Bloomberg News

S. Korea Crackdown on Underground Economy Stokes Angst: Economy

February 02, 2014

Market in Seoul

Stalls selling accessories are illuminated with tungsten lightbulbs in a market in Seoul. Photographer: Woohae Cho/Bloomberg

South Korean (KOGDPQOQ) bar owner Jeong Young Soo doused his body with paint thinner and set himself aflame, his final protest against a government crackdown to collect more tax from his industry.

The shock in front of Chuncheon city hall, northeast of Seoul, highlighted an underlying tension as President Park Geun Hye tries to squeeze an extra 27.2 trillion won ($25 billion) in revenue from the undocumented economy.

Extra pressure on groups from bar owners to doctors to mom-and-pop retailers contrasts with Park’s 2012 election-campaign focus on reducing the scope of industrial groups, known as chaebol, to create space for small- and medium-sized businesses. The clampdown may have the opposite effect, said Jean Lim, a Seoul-based economist at Korea Institute of Finance, a non-profit research center.

“The more successful and stringent this tax crackdown is, the bigger an impact it will have on reshaping the economy,” said Lim. “Enforcing tax transparency will get rid of small, uncompetitive businesses and lead to an eventual reduction in the number of businesses in the service industry,” he said, adding that chains and franchises may spread.

In a Jan. 10 interview at the presidential Blue House in Seoul, Park said that she was determined to avoid adding difficulties for small businesses, even while tackling tax evasion and “illicit practices.”

South Korea’s shadow economy was equal to 24.7 percent of gross domestic product in 2010, above an average 18.3 percent for 39 OECD members and 11 percent for Japan, according to a paper by the Institute for the Study of Labor in Bonn, Germany.

Chaebol Influence

The top 10 chaebols, conglomerates such as Samsung Group, had revenue equivalent to 84 percent of GDP in 2012 and employed just 5 percent of paid workers, according to data from CEOSCORE, a Seoul-based organization that monitors the chaebols. South Korea’s ratio of 28 percent of workers self-employed is almost four times that of the U.S., according to Organization for Economic Co-operation and Development data.

While the government is also targeting tax evasion by big corporations, some small businesses say they see themselves as bearing the brunt of the clampdown.

“Park Geun Hye should support small- to medium-sized businesses, not take them down,” said Bae Do Sik, aged in his 30s, who runs a driving school in the city of Jecheon, south of Seoul. “Who wouldn’t have some dirt if he or she gets shaken hard enough.”

Restaurants, Retail

Stiff competition for jobs in manufacturing and a lack of mid-sized employers and state-supported vocational schools drive people to establish their own businesses in the service sector, such as restaurants and retail outlets, said Lim at Korea Institute of Finance.

“This is changing, though,” said Lim. “Chaebols are franchising bakeries and chicken shops as they seek new areas of growth.”

As Park seeks extra money to help fund her election promises, investigators are trying to counter tax-avoidance methods such as bank accounts set up under other people’s names and the purchase of gold bars to hide wealth, the tax agency said. The government misses about 65 trillion won in tax revenue a year due to underground activity, according to ruling party lawmaker Yoo Sung Kull, a former vice finance minister.

Park is the first president to set revenue targets in the battle with tax cheats, according to the finance ministry, and aimed to raise 2.7 trillion won last year, 5.5 trillion won this year and a total of 27.2 trillion won by 2017, or 20 percent of the cost of her election pledges over the period.

‘Aggressive, Abrupt’

“The problem is that the crackdown is aggressive, abrupt and insensitive,” said Ahn Chang Nam, a tax professor at Kangnam University in Yongin. “Because fines are being abruptly slapped down, it gives no time for evaders to voluntarily report their wrongdoing. Getting caught up in it can easily mean going out of business.”

Doctors are in the government’s sights and “many are afraid of raids,” said Rho Hyung Cheol, a licensed tax accountant and adviser to the Korean Medical Association. “Plastic surgeons seem to be in more agony, in particular. They used to treat raids as passing squalls to hide from, but that’s changing.”

Nightclubs and bars have protested after tax officials demanded payment of levies required by law from some venues where customers give tips to bar staff. For Choi Seng Eun, a research fellow at Korea Institute of Public Finance, the extra enforcement is a step in the right direction.

No ‘Impediment’

On Nov. 21, Finance Minister Hyun Oh Seok told parliament that the government will “try our best not to make our tax investigations an impediment to normal business activities” and “diligent tax payers and small- to medium-sized entrepreneurs should not be dispirited by the investigations.”

In contrast, Choi Don Gwan, 72, who runs a bar in the city Taebaek and witnessed the fatal self-immolation in September of his friend Jeong, said he was concerned that Park’s efforts to boost revenue come at the expense of small businesses like his. The National Tax Service declined to comment on the bar owners’ cases.

“My friend died fighting against this after suffering a whole week in the hospital,” Choi said, adding that Jeong, who was the local head of an association of bar owners, had set himself on fire to attract attention to their plight. “I can’t believe it’s the government that is driving us out of business.”

To contact the reporter on this story: Cynthia Kim in Seoul at ckim170@bloomberg.net

To contact the editor responsible for this story: Paul Panckhurst at ppanckhurst@bloomberg.net


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