Income Inequality in Korea, : Evidence from Income Tax Statistics

Transcription

1 Income Inequality in Korea, : Evidence from Income Tax Statistics Nak Nyeon Kim and Jongil Kim Abstract This paper constructs long-term series of top income shares and top wage income shares using income tax statistics to study the evolution of income inequality in Korea. Income concentration was very high before WWII when Korea was under colonial rule but dropped sharply after WWII. It remained low during the period of rapid industrialization but has ascended since the mid-1990s. This U-shaped pattern of top income shares in Korea is similar to those in other industrialized countries but the factors for the shape may be different. We attribute the drastic fall in income concentration after WWII to economic collapse and political disruption from regime change after liberalization. We argue rising income concentration last 15 years could be attributable to two factors. First, we point out the drastic transition of major industries toward technology-intensive sectors along with deepening economic relationship with low-wage countries such as China caused diverging demands for different types of workers. We find the average wage income of the bottom income groups even declined in real terms last 15 years. Second, we suggest two institutional factors such as falling marginal tax rate since the 1980s and post-crisis changes in corporate governance system enforcing competition among the top management through performance-based rewards played an important role in increasing top incomes. I. Introduction The indices of income inequality such as Gini coefficient and poverty rate are constructed based on Household Income and Expenditure Survey by the Korea Statistical Office. 1 Although the household survey is a suitable source to compute the indices of income inequality, it does not allow us to study the long-run evolution of income inequality in Korea. The raw data of the household survey are available since 1990, the earliest year the official statistics of income inequality is reported by the Korea Statistical Office. 2 The household survey did not cover single-person households before In addition, it provides household income only for wage workers in the earlier years by excluding income of self-employed and family workers. In addition, it was found that the household survey leaves out a considerable number of top income households in the sample and severely understates household financial income(kim and Kim, 2013). Due to this problem of under-coverage and underreporting, the existing indices of income inequality do not allow us to study the evolution of income equality in Korea because a homogeneous series is available only for a small number of recent years and even available series may not adequately reflect real situation of income inequality. Instead of using the indices based on the household survey, this paper constructs long-term series of income concentration to study the evolution of income inequality in Korea. We compute income shares and wage income shares for top income groups such as the top 1% of income distribution by using income tax statistics. Although top income shares do not provide information on the income 1 To be exact, income inequality indices such as Gini Coefficient and income decile distribution are computed based on Household Income and Expenditure Survey by the Korea Statistical office and Farm household Economy Survey by the Ministry of Agriculture and Forestry. 2 The Gini coefficients, decile income distributions, and poverty rates since 1990 are reported in the website ( of the Korea Statistical Office. 1

2 distribution of lower income groups, it allows us to construct a homogeneous long-term indicator of income inequality. It also let us study the evolution of income inequality in Korea in comparative perspective since top income shares have been constructed for many countries such as France(Piketty, 2003), the U.S.(Piketty and Saez, 2003), the U.K.(Atkinson, 2005), and Japan(Moriguchi and Saez, 2008). 3 The income tax statistics in Korea goes back to the colonial period. The composite income tax which imposes tax on the sum of various types of income was introduced in 1934 for the first time. Since then, there are three major changes in tax system until now in addition to numerous minor revisions and thus available information from income tax statistics varies over time. Notwithstanding missing periods due to limited information from the tabulations of income tax statistics, this paper investigates the long-term trend of income inequality in Korea from 1933 to During this period, Korea underwent several different regimes. From 1933 to 1945, Korea was under Japanese colonial rule and experienced a wartime control system after After liberalization in 1945, the Korean Peninsula was divided into two nations in the South and the North. The Korean War broke out in 1950 and continued three years. After the war, South Korea achieved long and rapid economic growth although its growth rate subsided after the economic crisis in This paper will provide a starting point to discuss how income inequality has evolved under these different regimes. The paper is organized as follows. Section II describes the data and outlines the estimation methods. Section III presents our findings from the construction of top income shares and investigates the causes of the observed changes in trend. In Section IV, we present the trend of top wage income shares and explore the causes in comparison with other countries, particularly the U.S. and Japan. Section V concludes. The detail description of our data and methods, as well as a complete set of results, will be presented in Appendix. II. Data and Methodology 1. Construction of Top Income Shares Series Top income share is computed by dividing income accruing to a specified top income group by total income. For this, we have to define income that should be counted and individuals belonging to specified top income groups such as the top 1%. Our primary data source is income tax statistics published in the Annual Statistical Report on National Tax (Kuksae Tonggae Yeonbo, the annual report from now on) by the National Tax Administration of Korea and the Japanese Government General of Korea. The annual report provides tables with the number of taxpayers, the amount of reported income, and the amount of income tax by income brackets. We define income as a gross income before deductions of income and payroll taxes paid by individuals, but after employers payroll taxes and corporate income taxes. It includes all types of income such as capital income (interest and dividends), rental income (rents from real-estate lease), unincorporated business income (including self-employment income), and wage income (salaries, wages, and bonuses), pension, and other small items. However, realized capital gains are not included in income in our definition. Capital gains from land and house have been partially taxed due to special treatments and exemptions and those from listed stocks have not been taxed except for large shareholders designated by law in Korea. In addition, realized capital gains are volatile and lumpy as opposed to a steady source of annual income. 3 Top income shares series of various countries can be obtained from the World Top Income Database( Top income shares series seem to become an alternative measure of income inequality as they are accumulated. OECD report on income inequality paid attention to top income shares along with traditional indices of income inequality(oecd, 2011). So far, Korea has been left in the blank in studying top income shares. We expect our study will fill in the blank for Korea. 2

