Tax Equity and Income Inequality in Korea

Abstract

Applying newer methods of analysis to panel data from the Korean Household Panel Study, this study<br><br>empirically explored the various equity consequences of the Korean income tax system during the period of 1992 to 1998. In terms of either the structural measure of average rate progression or the distributional measure of the Center of Gravity of income distribution, tax effects on vertical equity were found to be insignificant throughout the sample years, despite the statutory progressivity. While these results basically agree with previous studies, this study also found that the absolute tax payments as well as the average effective tax rates failed to be monotone increasing in income deciles, providing strong evidence against the principle of progressive taxation. In addition, decomposition analysis found that the income inequality within income deciles was negatively affected by income taxation despite the unambiguous improvement in overall inequality both in 1992 and 1996. The analysis with Tax Mobility Matrices found that the Korean income tax system induced extensive income re-rankings affecting most households in all sample years, and, generally speaking, the middle-income class of the fifth and sixth deciles were most rank-shifted to adjacent deciles. The Mean Squared Relative Rank-Shift, which was computed as a summary measure of overall re-rankings, did not find any obvious trend; however, the average distance of rank-shifts gradually decreased from 1992 until 1997 and then rather sharply increased in 1998. Lastly, the sample year of 1998, which corresponded to the period of Economic Crisis in Korea, was distinguished from the rest in notable respects: the progression of effective tax rates was most prominent; the distributional tax effect on income inequality was also most prominent; yet, the percentage of rank-shifted households was lowest and the extent of the tax-induced re-rankings was second-lowest among the sample years.