Taxation in Menghe
Taxes provide the main source of revenue in the Socialist Republic of Menghe, and are administered and collected by the Ministry of Finance and Taxation. Since 1995, the majority of all tax revenue has accrued to the Central Government, with lower-level governments dependent on transfers, fees, and land sales in order to meet their funding needs.
Menghe's current tax system is the product of many seismic changes in the country's economy, which transitioned from a planned economy in the 1980s to a Socialist market economy in the 2000s. In its current form, the tax system is highly progressive, with steep income taxes, capital gains taxes, and inheritance taxes in the highest brackets. The punishing luxury tax, a product of the 1990s, remains in place, although in recent years it has been rolled back.
In 2017, total tax revenue amounted to ₩55,714 trillion ($2,476 trillion), or 38.6% of GDP. Military spending has been the largest driver of tax increases, followed by the expansion of social welfare programs.
List of taxes by type
National taxes
Tax revenue for the national government is managed by the Central Revenue Department, a subordinate body of the Ministry of Finance and Taxation. It is divided into two streams: Border taxes, and Inland taxes. The former consist mainly of customs duties, while the latter encompasses the following items:
- Income Tax
- Capital Gains Tax
- Estate Tax
- Value-Added Tax
- Alcohol and Tobacco Tax
- Luxury Tax
- Securities and Futures Transaction Tax
Local taxes
- Vehicle Licensing Tax
- Stamp Tax
- Land Use Fee
- Property Tax
History
When the Socialist Republic of Menghe was established as a new regime in 1988, it inherited the revenue system of the Democratic People's Republic of Menghe, which had abolished most taxes in the 1970s and 1980s. Instead, the DPRM relied mainly on revenue from State-owned enterprises, which were owned by national, provincial, prefectural, county, and village governments. This funds-pooling system was simplest to administer, but it created many problems with accountability; unprofitable enterprises could rely on a steady stream of transfers from their government units, and those which did turn a profit were not rewarded for doing so.
Under Choe Sŭng-min's slogan of "Meritocratic Socialism," funds-pooling SOEs were corporatized, allowing them to retain all additional profits after they remitted a certain amount to their parent agency in the state. A similar arrangement was put in place for farmers, in the form of a household responsibility system which allowed families to farm individual plots of land and turn over a set portion of the harvest to the town or village government. This system gave state enterprises and local governments new incentives to generate economic growth, and exempted traditional markets and semi-legal private entrepreneurs from tax burdens. Additional revenue came from a vast proliferation of fees and sales taxes, among them the infamous luxury tax created in 1993.
As the emerging private sector grew in size and local state-owned enterprises shrank, it soon became clear that the revenue-remittance system was not sustainable - especially after the 1999 Menghean financial crisis forced most local-level SOEs into bankruptcy. In 2001, as part of the sell-off package for unprofitable enterprises, the national government passed a new law converting the revenue-retention system into a value-added tax which was applied to both SOEs and private enterprises. The government also established an income tax, though it was estimated at the time that only 10% of the population had a tax rate above zero and the highest bracket stood at 15%.
From 2001 to 2014, the value-added tax made up between 40 and 50 percent of all tax revenue in Menghe. While relatively easy to assess and collect, it fell under steadily increasing criticism from reformists, who argued that it placed too small a burden on high earners and too large a burden on businesses, slowing economic activity and widening income inequality. Members of the upper and upper-middle classes opposed the change, however, because they would lose from an increase in income taxes.
Tax reform remained deadlocked until 2014, when the Innominadan Crisis and the escalated tension that followed created a spike in revenue demand for the national government. In the summer of 2015, the National Assembly successfully passed a comprehensive overhaul of the tax system, arguing that higher payments from the wealthy were necessary to support the continuing war effort and maintain national security. This reform raised taxes on individual incomes, capital gains, and inheritance, while reducing the value-added tax and implementing a progressive tax curve for businesses.
Administration
Taxation in Menghe is empowered by the National Law on State Revenue, passed in 1988 as an amendment to previous laws. Every major reform of the tax code was carried out alongside an amendment to the National Law on State Revenue.
At the central level, tax collection is the duty of the Central Revenue Department within the Ministry of Finance and Taxation. At lower administrative levels, it is overseen by a matching bureau or department, which has joint accountability to the Ministry of Finance and Taxation and to its respective administrative level.
Enforcement
Tax evasion is considered a serious offense in Menghe. The Central Revenue Department conducts annual taxpayer audits to identify potential cases of evasion or fraud. Once identified by the Central Revenue Department, tax-related crime falls under the jurisdiction of the National Armed Police within the Ministry of Internal Security, who are seen as less corrupt and less sensitive to local interests than regular municipal police.