3 Top income groups are defined relative to the total number of adults, defined as 20 years old and above. The total adult population can be computed directly from official population statistics provided by the Korea Statistical Office since For the period earlier than 1960 when population by age groups is available only for the years of population census, we interpolate data in missing years by using the growth rate between two census years. Other candidates for the control total for population could be total number of taxpayers or total employment. Because of tax exemption and withholding tax system, only a small fraction of individuals file income tax returns. Therefore, the number of total taxpayers is not a consistence reference for time-series and cross-section comparison since its scope varies among different tax systems. Total employment is too narrow since it excludes individuals relying on non-labor sources such as pension and capital income. Although the adult population, our control total, includes economically inactive population, it provides a relatively proper reference for comparison over time and across countries. Our definition is same as that of Moriguchi and Saez(2008) who constructed top income shares series for Japan. We cannot compute total income from income tax statistics because the tabulations in income tax statistics do not count taxpayers who do not file income tax returns. Thus, we rely on National Accounts to compute the control total for income. We obtain the amount of total income after subtracting items which do not belong to personal earning from the table of income by institutions in National Accounts. We subtract employers social contribution, imputed rents to owner-occupier, and financial intermediation services indirectly measured(fisim) from compensations to employees, operating surplus, and interest in financial income, respectively. For the colonial period when the statistics of income by institutions is not available, we obtain total income by subtracting imputed rents from factor income which is the sum of compensation to employees and operating surplus. This method cannot exclude retained corporate income but it is an ignorable amount at that time. To compute income accruing to top income groups (in this study, the top 0.01%, 0.05%, 0.1%, 0.5%, 1%, 5%, and 10%), we use method used by Piketty and Saez(2003). The top tail of income distribution is well approximated by a Pareto distribution. We estimate Pareto coefficients bracket by bracket for each year using the distribution tables of income tax statistics in the annual report. We employ a parametric interpolation method to estimate threshold and average income levels for top income groups. We then obtain total income accruing to the respective top income groups simply by aggregating income above the threshold. Finally, the income shares of respective income groups are computed by dividing the income of each group by the control total for income. Table 1 presents estimated threshold and average income levels for top income groups in The size of the top 0.01% income group is 3,895 and one should earn more than 1.10 billion won (US$ 995,346) to belong to this group. Its average income is 2.73 billion won. 4 Top 5-1% denoted in the table is the top 5% income group excluding the top 1% income earners. The size of this group is 1.55 million and its average income is 72.5 million won (US$ 62,747). <Table 1> Threshold and Average Income Levels for Top Income Groups in 2010 Percentile Threshold Threshold income levels Notes: (1) Unit of income is thousand won. Income groups Number of adults Average income levels Full Population 38,946,431 16,383 Top 10% 36,201 Top 10-5% 1,947,322 46,724 Top 5% 57,063 Top 5-1% 1,557,857 72,535 Top 1% 104,948 Top 1-0.5% 194, ,443 Top 0.5% 135,564 Top % 155, ,557 Top 0.1% 283,886 Top % 35, ,515 Top 0.01% 1,104,380 Top 0.01% 3,895 2,730,837 4 Annual average market exchange rate in 2010 (1,156 Korean won per one US dollar) was used for conversion. 3

