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Domestic resource mobilization for poverty reduction in East Africa : South Korea case study

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  • Domestic resource mobilization for poverty reduction in East Africa
  • Regional Department East A
  • African Development Bank Group


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Title Domestic resource mobilization for poverty reduction in East Africa
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Sub Title

South Korea case study

Material Type Reports
Author(English)

Regional Department East A

Publisher

[Ghana]:African Development Bank Group

Date 2010-11
Pages 53
Subject Country Estern Africa(Africa)
South Korea(Asia and Pacific)
Language English
File Type Link
Original Format pdf
Subject Economy < Macroeconomics
Holding African Development Bank Group

Abstract

This case study explores some of the key achievements of Korea’s tax reforms during its takeoff phase between the 1960s and 1970s, with a view to drawing useful lessons for East Africa Community (EAC) member countries today. It is part of a broader Project on Domestic Resource Mobilization carried out by the African Development Bank. This project aims at sharing best practices among EAC member countries.
Korea’s development is one of the most successful and rapid in human history, yet during its takeoff phase, it was similar in many respects to EAC member countries today. Korea’s Gross Domestic Product (GDP) per capita grew from US$ 130 in 1954 to about US$ 19,115 in 2008. This growth was relatively well shared, as evidenced by a Gini coefficient of 32 in 2008 - equal to the European average. Korea implemented an export oriented infant industry strategy to transform itself from an underdeveloped country into a First World power in one generation. In the 60’s, Korea’s GDP per capita was similar to that of EAC member countries today and much lower than South Africa’s. Korea was a fragile state, emerging from a devastating war with North Korea. It was also predominantly rural, with a large informal sector, much like the profile of some of the countries in East Africa. This formed the rationale for including Korea’s tax experience during its takeoff phase in the Project.
Tax reforms in the 60s and 70s consist in three phases which successively focused on: improving policies and laws, efficient implementation, and strengthening equity and introducing the Value Added Tax (VAT). First, until 1966, reforms focused on increasing revenue collection and supporting growth, mainly through revising tax policies. This involved for instance merging a number of taxes, increasing the share of indirect taxes and using tax incentives to support selected sectors. Growth increased and reached 9.3% in 1963, which was later sustained. But revenue collection still fell short of expectations. The focus, therefore, shifted from reforming policies to implementing them efficiently. Consequently, the second period, from 1966 to 1974, focused on strengthening the tax administration. The creation of the National Tax Service as a semi-autonomous body in 1966 initiated a period of rapid revenue growth. During the third period, from 1974 to 1980, the importance of equity as an objective of tax policy increased and the VAT was introduced. Korea’s tax reforms resulted in rapid revenue increase, from 9% of GDP in 1966 to 15% in 1980. Combined with a decrease in government expenditure, this enabled Korea to achieve fiscal balance, a priority strategic objective.
Two lessons of particular relevance to EAC countries emerge from Korea’s tax experience.
First, Korea achieved faster results by focusing its tax policies on a few priorities fully aligned with its national development strategy. In the 60s and 70s, Korea’s national strategy was on the one hand to rapidly achieve fiscal balance with a small government budget, and on the other hand to promote growth through an infant industry policy. However, trade-offs in the tax space were largely made up in other policy areas, for in particular through equity-oriented expenditure rural development programs and growth, which provided Korea with sustainable means to achieve equity. To this end, Korea successfully implemented tax policies focused on increasing revenues sufficiently to match low levels of expenditures by international standards, broadening the tax base, and providing incentives to strategic sectors. In practice, less priority was given to other tax objectives, such as neutrality and equity. EAC countries are challenged by multiple tax objectives which can be conflicting if pursued at the same time. For instance exemptions can be necessary to provide safety nets or stimulate investments, but conflict with the objectives of broadening the tax base and minimizing distortions.
Second, Korea broadened its tax base by making its tax administration both empowered and accountable. The National Tax Service (NTS) benefitted from full support by top Government officials. NTS was shielded from political interference in its operations, as illustrated from the President’s personal support to the Commissioner against external pressure. In addition, the enforcement capability of the tax administration was dramatically strengthened. For instance, three years after its creation, NTS staff headcount increased by 70% to reach 0.3 staff for 1000 inhabitants, 5 times the EAC average. On the other hand, the President was personally committed to the success of the tax administration, approving targets himself and closely monitoring performance. Operational empowerment and accountability for performance form a whole which together helped Korea succeed in broadening its tax base, as illustrated by a VAT Gross Compliance Ratio of 55% achieved by 1978, against 32% on average in the EAC today.