Local Finances Face 'Ice Age' Next Year... Local Allocation Tax to Decrease by 8.5 Trillion Won

Local Finance Hit Harder if This Year's Revenue Shortfall Included
"Did Total Government Spending Decrease Due to Government Expenditure Restructuring?"
National Budget Research Institute: "Total Spending Decreased Thanks to Reduced Local Grants"

Due to a decrease in domestic tax revenue next year, local allocation tax and other funds are expected to sharply decline, signaling a red alert for local finances. When factoring in this year's revenue shortfall, local governments are likely to face an ultra-tight fiscal situation next year.

According to the analysis of the government's budget proposal for next year released by the Nara Salrim Research Institute on the 4th, the allocation tax transferred to local governments next year is expected to decrease by 8.5 trillion won compared to this year. The education grants transferred to city and provincial offices of education also decreased by 6.9 trillion won. Compared to this year's budget, these represent reductions of 11.3% and 9.1%, respectively.

Under the current Local Allocation Tax Act and Local Education Finance Grant Act, 19.24% of domestic tax revenue must be automatically transferred as local allocation tax to local governments, and 20.79% as grants to city and provincial offices of education. The problem is that domestic tax revenue is expected to decrease by 10.1% (36.3 trillion won) next year compared to this year. As a result, the allocation tax and other funds transferred to local governments will be significantly reduced, inevitably impacting local government financial management.

Lee Sang-min, senior research fellow at the Nara Salrim Research Institute, explained, "Unlike the central government, local governments operate under the principle of balanced budgets. While the central government can politically determine expenditure size based on national consensus, local governments must automatically set expenditure according to revenue size. Unlike the central government, which can set necessary expenditure levels and manage surplus or deficit budgets through bond issuance and repayment, local governments can only set expenditure corresponding to revenue size, so fluctuations in revenue pose a significant burden on local government administration."

In fact, according to Article 137 of the Local Autonomy Act, local governments must operate their finances soundly based on the principle of balanced budgets. This means that local governments must fully bear the impact of changes in allocation tax and grants they receive, which depend on domestic tax revenue determined at the central government level.

Moreover, due to the historically large expected revenue decrease this year, local governments must also reflect revenue shortfalls. Because domestic tax revenue decreases lead to reduced grants to local governments, if a supplementary budget is enacted this year, grants paid this year will decrease. However, if there is no supplementary budget as the government has pledged, the revenue shortfall must be reflected in local finances next year. If the revenue shortfall is reflected all at once, local government finances next year could become even more strained.

Some have pointed out the need for 'revenue smoothing' through local allocation tax. Article 5 of the Local Allocation Tax Act currently states that "if national tax decreases, allocation tax can be adjusted until the following year considering local financial conditions." Lee Sang-min suggested, "The government has repeatedly applied a 'wrong faucet prescription' by abruptly turning off the cold water when revenue decreases and quickly turning on the hot water when revenue increases, without utilizing the local financial smoothing measures specified in the Local Allocation Tax Act. Considering the decrease in domestic tax revenue and the resulting reduction in funds transferred to local governments next year, I propose that this year's revenue shortfall be reflected after 2025."

Meanwhile, it has been pointed out that the government's expenditure growth rate next year, which is the lowest ever at 2.8% when including this year's domestic tax revenue shortfall, is largely due to the reduction in domestic tax revenue transferred to local governments rather than expenditure restructuring. The government explained that it conducted a comprehensive review of all projects related to next year's budget proposal and implemented expenditure restructuring amounting to 23 trillion won. Regarding this, Lee stated, "If domestic tax revenue had not decreased and the transferred funds had not been reduced by 15.4 trillion won, total expenditure next year would have increased by 5.3% from this year to 672.3 trillion won," adding, "the government's touted belt-tightening for fiscal soundness was not achieved through government effort and will but was automatically realized through the sacrifice of local governments caused by the decrease in domestic tax revenue."

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