4 (2) Top 10-5% is the top 10% excluding the top 5%. It is same for others. For our purpose, we basically use information on self-assessed income in the tabulation of composite income tax. Self-assessed income filed for composite income tax returns includes various types of personal income such as interest, dividends, rents, and pension as well as wage and business income. However, since the tabulation of income tax in the annual report changed along with tax reform, we cannot construct top income shares for some years. Figure 1 displays major changes in tax system since colonial period. For the period of , household s total income (the class III income following the terminology at that time, which is close to the current definition of composite income) was taxed if a household, the tax unit at that time, earns total income more than exemption point. For the period of , earnings from different sources were taxed separately because Korea did not adopt composite income tax system. Therefore, it is not possible to compute top income shares for this period since the tabulation in the annual report does not allow us to extract required information. <Figure 1> Evolution of Income Tax System in Korea present Composite income taxation Class Ⅲ income tax ( ) Composite income (1976-present) Separate income taxation Class Ⅱ income tax(interest) Interest Dividends Business income and rents Wage income ( , , 1995-present) (Financial income included in composite income) Others Tax unit Household Individual Source: Income Tax Law of Korea obtained from the website of the Ministry of Government Legislation( Notes: (1) Periods specified in the parentheses are those during which the tax statistics are available. (2) Income tax statistics used in this paper are shaded. The composite income tax system was introduced in However, due to extensive withholding system, there are years when financial income is not counted in self-assessed income for composite income tax returns. For the period of , interest and dividends were withheld at source and excluded from composite income tax returns. Since 1996, these financial income items were included if the total amount of financial income exceeds a certain level(currently 40 million won per person). 5 Due to data limitations, we cannot adjust for this inconsistency in counting financial income among periods. Similarly, for the period of , part of interest income was excluded. Interest income from some bonds specified by law (so called the class Ⅱ income) was withheld at source. Next, a fraction of top income groups could be exempted from filing composite income tax returns. Although the composite income tax system was introduced in 1975, individuals only with wage or pension income are not required to file composite income tax returns if their earnings from financial assets including interest and dividends do not exceed a certain amount, currently 40 million won. Thus, income accruing to this group of top income earners is not counted in the tables of composite income tax returns. So, we combine the tabulations of composite income tax and wage income tax to make up for these missing top wage earners. We then remove double-counted income of overlapping taxpayers, wage earners having multiple income sources, who are included in both tabulations of the composite income tax and wage income tax. However, we cannot make this adjustment from 1975 to 1994 since the annual report does not provide the statistics of wage income tax withheld at source by 5 This practice was suspended during due to economic crisis. 4

5 income brackets. Thus, we cannot construct top income shares combining the two income tax statistics during this period. Although we filled some missing years from 1979 to 1985 using internal source of the National Tax Administration, top income shares could not be estimated for remaining years. 6 In addition, one may concern about the possibility of tax evasion. Tax evasion will not be significant for the types of income, tax for which is withheld at source but may be so in case of business income which is self-assessed by taxpayers for tax returns. 7 We don t have reliable information on tax evasion and thus cannot make any adjustment for this. Finally, for the period of , the unit of income tax was family. For this period, tax was imposed on the aggregate income earned by all family members in the household and was allotted to individual family members in proportion to their income levels. The annual report for this period provides two different kinds of tabulation on income tax statistics, one in terms of the number of tax units by (household) income brackets and the other in terms of the number of individuals by tax-paid brackets. The tabulation of individuals by tax-paid brackets can be converted to that of individuals by income brackets. Here, we use this converted tabulation of individuals by income brackets for this period, which is consistent with what we use for estimation in later periods. 2. Construction of Top Wage Shares We use the same methodology to compute top wage shares. We use published tables classifying tax returns by size of salaries and wages from the annual report. Top wage shares can be constructed longer than top income shares since wage income tax statistics by income brackets go back to the 1950s. The share of top wage income is computed by dividing wage income accruing to top wage groups by total wage income. Here, top wage groups are defined relative to the total number of employment. Therefore, our definition of wage earners is consistent with the definition of employment in official statistics which includes both regular and temporary workers including daily workers. It is obtained from the Annual Survey on Economically Active Population (ASEAP). Because the tables in the annual report exclude a large proportion of low wage earners under the exemption point, we cannot use the total sum of wage income in the annual report except for recent years when the relevant information is provided. Therefore, again we use the wage and salaries in National Accounts to compute the control total for wage income. It allows us to compute top wage income shares back to 1963, the earliest year for which total employment is available in the ASEAP. Thus, wage income in our definition includes wages, salaries, bonuses, allowances and taxable part of non-cash compensation, but excludes retirement benefits. However, wage and salaries in National Accounts include pay to the workers who are not officially classified as employed in the ASEAP. Therefore, we have to remove wage income of this group from total wage income in National Accounts to be consistent with our definition of wage earners. The annual report in 2009 provides the number of workers by detailed types such as wage earners, both taxed and exempted, and daily workers whose income is withheld at source. When we aggregate all these types of workers reported in the annual report, we find the aggregate exceeds the number of 6 Since 2009, the annual report provides income tax withheld at source by income brackets for all the items such as pension, wages for daily workers, and part of business income which is exempted from filing composite income tax returns. It allows us to estimate top income shares including other income items in addition to wage income. However, we found it does not make any significant difference. It is due to the fact that the income levels of most individuals with income tax withheld at source for these items are not so high to be included in top income groups. Thus, our estimate combining composite income tax statistics and wage income tax statistics seems to cover almost all the individuals with high taxable incomes to be included in top income groups since most top income earners file either composite income tax or wage income tax returns. 7 When we compare National Accounts and the annual report, we found that about 26% of business income seems to evade tax. Other types of income such as interest, dividends, and wage, for which tax are usually withheld at source seem well detected by income tax statistics. See Kim and Kim(2013). 5

