Fiscal Rules Promoted to 'Stop Populism'... Will the May Special Session Pass Them?

Ruling Party: "Rapid Increase in National Debt"
Opposition: "Fiscal Balance Not Worsening"
May Passage Through the Budget Committee Seems Difficult

"There is truly no logic more meaningless than the argument that 'we do it because other countries do.' Shouldn't there be a rationale for why we have to follow that?" - Go Yong-jin, Democratic Party of Korea lawmaker "We have already experienced a tsunami, and we don't know when another tsunami might come, so why build a levee? I think this is the kind of logic behind the argument that there is no need to establish fiscal rules. Even individuals and households set spending ceilings, so isn't it problematic that the state does not do this?" - Bae Jun-young, People Power Party lawmaker

These are excerpts from remarks made during a heated debate among ruling and opposition members at the March 14 public hearing of the National Assembly's Planning and Finance Committee on the introduction of fiscal rules. Fiscal rules were a campaign promise of President Yoon Suk-yeol and symbolized a rejection of populism, but despite the March hearing, the Planning and Finance Committee failed to advance discussions on fiscal rules during the April extraordinary session of the National Assembly.

Marking one year since its inauguration, the Yoon Suk-yeol administration has strongly advocated for the legislative enactment of fiscal rules from the early days of its tenure. The government's main principle for fiscal rules is to manage the deficit of the management fiscal balance within 3% of the gross domestic product (GDP). The core content is to reduce the fiscal deficit ratio to within 2% of GDP if the national debt exceeds 60% of GDP, thereby preventing the expansion of fiscal deficits. Exceptions are limited to crisis situations such as war, large-scale disasters, and economic recessions. The proposal is to allow exceptions to fiscal rules only in 'crisis' situations, similar to the conditions for supplementary budget formulation under the National Finance Act. Fiscal rules are a fiscal management system legislated to impose constraints on the government's discretionary fiscal policies by setting standards for aggregate fiscal indicators. Depending on the application criteria, they are classified into fiscal balance rules, debt rules, expenditure rules, and revenue rules.

Related bills have been proposed mainly by ruling party lawmakers in the form of amendments to the National Finance Act. Lawmakers Ryu Seong-geol and Song Eon-seok of the People Power Party have also separately introduced a Fiscal Soundness Act. Although the Yoon Suk-yeol administration has strongly pushed for this, the topic has been consistently raised in discussions on fiscal soundness during previous administrations, including the Moon Jae-in government.

◆Why has it become a political issue? Supporters of the introduction point to the rapidly increasing national debt during the previous administration, especially due to COVID-19. They argue that the large-scale expansionary policies implemented to respond to the economic downturn caused by the pandemic have endangered public finances. According to the 2022 fiscal year national settlement report, the national debt at the end of last year was 2,326.2 trillion won, an increase of 13.09 trillion won (6%) from the previous year. The national debt alone reached 1,067.7 trillion won at the end of last year, surpassing 1,000 trillion won for the first time with an increase of 97 trillion won from the previous year. The issuance of government bonds increased due to supplementary budgets and other measures in response to COVID-19, raising confirmed debt by 89.2 trillion won compared to the previous year. In particular, the management fiscal balance (the balance excluding the four major social security funds such as the National Pension from the integrated fiscal balance) recorded a deficit of 117 trillion won, the largest ever.

On the other hand, opponents argue that South Korea's fiscal condition is relatively sound. According to the Fiscal Monitor report released by the International Monetary Fund (IMF) in April, South Korea recorded a fiscal balance (General Government Overall Balance) of 0% in 2021 and a deficit of -0.9% in 2022, but is expected to recover to 0% in 2023. From 2024 onward, it is projected to maintain a deficit of -0.1%. By the same standard, the average for G7 countries was -9.1% in 2021, -5.4% in 2022, and -5.6% in 2023. The argument is that compared to other countries, South Korea's situation is relatively better.

Lee Sang-min, senior researcher at the Nara Salrim Research Institute, explained, "To create fiscal rules, South Korea is making Galapagos-style calculations by setting management fiscal balance and integrated fiscal balance standards, but these do not align with global standards. When viewed as concrete standards reflecting economic reality, South Korea's fiscal balance has not deteriorated."

Yoon Young-seok, Chairman of the National Assembly's Planning and Finance Committee, is greeting Christine Lagarde, President of the European Central Bank, at the ECB Tower in Frankfurt, Germany, on the 26th (local time). April 27, 2023. [Provided by the Office of Yoon Young-seok, Chairman of the National Assembly's Planning and Finance Committee. Resale and DB prohibited] [Image source=Yonhap News]

◆Overseas cases Among OECD countries, all except South Korea and T?rkiye have introduced fiscal rules. Recent circumstances in various countries show that fiscal rules are not always strictly enforced.

European countries, as seen in the European Union (EU) case, have effectively formed political alliances through fiscal rules. The Maastricht Treaty, established in the early 1990s for participation in the European Economic and Monetary Union, led many countries to join. However, even in the EU, sanctions are imposed on member states whose fiscal deficits exceed 3% of GDP or whose debt ratios exceed 60%, but in response to the COVID-19 situation, efforts are underway to relax these limits to ease the burden on countries with chronic fiscal deficits.

Japan, which introduced fiscal rules from 1947 after World War II, has somewhat relaxed its application standards. Japan's 1997 Fiscal Structural Reform Law prohibited fiscal deficits exceeding 3% of GDP and banned government bond issuance for current expenditures, but these regulations were abolished following the 1998 Asian financial crisis. Since 2018, quantitative limits on total government expenditure have been removed.

Even in legislative contexts, the scope of application of fiscal rules remains controversial. There is also a lack of social consensus on how far exceptions should be recognized. For example, whether current demographic crises such as low birth rates and aging populations can be considered exceptions to fiscal rules. On April 27, at a plenary meeting of the Special Committee on Population Crisis, Democratic Party lawmaker Choi Jong-yoon requested, "The exemptions to fiscal rules cover large-scale disasters, calamities, and global economic crises, but please discuss how to reflect the population crisis in fiscal rules." The question is whether the role of fiscal policy can be limited due to adherence to fiscal rules in the face of the current population extinction crisis.

◆Will it be discussed in the May National Assembly session? Last month, Yoon Young-seok, chairman of the National Assembly's Planning and Finance Committee (People Power Party), along with some ruling and opposition committee members, went on a business trip to discuss the establishment of fiscal rules. They reportedly formed a consensus that "fiscal rules are a necessary principle" during a meeting with Christine Lagarde, President of the European Central Bank. The related final report is scheduled to be released at the end of this month.

Until now, the government and ruling party have shown strong determination to introduce fiscal rules, but exceptional situations such as tax revenue shortfalls have begun to emerge. Due to economic deterioration, there are concerns that tax revenues will fall short of initial projections, making it difficult for discussions on fiscal rules to gain momentum within and outside the Planning and Finance Committee. The inability to collect even the expected taxes due to a sharp economic downturn has weakened support for fiscal rules. In fact, national tax revenue until March this year decreased by 24 trillion won compared to last year. Even after removing illusion effects, the decrease in tax revenue effect in the first quarter was 14.3 trillion won.

The Ministry of Economy and Finance recently revised downward its forecast for the national debt ratio. According to the 2022-2026 National Fiscal Management Plan, the debt ratio target for 2025 was reduced by 7.4 percentage points to 51.4% of GDP compared to the 2021-2025 plan. Some speculate that the Ministry of Economy and Finance will not forcibly push for the introduction of fiscal rules, which could send a signal of tightening fiscal policy in an already cooling economy.

This content was produced with the assistance of AI translation services.