The purpose of this paper is to reexamine the necessity of levying value-added tax (VAT) on the financial services and to simulate its overall effect on the Korean economy. Indeed, we survey the arguments in the literature and the problems caused by levying VAT on the financial sector. In the empirical analysis, we employ a dynamic computable general equilibrium model to simulate possible effects on the economy.
 

Taking into account the tax burden of the economy, we simulate the effects for two scenarios. The first scenario is to levy VAT on the financial sector with keeping the other taxes unchanged and the second one is to levy VAT on the financial sector with adjusting the consumption tax such that there is no change in tax revenues due to the new taxation. That is, the second scenario is to implement the new taxation in a tax-neutral way.

In the former case, the negative effects on households and financial sector are dominated by the positive effects on non-financial firms and the government so that the taxation has a positive effect on GDP and employment. on the other hand, in the latter, households are ultimately positively affected and the financial sector significantly benefit from VAT taxation, while the overall positive effects on the economy are preserved. Hence, we conclude that the tax-neutral policy option is desirable if the new taxation is implemented.