6 total employment in the ASEAP. It indicates there are a considerable wage income earners not defined as employed in the ASEAP, our control total for workers. Therefore, we make the number of workers in the annual report identical with that in the ASEAP by deducting daily workers from the lowest wage level who tend to be not classified as employed by the ASEAP. Then, we subtract wage income of these deducted daily workers from total wage income in National Accounts and obtain our control total for wage income. We find total wage income in National Accounts is greater than our control total for wage income by 6.7% in However, since the annual report does not provide detailed statistics for other years, we cannot do this exercise for control total for wage income. Therefore, we deflate wage and salaries in the National Account each year by the same rate of 6.7% computed for III. Top Income Shares in Korea, , Historical Background Figure 2 displays the evolution of per capita GDP of Korea last 100 years. First, during the pre- World War II(WWII) period when Korea was under colonial rule, per capita GDP of Korea grew modestly as fast as those of Japan or the U.S. and stayed about 20 percent of the U.S. level. Second, the average income declined sharply due to the disruption from WWII, the division of country in 1945, and the Korean War in The average income of Korea in the 1950s plummeted to the level less than 10 percent of the U.S. level. Third, in the mid-1960s, the Korean economy began to grow rapidly and now Korea s average income approaches to about 70 percent of the U.S. level. During this period, Korea achieved rapid industrialization in a more compressed way than Japan which also caught up with the U.S. in a short time span relative to other developed countries. 100,000 <Figure 2> GDP per capita in United States, Japan, and South Korea ,000 1, USA Japan South Korea Korea/USA Source: Korea s GDP per capita from Kim ed.(2012) and those of other countries from Maddison( Note: GDP per capita in 1990 international Geary-Khamis dollars(log scale in the left axis) and the ratio of GDP per capita of Korea with respect to the U.S. (percentage in the right axis) Figure 3 shows long-run trends of the growth rates of population and total GDP and the level of consumer price index(cpi) in Korea. Due to political tumult after liberation and the collapse of economy during the War, Korea experienced hyperinflation as shown by a sharp rise of the CPI during this period. It made a big impact on the distribution of income. Before the Korean War, South Korea witnessed a big surge in population as Koreans who went abroad during colonial period returned 6

7 home and refugees escaped to the south from communist regime. Population decreased sharply as many people died during the Korean War. After the War, Korea experienced a baby boom which increased population growth rate temporarily. These factors may explain slow recovery of average income in Korea after liberalization. Figure 3 also presents the trend of GDP growth rate over time. Under Japanese colonial rule, Korea experienced a modest growth with relatively high fluctuation. The fluctuation was mainly caused by changing crop situation since agriculture was the major industry in Korea at that time. In the post- WWII period after recovery from politico-social chaos, Korea sustained a long span of high growth. Korea experienced negative growth just for two years in 1980 and 1998 during this long span of economic growth. After 30 years of high growth, the GDP growth subsided gradually as economic development of Korea enters a mature stage. Last 10 years, Korea grew less than 5 percent per annum which is relatively low compared to high growth rates in previous 30 years <Figure 3> Population and GDP Growth and Consumer Price Index in Korea GDP population CPI Sources: Korea Statistical Office(KOSIS); Kim ed.(2012); Park and Kim(2011). Notes: 1) The growth rates of population and GDP are 3-year moving averages of annual growth rates. 2) The growth rates of population and GDP are in percentage in the left axis and the consumer price index (2010=100) is in the right axis. 2. Trends in Top Income Shares Figure 4 displays three series of the top 1% income share; series 1 constructed from the composite income tax statistics, series 2 from wage income tax statistics 8, and finally, series 3 constructed after combining the composite income tax and wage income tax statistics 9. The series 3 is most comprehensive in coverage among three series and could be considered as our final estimate of top income shares. The difference between series 3, combining two income tax statistics and series 1 based on composite income tax statistics is exactly income share of the top 1% income group, with wage income only, who do not file composite income tax returns. 10 We cannot directly compare the 8 The trend of wage income concentration will be discussed in detail in the next section. 9 For the pre-wwⅡ period this procedure is not needed, since the composite income tax covers all the wage income above exemption point. 10 If we construct income shares of smaller fractiles such as the top 0.1% or 0.01% within the top 1%, the difference between the two estimates of top income shares decreases and become insignificant. The reason is there are few who do not file composite income tax returns among the upper income earners within the top 1%. 7

