Local allocation tax rises just W2.3tr despite W169tr surge in national tax revenue

Despite a semiconductor-driven boom set to push next year's national tax revenue up by about 169 trillion won ($123 billion), the ordinary local allocation tax — the discretionary fiscal transfer that local governments can spend as they see fit — is projected to grow by only 2.3 trillion won.

The government plans to channel the windfall into a new Future Response Fund and exclude those contributions from the tax base used to calculate local allocation tax. Even as national revenues surge, local governments stand to gain little additional fiscal room, and concerns are growing that funds local authorities previously controlled could effectively be redirected into centrally administered programs.

According to estimates released Wednesday by the Narasallim Research Institute, if the relevant legislation is amended as the government proposes, next year's ordinary local allocation tax would reach 68.5 trillion won — up 2.3 trillion won, or 3.4 percent, from the 66.2 trillion won in this year's supplementary budget. That increase stands in stark contrast to the projected 40.7 percent jump in national tax revenue, from 415.4 trillion won to 584.4 trillion won, a gain of about 169 trillion won.

The mechanism limiting how much of that windfall flows to local governments is the Future Response Fund. The government plans to deposit into the fund any tax revenue exceeding the average domestic tax growth trend of the past decade, and has budgeted 162.3 trillion won in fund receipts for next year. The 19.24 percent linkage rate between local allocation tax and domestic taxes remains unchanged, but contributions transferred into the fund are excluded from the domestic tax base used in the calculation — effectively shrinking the revenue pool on which the local share is computed while leaving the allocation ratio itself intact.

If the current formula were applied without any fund transfer, next year's ordinary local allocation tax would be estimated at 98.1 trillion won — a 31.9 trillion won, or 48.1 percent, increase over this year's supplementary budget figure. Once the fund transfer is factored in, that increase shrinks to 2.3 trillion won, a difference of 29.6 trillion won. The comparison is not against this year's actual allocation but against the amount local governments would have been projected to receive without the fund transfer.

The shift in how fiscal resources are distributed also affects local governments' policy autonomy. Ordinary local allocation tax is a general-purpose transfer designed to fill regional fiscal gaps, with local governments free to direct the funds according to local needs. A smaller increase in that transfer means less room for local authorities to expand existing programs or launch new policy initiatives on their own.

The government plans to set aside 15.3 trillion won in a local account within the Future Response Fund, using it to finance programs including 3.5 trillion won in local future growth support grants and 1.5 trillion won for multipurpose community service centers. However, the local account amounts to only about half of the government's own estimate of a 30.5 trillion won total reduction in local allocation tax — of which 29.6 trillion won is attributed to the drop in ordinary local allocation tax alone.

The nature of the support also differs. Ordinary local allocation tax lets local governments allocate spending according to local circumstances, whereas Future Response Fund programs are designed, targeted and administered by the central government. Even if funds are eventually channeled back to local areas, requiring them to pass through central government project selection and review makes it difficult to expect the same effect as a direct, unrestricted supplement to local fiscal resources.

The financial impact is largest in regions that currently receive the most ordinary local allocation tax due to significant fiscal shortfalls. Applying this year's inter-regional distribution structure, North Gyeongsang Province is estimated to receive 4.7 trillion won less than it would without the fund transfer, and South Jeolla Province 3.8 trillion won less. South Gyeongsang Province faces a gap of 3.4 trillion won, Gangwon Province 3.1 trillion won, North Jeolla Province 2.7 trillion won and South Chungcheong Province 2.6 trillion won.

These figures combine the ordinary local allocation tax for each metropolitan government and the basic local governments under its jurisdiction. The estimated reduction rate is uniform across regions at about 30.2 percent, but the absolute shortfall varies with the size of each region's existing allocation. The estimates are comparative projections based on this year's fiscal shortfall figures and distribution ratios, and do not predict actual allocations for next year, which will depend on fiscal demand, revenue and settlement outcomes.

The government's rationale for creating the fund is to accumulate revenue during temporary tax booms — such as those driven by the semiconductor cycle — in order to reduce fiscal volatility and fund long-term investment. A sharp spending increase during a revenue surge could force equally sharp cutbacks when revenues fall. The Narasallim Research Institute noted that local governments face the same volatility risk and need mechanisms to manage it.

The central question is how much local fiscal resources and decision-making authority are preserved in the process of managing revenue swings. Among the alternatives proposed are depositing a portion of the increase in local allocation tax into local governments' consolidated fiscal stabilization funds for use during revenue downturns, or pooling local funds in a jointly managed investment vehicle. Transferring centrally run programs with strong local characteristics — along with the accompanying funding — to local governments is also cited as a way to expand both local authority and accountability simultaneously.

Lee Sang-min, a senior research fellow at the Narasallim Research Institute, said transferring general-purpose local government revenue into a central government fund is difficult to characterize as progress in fiscal decentralization. He added that the government should disclose the fiscal impact on individual local authorities and hold sufficient consultations with local governments before changing the system.