KIPF
The contemporary needs of general and
earmarked grants in Korea:
Assessment
Hyun-A Kim
Korea Institute of Public Finance
2009 Copenhagen Seminar, Sept. 17-18
KIPF
Introduction
Political decentralization
• Fiscal decentralization began again in
1991 with the appointment of council
members, and established in1995 by the
election of local representatives in Korea
• Hypothetically, in an electoral process,
people articulate their demands by their
voting preference
• Local representatives has to obtain voters’
preference
• Some empirical results : the relationship
between election and fiscal expansion
2009 Copenhagen Seminar, Sept. 17-18
KIPF
Introduction
Fiscal decentralization…
• Given the political, global and fiscal trends
as well as other hosts of reason, local
government’s role has to be expanded
alongside the increase of its fiscal size.
• Intergovernmental fiscal transfers has
steadily grown
• However, fiscal power of local
governments has not symmetrically grown.
2009 Copenhagen Seminar, Sept. 17-18
KIPF
Increasing local expenditure by using grants
The budget size and expenditure
share of general government
Education
Local
Central
Total expenditure
120%
300
100%
250
80%
50.50%
48.40%
47.20%
46.10%
42.30%
40.30%
60%
200
150
40%
35.90%
37.70%
38.60%
40.50%
43.60%
45.10%
20%
100
50
13.60%
13.90%
14.20%
13.40%
14.10%
14.60%
2003
2004
2005
2006
2007
2008
0%
0
2009 Copenhagen Seminar, Sept. 17-18
Increasing local expenditure by using grants
Transfer to total government
expenditure in 2005
Source: OECD (2009)
2009 Copenhagen Seminar, Sept. 17-18
KIPF
Limited local tax share and taxing power
Limited local tax share and
low taxing power
• While the majority of expenditure are done at
the local level, only very limited autonomy is
available in local spending decisions.
• Local politicians tend to avoid increasing tax
rate
• Flexible tax rate is not activated…
• This tendency exacerbate soft budget
problem and lower taxing power.
2009 Copenhagen Seminar, Sept.17-18
KIPF
KIPF
Limited local tax share and taxing power
The steady share of local tax
20.2%
20.8%
20.5%
20.7%
20.5%
20.8 %
National
166
147
Rotio to the National
122
131
135
29
32
34
35
38
44
2003
2004
2005
2006
2007
2008
114
2009 Copenhagen Seminar, Sept.17-18
Local
Limited local tax share and taxing power
Revenue assignment
• Local revenue is composed of own source
revenue such as local tax(33%), non tax
revenue (29.7%), local bonds (2.7%)
• Intergovernmental fiscal transfer such as
revenue sharing (LST, 20.9%) and National
subsidy (13.8%) in 2007
• Without non-tax revenue, the share of
local taxes is around 50%. General and
earmarked grants are 29.5% and 19.6%
respectively
2009 Copenhagen Seminar, Sept.17-18
KIPF
An overview of intergovernmental fiscal transfer
KIPF
Revenue composition of local
governments
130
120
110
100
90
Own source revenue
Earmarked Grant
General Grant
Expenditure
80
70
60
50
40
30
20
10
0
1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007
2009 Copenhagen Seminar, Sept.17-18
KIPF
An overview of intergovernmental fiscal transfer
Types of grants in Korea
NonEarmarked
Mandatory
General grants (LST,
DRS 2010)
Mandatory
(SABND, LTF)
Matching
Grants
Earmarked
Nonmatching
Discretionar
y
(NTS)
Matching
Nonmatching
2009 Copenhagen Seminar, Sept.17-18
KIPF
Steady increase in local tax
Local taxes and grants share
100%
90%
80%
70%
60%
50%
40%
30%
20%
10%
0%
1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007
Earmarked
2009 Copenhagen Seminar, Sept.17-18
General
TAX
Intergovernmental fiscal transfers
Local Shared Tax
• Major fiscal equalization system by
revenue sharing  a fixed percentage
(19.24%) of Domestic National Tax
• The objective of ordinary LST is to equalize
the fiscal capacities of local governments
• Notably, dependence of LST to local
revenue has increased significantly from
15.0% in 2002 to 20.9% in 2007.
• 2.5% share of LST to GDP ( Japan 4%,
Northern European countries 2-4% share…)
2009 Copenhagen Seminar, Sept.17-18
KIPF
Intergovernmental fiscal transfers
Decentralization Revenue Sharing
• From the perspective of grant design, DRS is an
example of changing funding system
• Mainly, funding source of social welfare
programs has been changed from specific to
general grants (0.94% of National Domestic Tax)
• Central  local management and operation
• It is scheduled to return to LST in 2010
• It is easily expected that under-provision of
welfare spending since money is fungible under
the general grants
2009 Copenhagen Seminar, Sept.17-18
KIPF
Intergovernmental fiscal transfers
Decentralization Revenue Sharing
• DRS programs are from NTS projects such as
mainly social welfare related expenditure.
• The rationale of the implementation of DRS was
the devolution of welfare provision from central
and local governments
• Under the lower fiscal capacity and political
incentive, the reduction of social service
budget will happen
• Now, it is evaluated that DRS failed to be
operated in its real sense
2009 Copenhagen Seminar, Sept.17-18
KIPF
Intergovernmental fiscal transfers
Local transfer fund
• Local transfer fund was introduced in 1991
as a conditional block grant
• Contribution : around 70% of the LTF is to
be used for local road maintenance.
• Tax-sharing: the fund was transferred
directly to local govts without first being
accounted for in the central budget.