8 levels of top wage income shares (series 2) and other two top income shares (series 1 and 3) due to different definitions of control total. Though, the trends of top income shares series do not look much different from that of top wage shares series during the periods when both series are constructed. 11 Therefore, we may conclude that income concentration in Korea, very high during the pre-wwii period, dropped sharply after WWII, stayed stable at low level during the period of high growth, and increased noticeably after the mid-1990s <Figure 4> Top 1% income shares in Korea, Series 3 Series 1 Series Source: Appendix. Note: Top income shares series denoted as series 1 is constructed using composite income tax statistics. Series 2 is constructed using the wage income tax statistics. Series 3 is estimated by combining tax statistics of composite income tax and wage income tax. Figure 5 plots income shares of the top 1% and the next 4% (top 5-1%) based on the combined income tax statistics. The sharp drop of the top 1% income share after WWII is contrasted with the relative stability of the top 5-1% income share which shows no significant change after the War. It suggests that the sharp decline of income concentration during this period could be attributable to the top tail of income distribution within the top 1 %. Figure 6 investigates this point further by decomposing the top percentile into three subgroups. It shows income shares of the top 0.1%, the next 0.4% (top %), and the bottom half of the top 1% (top 1-0.5%). As the income share of the top 1% fell after WWII, all three subgroups exhibit similarly falling income shares but they are distinguished from one another in terms of magnitude. The higher income fractile within the top 1% experienced the larger fall of income share after WWII. In the pre- WWII period, the top 0.1% took a larger share of income than lower income fractiles even though it included 4 or 5 times less population. After WWII, the income share of the top 0.1% fell drastically from 7% to 2% and became lowest among the three subgroups. With the rising top 1% income share since the mid-1990s, a similar pattern is observed in the opposition direction among the subgroups. All three subgroups have been rising in income shares since the mid-1990s but the higher income fractiles exhibited the more rapid rise. The top 0.1% 11 Wage income accounts for more than half of total income. 12 One should note that both estimates of top income shares (series 1 and 3) were not adjusted for the inconsistent coverage of financial income over time. As already told, financial income over a certain amount began to be taxed as composite income in 1996 but this practice was suspended for 3 years ( ) after economic crisis. Therefore, our estimates of top income shares before 1995 and during could be underestimated because financial income was not counted for these periods. This factor partly explains a big drop of top income shares in

9 income share which stayed lowest in 1995 rose to the highest level among the subgroups in It indicates that deepening income concentration since the mid-1990s accompanied the sharper rise of income of the upper income tails in the top percentile. 25 <Figure 5> Top 1% and Next 4% Income Shares in Korea, top 1% top 5-1% 5 0 Source: Appendix. Note: Top 5-1% denotes the income share of the top 5% excluding the top 1 %. <Figure 6> Decomposition of Top 1% Income Shares in Korea, Source: Appendix. Note: Top % denotes the income share of the top 0.5% excluding the top 0.1 %. Top 1-0.5% denotes the income share of the top 1% excluding the top 0.5 %. Figure 7 displays top 1% income share series in Korea with those in other countries to provide a comparative perspective. Korea is not so much different from other countries in overall pattern of trend by showing a U-shaped pattern of income concentration. The top 1% income share in Korea was as high as those in other countries in the pre-wwii period. Notwithstanding missing years, we may guess that Korea s top income share fell sharply as those of other countries after WWII. The top income share in Korea remained low until the mid-1990s, while the U.S and the U.K exhibited a rising top income shares starting from the 1980s. 13 In the mid-1990s 13 Our guess is based on figure 4 which shows a complementary series based on wage income tax statistics which goes back to

