1) being the first full legislation to determine the total amounts of subsidies to be provided; (2) defining the basic principles of local subsidies; (3) providing for and restricting special subsidies; and (4) rationalizing the method for determining the reference financial demand at each local government (KRILA, 1998, 423). In particular, the amendment of the LSA in 1968 led to an increase in the total amount of local subsidies to 17.6 percent of all domestic taxes combined in an effort to help local governments overcome chronic financial shortages.

The LFA, on the other hand, required the state to reduce the total amount to be provided to local subsidies, or to revoke part of the local subsidies already provided, in the event a given local government had incurred excessive spending in violation of the law and/or failed to collect the necessary revenue on its own through error or negligence.
 
[Table 4-8] Changes in the Local Subsidy System: 1960s
 
  LSA
December 31, 1961
LSA
December 5, 1963
LSA
April 27, 1965
LSA
July 15, 1968
Sources of revenue Type-1: 40% of sales, entry, and electricity and gas taxes
Type-2: 85% of unrefined rice wine and liquor taxes
Type-1: 40% of sales, entry, and electricity and gas taxes
Type-2: 43% of unrefined rice wine and liquor taxes
50% of sales, electricity and gas, and liquor taxes 17.6 percent of all domestic taxes combined
Special subsidies 10% of Type-1 general subsidies Same as 1961 Same as 1961 Same as 1961
Distribution of special subsidies by local government type 20% to Seoul and the provinces, 15% to all other cities, and 65% to counties 20% to Seoul, Busan, and the provinces, 30% to all other cities, and 50% to counties Same as 1963 Same as 1963
Reasons for distribution of general subsidies Reference financial revenue of a local government falls short of its reference financial demand Same as 1961 Same as 1961 Same as 1961
Reasons for distribution of special subsidies Extraordinary financial demand unaddressed in distributing general subsidies; natural disasters or other emergencies occurred after general subsidies were determined; construction, restoration, expansion, or repair of government and public facilities Same as 1961 Same as 1961 Same as 1961
Source: LSA, amended annually
 
(2) Central Government Subsidies
The Grant Management Act (GMA), enacted on November 1, 1963, defined the basic terms and conditions of providing subsidies, including the application procedure, the principles of decision-making, and spending-related requirements. But as the GMA underwent not a single amendment until its repeal in 1986, it failed to address and reflect changes occurring in local finance.
The proportion of central government subsidies in local finance decreased from 24.6 percent in the 1960s to 16.9 percent in the 1970s. This decline does not mean there was an absolute reduction in the amount of subsidies provided; rather, it reflects the steady increase in the amounts of local taxes and subsidies that local governments were able to gather (KRILA, 1998, 434-436).
 
[Table 4-9] Central Government Subsidies: 1962 to 1970
(Unit: KRW 100 million)
 
Year Central government subsidies (a) Financial scale Proportion
National (b) Local (c) a/b a/c
1962 29 756 118 3.8 24.6
1963 38 608 160 6.3 23.8
1964 35 632 180 5.5 19.4
1965 53 1,055 233 5.0 22.7
1966 50 1,538 347 3.3 14.7
1967 95 1,990 464 4.8 20.8
1968 118 2,757 663 4.3 17.8
1969 162 3,760 1,027 4.3 15.9
1970 213 4,459 1,261 4.8 16.9
Source: KRILA, 1998, 436
 
(3) Local Government Bonds
The LFA of 1963 required local governments to seek approval from respective local councils and the Secretary of Interior before the issuance of local government bonds. The constitutional requirement for local councils, however, did not materialize during this period as no separate statute was passed defining the timeline by which such bodies were to be formed. The Secretary of Interior’s approval therefore became the sole precondition for issuing local government bonds.

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

  ##PAGE## II. Local Finance under the Yushin Constitution (1972 to 1979)
 
 
1. Overview
The Presidential Decree on Emergency Measures for Economic Stability and Growth proclaimed in 1972, also known as the “August 3 Measures,” abolished the legal grant rates on local subsidies and made local subsidies a matter of annual national budget instead, thus reducing the proportion of local subsidies in combined domestic taxes from 17.6 percent to 11 percent. This extreme measure had a considerable contractionary impact on the autonomy and finance of local government organizations, while strengthening the central government’s control over local administration further.
 
(1) Supervision of Local Finance
Despite the rise of the Fourth Republic and the new August 3 Measures, the local fiscal policy supervision system remained more or less the same as the one utilized during the Third Republic. Notably, however, the LFA, amended on December 31, 1975, sided more with cities and counties by allowing them to determine the amounts of contributions they would make to provincial public works and civil engineering projects. Article 26.2 of the same Act, however, also required the heads of cities and counties to seek the approval of their respective governors, the heads of Busan and the provinces to seek the approval of the Secretary of Interior, and the head of Seoul to seek the approval of the Prime Minister before spending additional funds not yet formulated into an official supplementary budget. This last added provision further broadened the scope of the central government’s interference in local affairs.
 
