OECD Criticizes 'Fuel Tax Cut' "Should Be Gradually Reduced"... Calls for Pension Reform Amid 'Aging Time Bomb' (Comprehensive)

2022 Korea Economic Report

[Asia Economy Sejong=Reporters Son Seon-hee and Kwon Hae-young] The Organisation for Economic Co-operation and Development (OECD) has criticized the South Korean government's fuel tax reduction policy implemented as a measure against 'high inflation.' The core of the criticism is that the universal fuel tax reduction policy, which benefits high-income groups, should be restructured into a selective support system targeting vulnerable groups. The OECD also called for securing pension funds through an increase in the value-added tax rate.

In the '2022 Korea Economic Report' released on the 19th, the OECD criticized the policy and recommended that "the fuel tax reduction should be gradually phased out according to a predetermined procedure." The OECD conducts comprehensive analysis and evaluation of economic trends and policies of member countries and issues policy recommendations; this Korea Economic Report is the first in about two years.

The OECD's stance is that policies involving tax expenditures, such as fuel tax reductions, should have their support targets 'selected.' The OECD pointed out, "Although many OECD countries have introduced similar emergency measures, such universal support is costly and benefits are concentrated among high-income groups." It further suggested, "It is a much more effective policy alternative to link domestic fuel prices to international fuel prices while executing transfer payments targeting vulnerable groups rather than providing fossil fuel subsidies." This approach, adopted by countries like Denmark and Germany, provides tax exemptions or temporary support payments only to low-income groups vulnerable to high oil price shocks.

Earlier, the South Korean government reduced the fuel tax by 20% on gasoline, diesel, and liquefied petroleum gas (LPG) in the second half of last year as international oil prices rose. The reduction was expanded to 30% in May this year and further increased to the legal maximum limit of 37% in July. While this policy was initially evaluated as lowering the perceived inflation rate, the government has been troubled as the high oil price situation lasted longer than expected. The paradoxical situation repeated where artificially lowering energy prices through flexible tax rates led to a surge in demand, further driving up prices. Additionally, last month, the National Assembly passed a bill to expand the flexible fuel tax rate adjustment limit to 50%. The government plans to maintain the current fuel tax reduction until the end of this year but has stated that there is "no decision yet" on further extension.

Regarding the rapid increase in national debt due to expenditures related to population aging, the OECD proposed a fiscal remedy of 'raising the value-added tax rate.'

According to the OECD, Japan gradually increased its consumption tax by 5 percentage points from 2012 to 2019 to cover aging-related costs, including pension expenditures. Since South Korea's current value-added tax rate is 10%, much lower than the OECD member average of 19.2% (2020), it can refer to Japan's case to secure funds for the national pension. Currently, the basic pension is fully funded through taxes.

The OECD stated, "The South Korean government should consider financing public pension funds, which serve a redistributive function, through general taxation," adding, "This could strengthen the link between pension premiums and benefit amounts."

The OECD also recommended introducing an automatic life expectancy linkage system for pension schemes, as applied in Germany and Japan. In Japan, pension benefits are linked to life expectancy under the condition that the income replacement rate does not fall below 50%. This can enhance fiscal sustainability and improve the predictability of future pension benefits.

Furthermore, the OECD recommended raising the national pension eligibility age, currently scheduled to increase to 65 by 2033, earlier to 68 by 2034, and more than doubling the national pension contribution rate from the current 9%. The OECD analyzed that if the pension eligibility age is raised earlier, the expenditure pressure equivalent to 2% of the GDP in 2060 would be reduced.

The OECD emphasized pension reform because rapid aging is expected to push South Korea's government debt ratio from the current level of about 50% of GDP to over 140% by 2060. The OECD stated, "South Korea will need additional revenue or expenditure cuts equivalent to 10% of GDP by 2060 due to rapid population aging and spending pressures to expand social safety nets."

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