10 when the top income share in Korea began to rise, the level of top income shares in Korea was similar to those in Japan and France which show a different pattern from the U.S. and the U.K. However, income concentration in Korea since the mid-1990s has ascended much faster than in Japan and France. In terms of slope, rising trend in Korea is similar to those in the U.S and the U.K. As a result, the top income share in Korea in 2010 was located in between two groups of countries which show diverging patterns in income concentration. 25 <Figure 7> Top 1% Income Shares in Korea and Selected Countries US UK Korea Japan France Source: Appendix 1; The World Top Income Database To better understand the mechanism that led the shift of trend in income concentration in Korea, we compute the top income composition for selected years. For in pre-wwii period, the annual report allows us to compute income composition of total taxpayers in the tabulation of class III income tax. Thus, the number of total taxpayers in the annual report accounts for a varying fraction of the top income group from the top 1.4% in 1933 to the top 4.8% in Therefore, in this period, we cannot construct the income composition for specified top income groups such as the top 1%. In post- WWII period, the annual report does not allow us to construct the top income composition before Figure 8 presents income composition of total taxpayers who filed composite income tax return in It also exhibits the income composition by income groups in Before the WWII, three major components of income were business income, wage income and rents, the sum of which accounts for more than 95% of total income during that time. The share of rents declined throughout while the shares of other two types of income rose. Rents at that time mostly consisted of farm rents paid to landlords. Even if we take into consideration that some part of interest income classified as class II income tax was not counted, the share of financial income was insignificant compared with other three types of income. Top income composition in 2010 shows that the upper income fraction tends to have the lower share of wage income. It is noteworthy the share of dividends increases faster for the upper income fractile in the top income group. It contrasts with the share of interest income which stays constant regardless of income level

11 <Figure 8> Top Income Composition, and 2010 in Korea Source: Authors calculation. Notes: 1) The business income in 2010 includes rents. 2) The income composition for is computed for total taxpayers in the tabulation of class III income tax who account for the top 1.4% in 1933 to the top 4.8% in Comparing income compositions of top income groups in 2010 and the pre-wwii period, we find the share of farm rents which was large in the pre-wwii period became nil in 2010 and those of wage income and financial income went up instead. According to the findings from top income compositions in U.S. and Japan, financial income, particularly dividends which took a large share of top incomes, fell sharply due to the negative effect of the Great Depression and WWII. It is different from the case of Korea where farm rents accounted for most capital income and dividends were insignificant. It reflects the backwardness of Korea in industrial development compared with other industrialized countries. 3. Understanding the Evolution of Income Concentration in Korea We have found in the previous section that (i) income concentration in Korea was as high as those in other countries in the pre-wwii period during ; (ii) it fell sharply after WWII and remained low during rapid industrialization until the mid-1990s; (iii) income concentration has increased last 15 years; (iv) as a result, in terms of top income shares, Korea is now higher than Japan and France although it is lower than the U.K and the U.S. In this section, we explore some plausible explanations for the evolution of income concentration in Korea. First, how can we explain a sharp fall of income concentration after WWII? High income concentration in the pre-wwii period reflects the characteristics of the Korean economy in colonial period. The Japanese colonizers in Korea played a dominant role with their comparative advantage in capital and technology. For instance, the Japanese in Korea contributed about 90% of starting capital to corporations in Korea and thus most executive officers in large corporations were Japanese. The Japanese in Korea that accounted for 2.9% of population in Korea (in 1940) also owned a sizeable area of land as large as 9.5% of cultivated land in Korea (in 1942). It implies that many Japanese landlords in Korea were big landowners. Although we cannot provide statistical evidence from income tax statistics that does not distinguish ethnicity of taxpayers, it is no doubt that the Japanese accounted for a large share of top income groups at that time. After liberation, these Japanese colonizers withdrew from Korea and left their assets which were vested in the U.S. Military Government in , transferred to the Korean government, and finally distributed to the private sector during the 1950s. The withdrawal of Japanese entrepreneurs as well as the severing of the Korean economy from the Japanese economic bloc made a disruptive impact on the Korean economy. In addition, the division of country into two nations and ensuing 11

