South Korea’s declining birth rate is a major challenge. This article explores how tax policies may be a contributing factor. Find out how tax reform could incentivize families and boost fertility rates.
South Korea’s Birth Rate Crisis: How Taxes are Playing a Role
In 2024, South Korea is grappling with a severe demographic challenge: a plummeting birth rate. The country’s fertility rate hit a record low of 0.81 children per woman in 2021, a significant decline with far-reaching consequences for its workforce, social programs, and overall economic future. While various factors contribute to this trend (among them, including rising educational and career aspirations, increased women’s participation in the workforce, and the high costs of raising children) a lesser-known culprit is South Korea’s tax policy.
Taxes and the Fertility Rate: An Unexpected Link
Taxes are an essential component of any modern society, providing the necessary funding for crucial public services and social safety nets. However, taxes can also have unintended consequences on individual and household decisions, including the decision to have children.High tax burdens can create economic uncertainty for families, reducing disposable income and making raising a child seem financially daunting. Moreover, the structure and design of the tax system can also play a significant role. For example, tax policies that provide incentives or support for families with children, such as tax credits or child allowances, can encourage higher fertility rates. Conversely, tax policies that are perceived as unfavorable or burdensome for families may have the opposite effect.
The Case of South Korea: A Tax System Unfriendly to Families
South Korea’s story exemplifies the connection between South Korea’s tax policy and South Korea’s fertility rate, that is, it shows the relationship between taxes and fertility. The country’s fertility rate has been on a steady decline since mid-1970s, and while many factors have contributed to this trend, changes in the tax system appear to have played a significant role.In the mid-1970s, South Korea underwent a series of major tax reforms as part of its rapid industrialization and economic development efforts. These reforms included increases in personal income tax rates, the introduction of a value-added tax (VAT), and changes to tax incentives for businesses and individuals. This, combined with rising education costs and increased female workforce participation, created a perfect storm for South Korea’s plummeting birth rate.
Figure 1: South Korea’s Fertility Rate and Tax Burden, 1960-2022
As shown in Figure 1, the tax burden in South Korea, measured as the total tax revenue as a percentage of GDP, has steadily increased since the mid-1970s. During this same period, the country’s fertility rate has plummeted, dropping from around 4 children per woman in the early 1970s to just 0.81 children per woman in 2021. This inverse relationship between the rising tax burden and falling fertility rate is clearly visible when directly correlating the two variables over time.
Beyond Correlation: Evidence for Tax Policy’s Impact
While correlation does not necessarily imply causation, the timing of these changes suggests that the tax reforms of the 1970s may have played a role in South Korea’s fertility decline. Increased personal income taxes and the introduction of the VAT likely reduced the disposable income available to families, making it more challenging to afford the costs of raising children.
Moreover, the tax system during this period did not provide significant incentives or support for families with children, further exacerbating the financial burden of parenthood. This, combined with other socioeconomic factors, such as the rising costs of education and the increasing participation of women in the workforce, created a perfect storm that led to South Korea’s precipitous fertility decline.
In addition to examining the trends in Korea’s fertility rate and tax burden over time, we employed a counterfactual analysis using the synthetic control method. This approach allows us to construct a “synthetic Korea” that serves as a comparison group, reflecting what Korea’s fertility rate might have looked like in the absence of the major tax reforms of the 1970s. By comparing the actual fertility rate with the synthetic one, the analysis suggests that tax reforms likely contributed significantly to South Korea’s declining birth rate.
The synthetic Korea is derived by weighting a combination of other countries that did not undergo similar tax changes, creating a control group that closely matches Korea’s pre-reform fertility trends. By comparing the actual fertility rate in Korea to the synthetic control, we can better isolate the causal impact of the tax reforms on the country’s declining birth rates.
Figure 2: South Korea’s Counterfactual analysis
As shown in Figure 2, the divergence between the actual and synthetic fertility rates after the 1970s suggests that the tax changes during this period did indeed contribute to the substantial drop in Korea’s fertility over the following decades.
Tax Solutions for a Demographic Challenge
South Korea’s experience highlights the need for tax policies that consider demographic impact. Policymakers must recognize that changes to the tax system can have far-reaching consequences on the decisions and behaviors of individuals and households, including their decisions about whether to have children.
By understanding the potential linkages between taxes and fertility, policymakers can design more holistic and effective tax policies that support both economic growth and demographic sustainability. Here are some strategies policymakers can adopt to address the South Korean declining birth rate:
Planned and Transparent Tax Changes, i.e., Prioritizing Tax Calendars and Planned Changes: Providing clear, transparent, and predictable information on upcoming tax changes can help firms and households better plan and manage their finances, reducing economic uncertainty surrounding tax increases or other reforms. This can, in turn, mitigate the potential negative impacts on fertility decisions.
Tax Relief for Families: Tax credits, deductions, or child allowances can ease the financial burden of raising children. This can incentivize more couples to decide to have children, ultimately impacting the South Korea fertility rate.
Targeted Tax Incentives: Offering specific deductions for childcare expenses or increased tax-free thresholds for parents provides additional financial support.
A Fair and Equitable Tax System
A tax system perceived as fair encourages childbearing decisions.
Coordinating Tax Policies with Other Demographic Measures: Integrating tax breaks with family-friendly initiatives like quality childcare, flexible work arrangements, and parental leave creates a more comprehensive approach.
Conclusion: Balancing Economic and Demographic Considerations
The relationship between taxes and fertility is complex. Both direct and indirect effects that can have significant implications for a country’s economic and social well-being exist. The South Korean experience serves as a cautionary tale, highlighting how changes to the tax system can inadvertently contribute to declining birth rates and demographic challenges.
As policymakers grapple with the pressing issue of low fertility rates, they must consider the demographic impacts of their policy decisions, including those related to the tax system. By considering demographic concerns when crafting tax policies and implementing supportive family-friendly measures, policymakers can strive for a balance between economic growth and long-term demographic stability, ultimately addressing South Korea’s declining birth rate crisis.
Find our working paper athttps://irvapp.fbk.eu/publications/detail/fertility-decline-and-tax-revenues-in-south-korea/
Francesco Moscone, Brunel University London & Ca’ Foscari University, Venice
Asieh Hosseini Tabaghdehi, Brunel University London
Jong-Chol An, Ca’ Foscari University, Venice
Changkeun Lee, KDI School of Public Policy and Management