Overseas taxation
In 2013, the National Social Consultative Conference floated a proposal that would allow the central government to collect taxes on revenue earned by Menghean citizens and businesses operating overseas. As with most NSCC proposals, the wording remained vague, and left open the questions of how to avoid double taxation and how to divide responsibility over overseas revenue. As of 2017, the National Assembly has not drawn up a formal law on overseas taxation, though it has organized feasibility studies on the best implementation of such a law.
Individual taxes
Income Tax
Under the revised scheme created in 2015, Menghe's income tax system has # brackets. The rates below are marginal; i.e., if someone reports an annual income of ₩150,000, they are taxed 0% on the first ₩100,000 and 5% on the next ₩50,000, for an effective tax rate of 2.14%. Individuals earning less than ₩100,000 per year are exempted from the income tax, a sizeable share of the population in rural areas.
Income taxes are based on all income earned while on Menghean territory, and apply to both permanent residents and non-residents. The tax year matches the calendar year, and income taxes must be paid on or before April 31st of the following year.
| Income bracket (Menghean Won) | Approximate value (OSD) | Marginal tax rate |
|---|---|---|
| ₩0-100,000 | $0-4,450 | 0% |
| ₩100,000-240,000 | $4,450-10,600 | 8% |
| ₩240,000-400,000 | $10,600-17,700 | 12% |
| ₩400,000-650,000 | $17,700-28,750 | 20% |
| ₩650,000-1,000,000 | $28,750-44,250 | 35% |
| ₩1,000,000-2,000,000 | $44,250-88,500 | 45% |
| ₩2,000,000-5,000,000 | $88,500-221,000 | 57% |
| ₩5,000,000+ | $221,000+ | 67.5% |
Capital gains tax
Until recently, Menghe's tax system did not distinguish between capital gains and other forms of income; money earned through the sale of capital was taxed at the regular income-tax rate. The 2015 tax reform implemented a flat 27% tax rate on capital gains, with a marginal 40% rate on any annual gains above ₩500,000. Losses on capital sales can be deducted from the capital gains tax for the following five years, subject to regulations intended to discourage deliberate loss-making as a form of tax evasion.
Day traders who rely on capital gains as their main source of income cannot register themselves as self-employed businesses for tax purpose, and are taxed at the capital gains rate, which is higher than the business tax.
Payroll tax
In addition to the national income tax, workers are also charged a payroll tax, which is applied to their State Pension Account. Formally, responsibility for the tax is split evenly between employers and employees, with each charged 5% of the worker's annual wage; e.g., if a worker earns ₩200,000 per year, the employer pays ₩210,000 including taxes, and the employee is taxed an additional ₩10,000 at the end of the year, on top of their regular income taxes. In practice, the employer typically withholds the individual contribution from an employee's paycheck and contributes it to their fund automatically.
There is no earnings cap on the payroll tax; rather, once the annual contribution to an individual's account reaches ₩40,000 (corresponding to an annual income of ₩400,000), additional revenue from the payroll tax is diverted to a "solidarity fund" to support low-income workers and workers who were nearing retirement by the time the new pension system came into effect. Up to this cap, however, an individual's pension is proportional to the income they earned over the course of their life.
Self-employed individuals, including farmers and rural petty merchants and shopkeepers, are exempted from the payroll tax. Instead, they are "encouraged" to set aside an appropriate amount of money each year in retirement savings.
Inheritance tax
Also added in 2015, the inheritance tax follows three brackets. It is levied on the value of the amount passed on to each recipient, and is paid by the recipient at the end of the tax year, making it a "true" inheritance tax rather than an estate tax. The tax is applied to gifts given during one's lifetime as well, to avoid the use of a pre-death loophole.
By default, charitable contributions are exempt from the gift and inheritance taxes, because the recipient is registered as a charitable organization.
| Size of inheritance or gift | Tax rate for children and parents | Tax rate for other recipients |
|---|---|---|
| under ₩1,000,000 | 0% | 0% |
| ₩1,000,000 to ₩10,000,000 | 9% | 14% |
| over ₩10,000,000 | 30% | 40% |
Commercial taxes
Business tax
All profit-seeking enterprises in Menghe are taxed at a flat 20% rate. The first ₩200,000 of revenue are not subject to the tax, a measure intended to exempt small street vendors and rural petty traders.
Value Added Tax
Since 2015, most goods and services in Menghe are subject to a flat 10% value-added tax. This includes both final sales to the consumer and supply-chain transfers between manufacturers. Basic necessities - food, school supplies, prescription medicine, and household utilities - are exempted. Other "socially positive items," including books, newspapers, and tickets to cultural events, are taxed at a reduced 5% rate.