12 political chaos brought economic disorganization in South Korea. Vested properties of Japanese were managed by officially designated managers until they were transferred to the Korean entrepreneurs depreciated in both nominal and real value. Therefore, it is not plausible the Koreans who would replace the Japanese in top income groups after liberalization earned as much as the Japanese. Income inequality among Koreans at that time may be attributable to inequality in landownership. During colonial period, the landownership was concentrated in the hands of a small number of landlords and most farmers were small sharecropping tenants in Korea. 14 This landownership was deconcentrated by land reform. According to the Land Reform Act in 1949, the holdings of Korean landlords owning more than 3 chongbo (7.5 acres) were not allowed and the excessive holdings were redistributed to tenants. Although the landlords received securities for the land transfer, the real value of securities sharply dwindled with high inflation. As a result, the landlords who accounted for a large proportion of the top income group lost their important income source after the land reform. Deconcentration took place in the late 1940s even before the land reform because landlords expected the land reform and sold out their land widely. In sum, the land reform in addition to the withdrawal of Japanese and the collapse of economy immediately after liberalization had a large effect in reducing income concentration after liberalization. Income concentration in Korea is thought to stay low throughout the 1950s during which Korea experienced the War and recovered with help of the U.S. aid. After sharp decline after liberalization, it stayed relatively low throughout 30 years of rapid growth until the mid-1990s. Since then, it shows an ascending trend with a steep slope compared with countries such as Japan. It is against Kuznets inverse-u shape hypothesis that income inequality tends to deteriorate first and improve later along the development process. How can we explain this? First of all, the reversal of Kuznets curve in Korea seems related with structural change in the Korean economy. During the period when income concentration stayed low, rapid economic growth accompanying drastic expansion of modern industries decreased the labor surplus of the economy rapidly. With active job creation in modern industries, benefits of growth spilled over to every corner of the economy including the bottom income groups. Figure 9 presents annual growth rates of working age population, non-agricultural employment, and population of farm households in Korea. During the period of high growth, non-agricultural sector expanded employment at the rates as high as 4-8% per annum as Korea pursued industrialization by promoting labor-intensive export industries. It induced the labor movement from agriculture to other industries such as manufacturing. The decrease of farm household population by 4-5% per annum led to the end of labor surplus and the ensuing wage increase in the rural areas. It pushed the mechanization of farming in Korea and increased labor productivity in agriculture and farm household income. During the initial period of industrialization, the impact of expanding non-agricultural sectors is too small to have a considerable effect on farm household income. This is the reason why we often observe a polarizing pattern of income growth between traditional sector and modern sector during industrialization. Farm household population continued to increase until the mid-1960s after initial spurt of economic growth because high population growth overwhelmed the labor drain from the rural areas. Until the mid-1970s, Korea s rural areas were overpopulated with surplus of farmers. Although the land reform abolished tenancy, overpopulation in the rural areas continued until high growth started to reduce the rural population as figure 9 shows. As rapid growth in Korea actively created jobs in non-agricultural sectors and induced labor movement out of agriculture, overall earnings of workers increased in all sectors of the economy. 15 In this respect, benefits of economic growth during this period trickled down to bottom income groups. Thus, Korea could maintain low income concentration even though it underwent a drastic structural change. 14 Land under tenant farming accounted for 57.9% of total cultivated land in 1940 (67.6% in case of paddy field) and tenant farmers accounted for 76.4% of farm households. 15 According to the figure 14 we will discuss later, the average wage income of all income groups including both the top and the bottom increased at the similar rates during the period of high growth in Korea. 12

13 <Figure 9> Growth Rates of Working Age Population and Non-agriculture Employment in Korea Non-agricultural employment Working age population Farm household population Notes: 1) The pre-wwii growth rates are for South Korea only. 2) The growth rates of non-agriculture employment and farm households are computed after obtaining the moving average over 5 years. Sources: Statistical Yearbook of the Government of Colonial Korea (Chōsen sōtokufu tōkei nenpō), Statistical Yearbook of Korea (Hankuk Tonggae Yeongam); Annual Report on Economically Active Population Survey(Kyungjae Hwaldong Ingu Yeonbo) However, job creation became stagnant after the mid-1990s as displayed in figure 9, which weakened the trickle-down effect we saw previously in the period of high growth. The growth rate of non-agricultural employment fell to around 2% in the 2000s. It corresponds with subsiding GDP growth rate as Korea enters a mature stage of development. In addition to the stagnant economic growth, the employment inducement effect of economic growth has been weakened since the 1990s as industrial structure in Korea shifted toward technology-intensive industries from labor-intensive ones. This trend accelerated as Korea deepened its economic relationship with China after Korea established diplomatic relations in In addition, Korean companies relocated labor-intensive industries and production process to the sites in low-wage countries, which further reduced demand for unskilled workers in Korea. It resulted in reduction of manufacturing employment since the job creation in high-technology industries cannot compensate for the job destruction in low-skill laborintensive industries. Korea s manufacturing sector which actively absorbed the labor during the period of rapid growth, now releases the labor. To summarize, as job creation effect of economic growth became weakened, polarizing demands for workers with different skill levels put an end to the trickledown effect of economic growth which had a favorable effect in income inequality until the mid- 1990s. This explanation based on the structural change in Korea may well account for deterioration of income inequality in Korea but may not fully explain increase of top incomes. Next, we will investigate tax system, particularly the change in tax rates which might have a direct effect in top income shares. According to figure 10, the highest statutory marginal tax rate(mtr) denoted as top MTR ascended fast during the 1960s and the 1970s and hit a peak of 70%. Then it steadily declined to the half of the peak level. 16 Korea was no exception to the neoliberalism trend of public policy many developed countries adopted in the early Among them, Anglo-Saxon countries such as the U.S and the U.K The MTRs in figure 10 are those for the wage income since we use tax rates for the wage income for years before After introduction of composite income tax system in 1975, income tax rates became identical among various types of income. 13

