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S. Korea’s Lee Fails to Win His Party’s Support for Tax Plan

South Korean's President Lee Myung Bak
Lee Myung Bak, South Korean's president. Source: Yonhap News via Bloomberg

South Korean President Lee Myung Bak failed to sell a tax cut plan to his own political party, underscoring how Lee’s faltering popularity is damaging his leadership ahead of elections next year.

The government agreed with the ruling Grand National Party to drop the proposals, the finance ministry said in a statement today. The plan had called for lowering the corporate tax rate to 20 percent from 22 percent to bring it closer to the levels of Asian neighbors, and cutting the top income tax rate.

Lee’s approval rate has fallen to less than half its level when he took office in Feb. 2008, as accelerating inflation and a widening wealth gap fueled public discontent. Abandoning the planned tax reductions could weigh on an economy that’s at risk of a slowdown due to weakening overseas demand.

“The ruling party made a political and populist decision to win the elections as most people believe that the tax cuts would only benefit a few rich people,” said Lee Sung Kwon, an economist at Shinhan Investment Corp. in Seoul. “The corporate and income tax cuts would have boosted the economy amid growing concerns about a slowdown.”

South Korea’s government also said today it plans to charge foreign investors a 14 percent tax on interest income from so-called kimchi bonds, or foreign currency-denominated bonds issued by the nation’s government agencies and companies. Local investors already pay the tax, whose rate is in line with that for won bonds. The tax will take effect on Jan. 1, 2012, if it’s approved by parliament.

Chamber of Commerce

The Korea Chamber of Commerce & Industry said the scuttling of the plan to reduce taxes may hurt local companies.

“We regret the decision to drop the tax cut plan, which should be negative for our companies’ competitiveness in global markets and foreign capital investment,” the organization said in a statement today. “It will also undercut the people’s trust in the government policies and reduce the room for corporate investment.”

Lee’s approval rate stood at 34.4% last week, compared with 76% in the first week he took office in Feb. 2008, according to Realmeter, a polling company in Seoul. Parliamentary elections will be held in April and the presidential election will be in December next year.

Bank of Korea Governor Kim Choong Soo and his board will meet tomorrow to decide whether to raise interest rates for a fourth time this year to curb inflation. The board will probably leave the policy rate at 3.25 percent for a third month as global economic uncertainties mount, according to 14 of 18 economists surveyed by Bloomberg News. The remaining four predict an increase.

Surging Inflation

Consumer prices jumped 5.3 percent from a year earlier last month, the fastest increase in three years, as food costs climbed. Inflation in South Korea has exceeded the Bank of Korea’s 4 percent target ceiling every month this year.

At the same time, in a sign of the fallout from a weakening global economy, industrial production rose less than expected in July, and confidence among manufacturers and consumers fell, reports last month showed.

The International Monetary Fund said the South Korean government should introduce measures that let more of its citizens benefit from economic growth.

“Policies that help expand the sources of growth beyond the tradables sector, thereby creating a second engine of growth, would allow the benefits of growth to be shared more broadly,” the IMF said in a report dated July 14.

Asian Tax Rates

South Korea’s top corporate tax rate of 22 percent compares with Hong Kong’s at 16.5 percent and 17 percent in both Taiwan and Singapore, said Jang Jae Hyung, a director at the nation’s finance ministry. The government had also planned to reduce the top income tax to 33 percent from 35 percent.

The government expects to retain about 2.8 trillion won ($2.6 billion) in tax revenue by scrapping the planned reductions, the finance ministry said.

Finance Minister Bahk Jae Wan pledged at a parliamentary committee meeting on Sept. 1 to balance the budget by 2013, faster than the previous plan of 2013 or 2014.

The government also plans to expand tax incentives to companies for hiring new workers, the ministry said. Tax deductions for facilities investment will be terminated while taxes on capital gains from financial products including those involving derivatives will be legislated, the ministry said.

The proposals will be submitted to the National Assembly for approval late this month, the ministry said.

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