By national law, enterprises are required to include the value-added tax (and all additional duties and luxury taxes) in the listed price advertised to the customer, regardless of whether they are a final retailer or an intermediary supplier. Failure to do so can be prosecuted as fraud.
Additional duties
On top of the basic value-added tax, certain goods are subject to additional duties, which serve as a form of sin tax:
| Item | Duty applied |
|---|---|
| Alcoholic beverages | 22% |
| Tobacco products | 50% |
| Hydrocarbon fuels (automobile) | ₩12.8 per litre |
| Hydrocarbon fuels (aviation) | ₩6.4 per litre |
| Airline tickets | 5% |
Luxury Tax
One particularly significant form of value-added tax in Menghe, counted separately from the others, is the luxury tax - or more appropriately, luxury taxes, as different items are taxed at different rates. It was established in 1993 as a punitive tax on "frivolous goods," as part of Choe Sŭng-min's promotion of austerity. Initially limited to a few high-price items, like designer jewelry and valuable art, it soon expanded to cover a wide range of consumer products, with the steepest increases happening amidst the galloping inflation of the late 1990s. In 1999, several items were taxed at over 100% of their nominal value.
Internationally, Menghe's luxury tax gained particular notoriety because it often treated imported and domestically-produced goods differently - Menghean automobiles, for instance, were exempted, while foreign automobiles were not. Officially, this was done because foreign-made brands conferred greater prestige, and were usually of higher quality, but foreign governments accused Menghe of creating hidden barriers to trade in order to benefit domestic producers. The rate of the tax on a given item could also change unpredictably from year to year, creating an unstable environment for foreign companies.
By the mid-2000s, concerns over evasion and burdensome market effects led the Central Revenue Department to gradually roll back the Luxury Tax, exempting goods which were increasingly common among middle-class citizens and lowering the rate on the remaining items. While tax reform in 2015 did not entirely eliminate the luxury tax, as some had hoped, it did consolidate the number of categories and require rates to remain more stable.
Local taxes
Since 1995, local governments - specifically, Metropolitan governments in urban areas, and County governments in rural areas - have been responsible for collecting the property, vehicle-licensing, and utility taxes in Menghe, as well as other special fees.
Property taxes
Formally, all land in Menghe is owned by the local state (i.e., either the city or county), but it can be leased to individuals for periods of 10, 20, or 40 years. In all cases, the local state collects an annual "land use fee" on the assessed market value of the land, which serves as a de-facto property tax on owned land. The size of the fee varies by jurisdiction.
A separate property tax is applied to the sum total of all assets owned by an individual, excluding plots of land but including residential houses or other improvements built on them. As with land use fees, the rate of taxation varies by jurisdiction and is highest in developed cities; Donggyŏng taxes property at a flat rate of 2.6%, the highest rate, and some cities have implemented progressive tax brackets for wealth. The property tax is the largest source of tax-based revenue available to local governments in Menghe.
Real estate transaction tax
In counties and cities where individuals are allowed to transfer land leases to one another, the local government collects a tax on the value of the transaction, usually 5-10%. In many counties, especially inland-rural ones, individual households cannot sell their real estate except by selling it back to the local government, which can then lease it to a new buyer - a process which yields enormous profit margins for the local government and serves as a form of indirect tax.
In 2015, the National Assembly passed a law authorizing certain cities and counties to collect an elevated tax on real-estate transactions, with the goal of cooling down the real-estate market and restricting speculation. In Donggyŏng, individuals and couples who already own one home and sell another are taxed 20% on the value of the transaction if they sell the second home within one year of buying it, and 10% if they have owned it for 1 to 2 years; similar laws were adopted in Sunju, Haeju, Anchŏn, and Insŏng, as well as a number of other jurisdictions.
Vehicle licensing taxes
Taxes on vehicles are assessed at the time of license registration. The rates are set by the central government and are uniform across the country, but revenue is collected by local governments.