14 cut income tax rates drastically in the 1980s. Top MTR is just the highest rate of marginal tax corresponding to the top income range specified by tax law. With top MTR alone, we cannot evaluate true tax burden of top income groups until we take into consideration the number of taxpayers in the group, who should pay their tax at top MTR. For instance, even though top MTR is high, tax burden would not be high if few taxpayers earn income high enough to belong to the range affected by top MTR. Thus, we estimate MRT for the average taxpayer in top 0.1% wage income group to see true burden of tax for additional income. Figure 10 presents MTR for the average taxpayer in the top 0.1% wage income group (top 0.1% MTR in the figure) after taking into consideration the weight of taxpayers who pays at the top MRTs <Figure 10> Top 0.1% Wage Income Shares and Marginal Tax Rate in Korea Top MTR Top 0.1% MTR Top 0.1% Income Share Top 0.1% Wage Share Note: Top income shares (%) in the right scale, MTR (%) in the left scale As we can expect, the top 0.1% MTR is lower than top MTR since some individuals in the group do not pay tax at top MTR. It was high in the late 1970s at 54% when the top MTR was 70%. It continued to fall afterwards and went down to 35% in recent years. How could the declining MTR affect top income shares in Korea? In theory, the tax cut may have a supply side effect by incentivizing economic activities of top income groups. In addition, it may reduce tax evasion or increase reported income for tax returns by pass-through of income from other types of income (for instance, corporate income) to personal income(matthews, 2011). The CEOs may intensify their behaviors to seek rents as MTR goes down(piketty, Saez, and Stantcheva, 2011). In addition, the lowering MTR may increase the saving capacity of top income groups which helps wealth accumulation and thus ensuing income increase To compute MTR for the average taxpayer in the top 0.1% wage income, we followed the methodology of Moriguchi and Saez(2008: Appendix C.3). We decompose the top 0.1% into the top 0.01% and the top % and compute MTRs for the threshold income levels of two subgroups. To compute corresponding MTRs for the threshold income levels, we use income after deduction and tax schedule by income brackets after assuming the average household has 4 family members (household head with wage income only, nonworking spouse, two dependent children). Then, we estimate MTR for each subgroup by taking a simple average of MTRs of upper and lower threshold income levels. Then, we obtain the top 0.1% MTR by averaging two subgroups MTRs weighted by average income level of each group. 18 Although the top 0.1% wage income share rose in Korea, other types of income including capital income increased much faster than wage income for the group. Thus, the positive effect of tax cut on asset accumulation may have been substantial in Korea. It may not be true of the U.S. where wage income drove rising income concentration. 14

15 Although we cannot clearly distinguish which factor was important in Korea, the falling MTR seems to have helped income concentration to rise last 15 years. We can support this argument by comparing Korea with other countries in figure 11. First of all, a close relationship between declining MTRs and rising top income shares could be clearly observed in the cross-country comparison. Top income shares rose faster in the countries where MRTs dropped more. Korea belongs to the group which experienced fast rising top income shares and relatively large tax cut. <Figure 11> Changes in Top 1% Pre-tax Income Shares and Top Marginal Tax Rates Korea Source: Piketty, Saez and Stantcheva (2011) except for Korea based on authors calculation. Note: Changes in top income shares and top marginal tax rates are those in % point between and IV. Top Wage Income Shares in Korea, , This section explores the evolution of top wage income shares in Korea. Unfortunately income tax statistics in the pre-wwii period does not provide the tabulation of wage income tax by income brackets and thus we confine our analysis to the period after WWII. The share of the top 1% group in wage income was already displayed in figure 4. Its overall pattern is not so much different from that of top income shares. Top 1% wage income share series stayed low until 1997 but showed a rapidly rising trend afterwards. Wage income concentration in Korea has been lower than that of total income throughout the period. 19 It implies that non-wage income has been the more important factor for income inequality than wage income. Figure 12 decomposes the top percentile into three subgroups: the top 0.1%, top %, and top 1-0.5%. Although the top 0.1% wage income share has been lower than shares of other subgroups, it has reduced the gap with other subgroups since It implies that wage income of the top 1% increased faster than those of other subgroups. It is noteworthy that, in figure 6 which displayed the top income shares series, the top 0.1% share surpassed those of other subgroups. In addition, the gap. 19 One should note that top wage income shares and top income shares are different in terms of their control total. The former is relative to total employment and the latter is relative to total adult population. Therefore, top wage income shares tend to be lower than top income shares since the latter counts economically inactive population in the denominator. 15