Disputes are heating up in South Korea over whether the Yoon Suk Yeol administration should go ahead with its controversial tax-reduction initiatives even though revenue is forecast to decline this year as a result of sluggish corporate earnings.

The country’s tax revenue stood at 151 trillion won ($108.6 billion) during the first five months of this year, down 9.1 trillion won, or 5.7 percent, from a year earlier, according to the Ministry of Economy and Finance.

The main culprit was a sharp decline in corporate taxes stemming from poor business performance. The government collected 28.3 trillion won in corporate taxes during the five-month period, down 35.1 percent from a year earlier. Companies listed on the main bourse Kospi suffered a 45 percent drop in operating profit on-year in 2023, while those listed on the tech-laden Kosdaq were hit by a 39.8 percent decrease over the same period.

Some categories, such as income tax and value-added tax, increased during the first five months on an on-year basis, but the broader trend is that the government seems unlikely to avoid incurring a deep shortfall in tax revenue at the end of the year.

The tax shortfall for this year is forecast to reach 10 trillion won, but it could go as high as 20 trillion won if conditions deteriorate further in the coming months.

This will mark the second straight year in which tax revenue remains in the red, coming at a tricky time when the government is taking steps to ease or scrap some taxes that will further widen shortfalls in tax revenue next year.

In 2023, the country’s total revenue fell 77 trillion won on-year to 497 trillion won, as a result of sluggish corporate performance and the slump in the real estate market. This year the property market shows sign of a recovery, but many companies continue to confront slow sales amid lackluster domestic demand, suggesting that the government will end up with less tax revenue.

There are two troubling issues over the tax shortfall. The first issue is that a bigger fiscal deficit makes it difficult for the government to finance its essential spending plans. The Yoon administration, which officially espouses “fiscal soundness,” cannot easily opt to issue debt or set up a supplementary budget to deal with the deficit.

The trouble is that the government is being increasingly cornered in its spending capacity, not least because it has already spent 65 percent of its budget in the first half of this year, on the assumption that the economy will recover at a stronger pace in the second half. But major think tanks as well as the Bank of Korea project that the economy may rebound at a slower pace than anticipated. All in all, the worsening situation is feared to push the government to take unconventional methods again. Last year, its use of the foreign exchange stabilization fund to make up for the gap in tax revenue sparked disputes.

The second issue involves the seemingly contradictory policy initiatives the Yoon administration plans to implement. The government, the presidential office and the ruling People Power Party are putting out new plans that require extra spending. At the same time, the government is set to introduce tax cuts, such as scrapping the plan to impose capital gains tax on all financial investment income and changing the tax code to cut inheritance and comprehensive real estate taxes.

Critics argue that the outdated tax systems should be revised, but the government should suspend proposed tax reduction plans until the economy fully recovers and tax revenue returns to a normal level. A supplementary budget is also considered an option to tackle the sluggish economy.

If the deepening tax shortfall remains unresolved, a much-dreaded situation could unfold in which the planned budget may not go to essential welfare and social infrastructure projects. The government must seek effective ways to prop up tax revenue -- all the better if it can do so without compromising its own pledge to achieve fiscal soundness.