Despite the tight financial situation, the government considers extending tax cuts on oil products again

A gas station in Seoul on August 15. Yonhap News

The government is examining another extension of tax cuts on oil products, which ends at the end of this month, because of prospects that the recent surge in international oil prices could stimulate inflation. However, experts also point out that providing tax cuts on oil products, an emergency measure, for over a year could lead to side effects, such as a lack of tax revenues and a worsening current account balance.

According to the Ministry of Economy and Finance on August 15, the government is discussing the specific period and the rate of cuts based on the premise that tax cuts on oil products, such as gasoline, diesel, and liquefied petroleum gas (LPG), which are scheduled to last until the end of this month, will be extended. Officials mentioned extending the tax cuts for two more months to as much as four more months than originally planned and adjusting the rate of cuts for some products, such as diesel.

When international oil prices jumped after the war between Russia and Ukraine, the government decided to cut taxes on oil products, such as gasoline, diesel and LPG for up to 37%, the legal limit, beginning last July. Originally, the tax cuts were to be provided until the end of last year. But the government extended the tax cuts for four more months on two occasions claiming to minimize the burden on citizens. However, considering the price fluctuation of each oil product and the impact on tax revenues, the government reduced tax cuts on gasoline to 25% this year.

The government is probably considering another extension because international oil prices have climbed recently. According to Opinet, an oil price information system provided by the Korea National Oil Corporation, a barrel of Dubai crude oil cost $87.61 and a barrel of Brent crude cost $86.21 on Monday. The prices were higher than the prices on December 19, 2022 (Dubai $75.36 and Brent $79.80) when the government announced that it would adjust the tax cuts to the current level.

As international oil prices, which come under prime costs, rise, domestic consumer prices are showing signs of climbing. According to Opinet, in the second week of August, the average price of ordinary gasoline at gas stations in Korea was 1,695 won per liter, nearly 130 won more expensive than the price in the second week of last December (1,569 won /ℓ). The inflation recently slowed down to the low 2% level, thanks mostly to the fall in international oil prices in the first half of this year. So if oil prices rise, it is likely for consumer prices to rise as well.

As for the tax authorities who are facing an unprecedented shortage in tax revenues, extending the tax cuts on oil products any longer could be a burden. The government’s tax revenues in the first half of this year were 178.5 trillion won, 39.7 trillion won less than the same period last year. As the tax cuts lasted for a prolonged period of time, revenues from the traffic, energy and environment tax, a related tax item, dropped by 700 billion won in the same period.

Experts point out that if the government continues to apply emergency measures, such as the tax cuts on oil products, for an extended period of time, it could lead to other side effects in addition to reduced tax revenues. By artificially lowering the price of oil products, consumers will continue to use energy as before rather than reduce the amount of energy they use according to the higher price. This will lead to the result of importing oil at an expensive price, aggravating the international balance of payments.

Ha Joon-kyung, a professor of economics at Hanyang University explained, “Tax cuts on oil products are a measure to buy time for a while by easing the shock from an unexpected surge in oil prices,” and said, “While they provided tax cuts for a long period of time, they should have adjusted to the higher oil prices and provided measures to conserve energy and to support the people likely to suffer from higher prices.”