• Qualitatively, it was almost same with the
NTS
• This was abolished in 2005  LST
• Earmarked  General way
2009 Copenhagen Seminar, Sept.17-18
KIPF
Intergovernmental fiscal transfers
National treasury subsidy
• National treasury subsidies are categorical
grants provided by the central
government to local governments for
specific projects
• Social welfare and the increase of fiscal
needs after local autonomy are the
reasons of expanding NTS from 1995 to
2002  The reform of NTS in 2005
• Finally, reliance on earmarked grants has
been reduced from 22% in 2002 to 13.8% in
2007.
2009 Copenhagen Seminar, Sept.17-18
KIPF
Intergovernmental fiscal transfers
Special Account of Balanced
National Grants
• Implementation of new formula to
distribute for provincial bases : NTS 
earmarked block grant
• The discretionary power of the line
ministries had been reduced because
nearly half of the SABND grants are formula
based
• Fiscal flexibility in local government
• However, the three-year implementation
evaluation did not manifest local efforts to
promote high quality of public delivery
2009 Copenhagen Seminar, Sept.17-18
KIPF
Intergovernmental fiscal transfers
KIPF
Political needs : Tax-sharing or
general grants?
• With a long debate, new ‘tax-sharing’ way of
revenue increasing in local govt. are determined
by the Introduction of Local Consumption Tax and
Local Income Tax
• For example, 20% of VATLCT
• Arguments : urban concentration of tax bases,
qualitatively same with LST…..
• Despite of many problems, political meaning of
LOCAL TAXES dominate rather than GRANTS….
2009 Copenhagen Seminar, Sept.17-18
KIPF
System change of intergovernmental fiscal transfers
Reform of the specific grants:
Comparison of transfers
from 2005
Determination Method of
Financial Resource
Distribution Method
among Regions
LST, DRS
Constant Portion of
Domestic Tax Revenue
Formula Based
• 100% of Liquor tax
• Specific Transfer
• Other Fees
Formula Based
SABND
NTS
Determined Every Year
2009 Copenhagen Seminar, Sept.17-18
at discretion
KIPF
Intergovernmental fiscal grants
Contrasting figure after 2000
(among 16 regions)
General Grants
8%
Capital area
Earmarked Grants
Non capital area
8%
7%
7%
6%
6%
5%
5%
4%
4%
3%
3%
2%
2%
1%
1%
0%
0%
1997
2000
2009 Copenhagen Seminar, Sept.17-18
2005
Capital area
1997
Non capital area
2000
2005
Intergovernmental fiscal transfers
Recent change turns to the
way of general grants….
• NTS DRSLST , NTS SABND, LTFLST
• Tax sharing or general grants : The introduction of
Local Consumption Tax and Local Income Tax
• ‘Federalist approach’ : simple lump-sum transfers
with no conditionality would be desirable
• Korea is one the leading countries to expand
general grants for fiscal federalism
• Easy money dependency is getting bigger
2009 Copenhagen Seminar, Sept.17-18
KIPF
KIPF
Discussion
Would this trend be desirable in
Korea?
• This paper tends to focus more on the effectiveness
of earmarked grants in Korea as a developing
economy
• The reasons are following :
• 1) Korea is not a developed country, but in an
immature stage in local autonomy
• 2) Soft budget relations between donor and
recipient
3) Welfare expenditure needs rises
2009 Copenhagen Seminar, Sept.17-18
KIPF
An assessment
Soft-budget problem
• Intergovernmental risk sharing might be
fundamental issue
• Soft budget relations between donor and recipient
may exacerbate the effectiveness of grant
purpose regardless of the choice of grants
• To smooth soft budget problem, tight linkage
between marginal increase of revenue and their
works should be done
• Now, local governments are not main providers of
education, health, social services  to be the
ultimate fiscal charger, expenditure assignment
should be rearranged
2009 Copenhagen Seminar, Sept. 17-18
An assessment
KIPF
Fundamental incentive effect in LST
• “Tax effort problem” : Intrinsically, local gvts have
incentive to enlarge local needs while reduce
local revenue
• The process of calculating the incentive revenue is
not legally binding. The ambiguity leads local gvts.
to believe that efforts to boost their tax revenue
reduce the amount of the LST that they receive
• Accountability and responsibility of general grants?
2009 Copenhagen seminar, Sept. 17-18
KIPF
An assessment
Welfare expenditure rises…
• Fiscal needs  Social welfare
• Intergovernmental welfare arrangement in
function and money is the hottest issue
• Asymmetric information problem between central
(revenue source) and sub-central (local
information) governments is growing especially in
welfare service program
• Under-provision of public good such as politically
unattractive service (disabled supports, low
income people…..) would happen
2009 Copenhagen Seminar, Sept.17-18
KIPF
Enlargement of social service in local expenditure
Composition of local expenditure
between OECD and Korea
35%
Korea
OECD
30%
25%
20%
15%
10%
5%
0%
Public·admin
Econ·develop
2009 Copenhagen Seminar, Sept. 17-18
Housing
Health
Education
Social protect
KIPF
Enlargement of social service in local expenditure
Per capita social expenditure in Seoul
90
Public Admin
Social Expenditure
Economic Expenditure
75
60
45
30
15
0
1995
1996
1997
1998
1999
2009 Copenhagen Seminar, Sept.17-18
2000
2001
2002
2003
2004
2005
2006
2007
KIPF
Conclusion
Findings and policy suggestion
• Own purpose of grants is established from 2000,
especially in earmarked grants.
• Soft budget issue and the introduction of tax-
sharing with the same source of money seem to
impede the justification of the increase of general
grants.
• My conclusion : with these observations, the
function of earmarked grants in comparison with
general grants might be more suggestive in Korea.
2009 Copenhagen Seminar, Sept.17-18