South Korea’s ambitious tax reform, designed to tackle a fiscal shortfall and realign its revenue streams, has rattled both investors and foreign financial institutions. What was once a buoyant rally under President Lee Jae Myung’s pledge to lift the Kospi to 5,000 points is now shadowed by concerns over the economic implications of sweeping tax changes.

As Korea JoongAng Daily reports, optimism over Lee’s market-friendly agenda initially helped push the Kospi up more than 30% in 2024. But following the government’s tax announcement, the market shed 3.9% in a single session — the steepest drop since Lee took office in June. According to The Korea Herald, the total capitalisation loss reached KRW116 trillion, erasing recent gains and souring investor sentiment.

Foreign banks sound the alarm

Foreign investment banks have been quick to criticise the new tax blueprint. The Korea Economic Daily notes that CLSA, in a sharply worded report titled “Yikes, tax hikes,” warned that the government’s measures offered “only sticks, no carrots.” CLSA strategist Shim Jong-min argued that the announcement could prompt near-term market corrections, even if the proposal does not pass Parliament in its current form.

Citigroup also expressed concern, cutting South Korea to zero in its emerging market allocation. “Recent policy steps stand in contrast to the Value-Up agenda,” Citi stated, referring to the Lee administration’s flagship initiative to improve corporate governance and shareholder value. JPMorgan, in its latest Korea strategy report, stressed that without stronger reforms and improved earnings, the current rally would be hard to sustain.

Key tax measures and their impacts

The tax reform includes a series of changes that many see as anti-market. According to The Korea Economic Daily, the corporate tax ceiling will rise from 24% to 25%. The threshold for capital gains tax will be lowered from KRW5bn to KRW1bn, significantly increasing the number of retail investors subject to the levy.

Additionally, the securities transaction tax will increase by 5 basis points to 0.2%. A separate tax on dividend income from high-dividend companies will also be imposed, with rates ranging between 20 and 35%. These measures are expected to generate KRW8.2 trillion in revenue next year, according to The Korea Herald, which the government considers necessary after two years of falling tax income.

However, critics argue the move is both ill-timed and contradictory. The dividend tax scheme, in particular, has disappointed investors. Korea JoongAng Daily notes that while investors hoped for broad-based relief on dividend income, the criteria were too strict. Only firms that increased dividends or maintained a payout ratio above 40% will qualify. This covers just 13% of listed companies.

Contradictions with market-friendly pledges

What makes the reform especially controversial is how it contradicts the administration’s earlier promises. The “Korea Value-Up” programme, launched by the Financial Services Commission in early 2024, was intended to narrow the longstanding “Korea discount” — the undervaluation of Korean equities due to weak governance and low shareholder returns.

The Korea Herald underscores the irony: an administration that ran on a platform of market revitalisation is now accused of undermining that very narrative. The dual imposition of capital gains and transaction taxes is seen as excessive by international standards, particularly as most major markets opt for only one.

The Korea Economic Daily quotes CLSA’s Shim Jong-min saying the optics of the tax policy alone are enough to shake investor confidence. Sectors such as banking, which had rallied on the prospect of favourable dividend tax treatment, have already begun to retreat.

Political infighting adds to uncertainty

The domestic political response has further muddied the waters. Korea JoongAng Daily reports that a petition opposing the capital gains tax revision garnered over 135,000 signatures. Rep. Jung Chung-rae, the Democratic Party’s new leader, has called for alternative proposals to soften the capital gains threshold, although the presidential office denies any request to revise the policy. Mixed messaging has only heightened investor unease.

Even within the ruling party, there are divisions. At least 13 lawmakers have raised objections, while others remain silent or ambiguous. In a market where foreign investors account for nearly one-third of trading volume, such policy inconsistency is particularly damaging. As The Korea Herald points out, clarity and credibility are crucial — especially during periods of global economic volatility.

Longer-term optimism persists

Despite near-term volatility, some analysts retain a cautious optimism. Reuters highlights the broader structural advantages that continue to support South Korea’s appeal, including strength in semiconductors, artificial intelligence, autos, shipbuilding and biotech. Societe Generale analysts described the tax reform as “a win-some-lose-some event,” noting that while the short-term impact may be negative, the long-term outlook is not entirely bleak.

Manoj Jain of Maso Capital, quoted in Reuters, said he has noticed a more receptive attitude among Korean corporate boards toward shareholder feedback, a sign that the Value-Up initiative may still yield positive governance changes over time.

Ultimately, the Lee administration faces a fundamental challenge: how to balance fiscal discipline with capital market growth. While the need to address falling tax revenues is real, the approach taken so far risks destabilising the very markets it seeks to support.

As The Korea Herald argues, South Korea does not need hasty policy shifts that spook investors. It needs a cohesive and credible roadmap for reform — one that fosters growth, encourages investment and restores confidence in the government’s strategic direction.

If President Lee is serious about achieving his Kospi 5,000 target, the administration must not only listen to public and institutional feedback but also ensure that its tax agenda aligns with its economic goals. For now, investors are watching closely and warily.