In 2016, the central government authorized a modification of this tax, reducing the basic taxes on vehicle category and allowing them to vary based on a vehicle's emissions certification. In the same year, it also established a five-year window during which electric, Hydrogen-powered, and solar-powered vehicles are exempt from both vehicle taxes, with an option to renew the exemption before it expires in 2022.
| Vehicle class | Non-compliant | Tier 1 | Tier 2 | Tier 3 | Tier 4 | Tier 5 | Tier 6 |
|---|---|---|---|---|---|---|---|
| Mopeds and motorcycles | ₩255 | ₩134 | ₩102 | ₩64 | ₩51 | ₩42 | ₩27 |
| Passenger cars | ₩540 | ₩284 | ₩216 | ₩135 | ₩108 | ₩79 | ₩36 |
| Light commercial vehicles | ₩646 | ₩340 | ₩259 | ₩162 | ₩129 | ₩85 | ₩43 |
| Trucks (non-trailer) and buses | ₩1,940 | ₩863 | ₩658 | ₩411 | ₩329 | ₩250 | ₩137 |
| Freight trucks | ₩5,272 | ₩1,722 | ₩1,312 | ₩820 | ₩656 | ₩567 | ₩473 |
Agricultural tax
As part of the "household responsibility system" which replaced collective agriculture, farming households were expected to turn over a set quota of their harvest to the village government every year; this harvest was then purchased by the county government at a standardized price, with the town or village keeping the returns from the sale and the county selling the crops to private enterprises or directly to the public, in both cases at a profit. In some counties, farmers were able to pay the agricultural tax in cash, but this was not the norm.
Initially held at a manageable level, the agricultural tax skyrocketed alongside the overall rate of development, driven by a combination of higher yields per hectare and greater demand for revenue among local governments. The burden was especially heavy for impoverished farmers in the interior, who had reduced access to fertilizer and irrigation improvements and struggled to keep up with higher harvest requirements. Concerned that rural unrest would spill over into violence, in 2002 the National Assembly formally abolished the agricultural tax.
School fees
Beginning in the early 1990s, many public schools in Menghe charged fees for students' attendance, to partially offset local tax funding. After a 1997 law diverted all income, business, and value-added tax revenue to the central government, local public schools were forced to steadily increase the attendance fee, sometimes preventing the children of lower-income families from attending.
In 2004, the National Assembly formally abolished the collection of school fees, and established a grant system to supplement local education budgets with central tax revenue. This reform improved access to public education, but did little to reduce the inequality in school quality between cities and counties.
Alternative revenue sources
Although the highest-yielding taxes in Menghe are all directed toward the central government, local governments are still responsible for many expensive social services, including policing, medical care, and education, as well as their own economic development and infrastructure expansion funds. Every year, the central government allocates supplementary funds to the provinces, which can then distribute them among smaller administrative units; yet this is not always sufficient to meet budgetary needs, especially further down the administrative chain.
In order to make up the difference, many bureaucratic agencies within city and county governments vastly expanded their collection of fines and fees during the 1990s and 2000s. Some scholars have suggested that this form of financing stimulated Menghe's economic growth by giving local governments and bureaus an incentive to raise local GDP and bring in businesses, but others have argued that it hindered growth by creating hidden tax burdens for businesses, especially foreign-owned ones.
Many local governments also came to rely on land sales, confiscating land from farmers or village homes and reselling it to developers at an elevated price. While the central government passed a number of laws intended to reduce land appropriation and guarantee fair compensation, it has thus far refused to legalize formal private ownership of land.
Customs and duties
History
Under the DPR Menghe's planned economy, all international trade had to be conducted through state-owned importer-exporter corporations. As state-owned enterprises were not taxed, Menghe formally had no tariffs on any products, but importer-exporter corporations did set prices in accordance with state policy and remit profits back to the central government, a form of de-facto tariff on Menghe's limited trade.
In 1992, Menghe partially liberalized its trade policies, allowing all enterprises to exchange goods across borders (subject to regulation). To make up for the loss of revenue, the central government imposed a new schedule of customs on imported goods. Tariffs on most products were between 5 and 10 percent, but the government imposed higher tariffs on automobiles, electronics, consumer appliances, and other manufactured goods where the country was working to generate competitive domestic firms.
During the 2000s, however, Menghe campaigned to join the Septentrion Trade Organization, an effort which involved lowering tariff rates on a wide range of goods. The Ministry of National Economic Development used the tariff reduction period to apply pressure to fledgling domestic producers, demanding that they become competitive before the STO compliance deadline.
Current tariffs
Since entering the STO, Menghe has steadily reduced its tariffs below its required ceilings, in an effort to facilitate international trade. Current tariffs on non-agricultural products average 8.7%, but vary extensively over more than 8,000 categories, many of which are exempt from customs duties. Tariffs on agricultural and other food products can be considerably higher, and tariffs on alcohol products exceed 40%, a measure intended to prevent citizens from circumventing the domestic alcohol tax by crossing the border to Polvokia.
Menghe has also negotiated with certain neighboring countries for further bilateral tariff reductions, and has imposed additional non-tariff reductions on trade with other countries. Since 2011, there have been some efforts to create a free-trade zone encompassing Menghe, Dayashima, and possibly Polvokia and Dzhungestan, but so far a final compromise has proven impossible to achieve.