Comparison of Fiscal and Distributional Effects of VAT Exemptions in Korea and Japan
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This paper estimates and compares fiscal and distributional effects of Korean and Japanese VAT exemptions. VAT exemptions have two types of fiscal effects on revenue: they lead to reductions in VAT revenue via the output tax and revenue increases via the undeducted input tax through cascading effects. The results of input-output analyses for both countries indicate that the former effect outweighs the latter, reducing VAT revenue but that the exemptions mitigate the distributional regressivity of its incidence. In Korea in particular, the expansion of an aged population means there are more individuals affected by VAT regressivity, as most members of this population belong to low-income deciles, mainly because they are retirees. As is suggested by the life-cycle hypothesis, older populations are likely to have higher propensity to consume than younger ones. In Japan, the VAT was supposed to increase from 8% to 10% in October 2016, having already increased from 5% to 8% in April 2014. The additional increase was expected to exacerbate the negative impact of the VAT on income redistribution. For this reason, it has been repeatedly postponed, and now is not expected to take effect until October 2019. The growing socioeconomic resistance of the Japanese people to the VAT increase may require additional VAT reforms in Japan. It might, for example, need to increase tax revenue to cope with its growing national debt to GDP ratio as well as with its increasing welfare expenditure. The VAT is one of its key potential revenue sources. In addition, it might also need to broaden the scope of VAT exemptions to include more necessities at the expense of a little revenue so as to ease the potential increase in VAT regressivity expected to ensue from the October 2019 rate increase.
Abstract
This paper estimates and compares fiscal and distributional effects of Korean and Japanese VAT exemptions. VAT exemptions have two types of fiscal effects on revenue: they lead to reductions in VAT revenue via the output tax and revenue increases via the undeducted input tax through cascading effects. The results of input-output analyses for both countries indicate that the former effect outweighs the latter, reducing VAT revenue but that the exemptions mitigate the distributional regressivity of its incidence. In Korea in particular, the expansion of an aged population means there are more individuals affected by VAT regressivity, as most members of this population belong to low-income deciles, mainly because they are retirees. As is suggested by the life-cycle hypothesis, older populations are likely to have higher propensity to consume than younger ones. In Japan, the VAT was supposed to increase from 8% to 10% in October 2016, having already increased from 5% to 8% in April 2014. The additional increase was expected to exacerbate the negative impact of the VAT on income redistribution. For this reason, it has been repeatedly postponed, and now is not expected to take effect until October 2019. The growing socioeconomic resistance of the Japanese people to the VAT increase may require additional VAT reforms in Japan. It might, for example, need to increase tax revenue to cope with its growing national debt to GDP ratio as well as with its increasing welfare expenditure. The VAT is one of its key potential revenue sources. In addition, it might also need to broaden the scope of VAT exemptions to include more necessities at the expense of a little revenue so as to ease the potential increase in VAT regressivity expected to ensue from the October 2019 rate increase.
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