Economists question short-term benefits of proposed tax cuts

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The bleak economic climate inspired by the government’s recent pledges to clean up the nation’s bad-loan problems has driven bureaucrats and politicians in search of tax measures to stimulate the economy.

Economists are skeptical, however, as to whether tax cuts will be effective.

Last week, two government advisory panels separately agreed to alleviate the tax burden on companies that invest in plants and equipment, as well as in research and development. This strategy is aimed at stimulating corporate spending.

These proposed tax cuts will probably be incorporated into a series of tax-cutting measures planned for the next fiscal year.

Prime Minister Junichiro Koizumi hopes to implement tax cuts of more than 1 trillion yen in fiscal 2003, although it is unclear how far beyond 1 trillion yen these cuts may go.

Amid a deteriorating economic outlook, tax-cutting measures are increasingly being viewed as a means of revitalizing the ailing economy.

As well as breaks for companies, politicians and bureaucrats are examining other tax-related steps aimed at easing the pain of bankruptcies and unemployment expected to result from the anticipated drive to accelerate bad-loan disposals.

Measures under discussion include slashing the tax burden on land transactions, simplifying tax procedures for stock investments and cutting the inheritance tax.

But many economists question whether these steps can really stimulate the economy in the short term.

“There might be some effects to stimulate the economy, if not nil. But it would be difficult to expect any considerable (positive) impact (on the economy),” said Keisuke Naito, senior economist at the Mizuho Research Institute, in reference to the proposed tax breaks for companies.

According to Naito, although tax cuts related to corporate investment and R&D would be better tools with which to stimulate corporate spending than actually lowering the corporate tax, business owners will still hesitate to invest in facilities and equipment given the current economic stagnation.

“Corporate owners will purchase new equipment when they think the new investment can increase their sales, not because of the change in the tax system. Demand is so weak right now,” Naito said.

The tax debate is likely to continue toward the end of the year, when the ruling coalition — spearheaded by the powerful tax council of the Liberal Democratic Party — finalizes a tax reform policy and the government finally compiles a budget for fiscal 2003.

According to some economists, the government’s fiscal constraints will make it difficult to jump-start the economy via taxation measures.

This is due to the limited size of the tax cuts, along with the accompanying tax hikes that are expected in later years.

“To stir demand with tax, a hefty (tax cut) is needed,” said Kenji Yumoto, chief senior economist at the Japan Research Institute. “Even if a considerable tax cut of this kind is implemented, its effect would be only temporary.”

Yumoto pointed out that the size of the latest proposed tax reduction is well below the 9.4 trillion yen cut in the late 1990s, adding that the effects of even a major tax cut were only temporary.

Moreover, the effects of the proposed cut would be diluted as taxpayers would be aware of ensuing tax hikes, he said, referring to a government plan along these lines.

Yumoto said that the government should adopt a more flexible approach toward taxation policies to achieve economic stimulus effects.

It could, for example, focus tax cuts related to land transactions on those conducted within special economic zones, rather than reduce taxes in this category on a nationwide basis, he said.

The government should also consider a long-term tax strategy aimed encouraging individual investors to make long-term stock investments, Yumoto said.

Meanwhile, Naito voiced concern over the possibility that the changing economic climate has pushed the tax reform agenda away from the original goal of making the country’s fiscal system sustainable.

The tax reform plan for fiscal 2003 was initially designed as the first step of a four-year overhaul, led by Koizumi, of the country’s tax system.

“Later it was turned into revitalizing the economy,” Naito said. “In October, the fall in stock prices has narrowed the focus (of tax reform) to tax cuts. Restoring fiscal health appears to be growing distant.”