South Korea’s fiscal deficit has been rising at an alarming pace this year due to the combination of a steep rise in government expenditure and declining tax revenues.
The overall fiscal balance -- the difference between the government’s gross revenue, including taxes and proceeds from asset sales, and its total expenditure -- recorded a deficit of 26.5 trillion won ($22.8 billion) in the first nine months of the year, according to a report released by the Ministry of Economy and Finance last week.
Over the cited period, the deficit of the managed fiscal balance -- the shortfall in the government’s income compared with its spending, excluding social security funds -- soared to 57 trillion won. This figure provides a more accurate picture of the state of fiscal management.
The deficits of the overall and managed fiscal balances for the January-September period were the largest since 1999 and 2011, respectively.
Government officials downplay the record deficit as a “temporary phenomenon,” attributing it to fiscal stimulus measures to help bolster the sluggish economy and welfare allowances for low-income families.
But the deficit seems far from temporary. Rather, the country’s fiscal imbalance will most likely worsen down the road, as President Moon Jae-in’s administration is poised to adhere to an expansionary fiscal policy despite the likelihood that tax revenue will continue to decline amid a prolonged economic downturn.
In the first nine months of 2019, government spending reached 386 trillion won, up more than 40 trillion won from the same period last year.
Total tax revenue declined by 5.6 trillion won from a year earlier to 228.1 trillion won during the January-September period, the first on-year decline since 2013 for the nine-month period.
The decrease was attributed mainly to a reduction in corporate tax revenue, which reflected the plummeting profits of local companies troubled with worsening business conditions at home and abroad.
The Moon administration has expanded fiscal expenditure mainly to create low-paid temporary jobs, pay subsidies to small businesses to offset the heavier labor costs imposed by steep minimum wage hikes and finance populist welfare programs.
Such fiscal expansion has done little to bolster the economy and improve employment. The country has seen its economic growth decelerating at a faster pace than other member states of the Organization for Economic Cooperation and Development. Its unemployment rate has risen to a level not seen since the Asian financial crisis in the late 1990s.
In July, the Bank of Korea slashed its economic growth outlook this year to 2.2 percent from its previous forecast of 2.5 percent three months earlier. The central bank suggested last week it would be difficult to achieve the lower growth target due to a decline in exports and investment. Many private institutions at home and abroad predict that Asia’s fourth-largest economy will grow far less than 2 percent in 2019.
Ineffective fiscal spending is set to increase more steeply next year. The government has allocated 513 trillion won for its 2020 budget, up 44 trillion won or more than 9 percent from this year, with the planned increase set aside mostly to finance projects aimed at wooing voter support ahead of April’s parliamentary elections.
What is concerning is that reckless fiscal expansion unaccompanied by increased revenue will lead to a surge in national debt. If state bonds are issued to fill the expected budget deficits, national debt is projected to exceed 800 trillion won in 2019 and reach 1,061 trillion won by 2023.
Without changes in the administration’s policy, the country runs the risk of facing both fiscal instability and a sluggish economy.
It should stop pursuing tax-fueled growth and refrain from expanding what many economists criticize as populist welfare programs. It needs to carry out regulatory and labor reforms to help revitalize corporate activity and market vitality. President Moon should prove the sincerity of his recent corporate-friendly approach with substantial measures that can boost business sentiment and investor confidence.
Curbing inefficient and reckless government spending is also necessary to secure more fiscal room to prepare for the possibility of a full flare-up in external risks down the road.
The government should heed the warning that an economic crisis more severe than before could hit the nation, if it adheres to fiscal expansion without making painstaking efforts to boost long-term growth potential by improving productivity through regulatory and labor reforms.