(2) Revenue Structure
The local revenue structure in the early 1970s was heavily dependent on local subsidies. Beginning in 1973, however, the proportion of local taxes began to increase dramatically. This is because the proportion of local subsidies in annual domestic taxes combined was lowered from 17.6 percent to 11 percent, while the amendment of the Local Tax Act (LTA) on March 12, 1973, introduced the local resident tax, and the amendment of the same legislation on December 31, 1976, converted the business location tax, formerly earmarked for the national budget, into a local tax (KRILA, 1998, 406-407). All in all, however, the proportion of local finance to the national one stayed below 30 percent throughout the 1970s, as it did in the preceding decade.
 
[Table 4-10] Changes in Local Revenue Structure: 1971 to 1980
(Units: KRW 100 million and percentage)
 
Year Total Local taxes Percentage (%) Non-tax revenue Percentage (%) Local subsidies Percentage (%) Central subsidies Percentage (%)
1971 1,568 398 25.4 254 16.2 652 41.6 264 16.8
1972 1,764 466 26.4 308 17.5 673 38.1 317 18.0
1973 2,155 741 34.4 383 17.8 719 33.4 312 14.4
1974 2,718 1,097 39.7 520 19.1 813 30.0 305 11.2
1975 4,304 1,586 36.8 718 16.7 1,178 27.4 822 19.1
1976 5,680 2,270 40.0 1,032 18.2 1,515 26.6 863 15.2
1977 8,165 3,363 41.2 1,930 23.6 1,834 22.5 1,038 12.7
1978 10,856 4,457 41.1 2,626 24.2 2,469 22.7 1,304 12.0
1979 15,936 - - - - - - - -
1980 19,454 7,678 39.5 4,407 22.6 4,100 21.1 3,269 16.8
Source: KRILA, 1998, 407
 
[Table 4-11] Comparison of National and Local Finances: 1971 to 1980
(Unit: KRW 100 million)
 
Year National finance (A) Local finance (B) B/A (%)
Amount Index Amount Index
1971 5,515 100 1,568 100 28.4
1972 6,053 110 1,764 113 29.1
1973 6,911 125 2,155 137 31.2
1974 11,887 216 2,718 173 22.9
1975 13,744 249 4,304 274 31.3
1976 22,983 417 5,680 362 24.7
1977 29,908 542 8,165 521 27.3
1978 40,405 733 10,856 692 26.9
1979 55,075 999 15,936 1,016 28.9
1980 66,352 1,203 19,454 1,241 29.3
Source: KRILA, 1998, 408
 
 
2. Local Tax System
 
The 1970s saw a surge in economic development projects, with all taxes reformed and redesigned to support the goals of those projects. Surtaxes and value-added taxes on national taxes were finally abolished in 1973, and the local resident tax was introduced in their stead to compensate for some of the losses to local tax revenue. In 1962, the registration tax was converted into a local tax, while the local tax on entertainment, food and beverages was converted into a national one. Cities and counties were also allowed to levy business location taxes for earmarked purposes, while their value-added taxes or surtaxes on provincial taxes were abolished.
 
 [Table 4-12] Changes in Local Tax Items in 1973 and 1976
 
Year General taxes Earmarked taxes
Provincial taxes Municipal taxes (levied by cities and counties)
Independent taxes Provincial surtaxes Independent taxes
1973 Taxes on residents, property acquisition, automobiles, entertainment and food and beverages, cattle slaughter, horseraces, and licenses
*Additional tax items for Seoul and Busan: property and farmland taxes
VATs on residents, property acquisition, automobiles, entertainment and food and beverages, cattle slaughter, and license taxes Property and farmland taxes Urban planning and public facility taxes (excepting provinces)
1976 Taxes on property acquisition, registration, and licenses
* Additional tax items for Seoul and Busan: taxes on residents, property, automobiles, farmland, cattle slaughter, and horseraces
None Taxes on residents, property, automobiles, farmland, cattle slaughter, and horseraces Urban planning, public facility, and business location taxes (excepting provinces)
Source: LTA and its amendments
 
 
3. Local Finance Adjustment System
 
(1) Local Subsidies
The August 3 Measures (1972) called for absolute rigidity in national finance and abolished the legally required rate on local subsidies effective beginning in 1973. The measures thus pegged the total amount of local subsidies each year to the annual central government budget, thereby removing the legal grant rate system. The total amount of local subsidies could now make up only 11 or 12 percent of all domestic taxes combined. This measure severely weakened the ability of local governments to plan and manage their finances in any systematic and stable manner (KRILA, 1998, 427).
 
(2) Central Government Subsidies
The proportion of central government subsidies in either national or local finance also decreased in the 1970s, reflecting drastic cuts in the amount of national revenue being transferred to local governments after implementation of the August 3 Measures (KRILA, 1998, 437).
 
[Table 4-13] Central Government Subsidies: 1971 to 1980
(Unit: KRW 100 million)
 
Year Central government subsidies (a) Revenue structure Proportion
National (b) Local (c) a/b a/c
1971 264 5,515 1,568 4.9 17.0
1972 317 6,053 1,764 5.2 18.0
1973 312 6,911 2,155 4.5 14.5
1974 305 11,887 2,718 2.7 11.2
1975 822 13,744 4,303 5.9 19.0
1976 863 22,983 5,680 3.8 15.2
1977 1,038 29,908 8,165 3.5 12.7
1978 1,304 40,405 10856 3.2 12.0
1979 2,532 55,075 15,963 4.6 15.9
1980 3,269 66,352 19,454 4.9 16.8
Source: KRILA, 1998, 436

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