An interim report compiled Oct. 24 by the Liberal Democratic Party’s study group on fiscal reform has drawn public interest as an indicator of the future direction of fiscal policy b the ruling party and the government.
Media attention on the report tended to focus on the likely increase in the consumption tax rate, giving an impression to the public that the LDP’s priority is on a tax hike. However, there was much more to that report.
While making it clear that the current structure of government spending is unsustainable, the LDP panel proposed that an increase in social security costs be kept to the minimum and local government expenditures be streamlined. It also cited methods used by other industrialized countries for fiscal reform, such as setting macroeconomic targets and stringent rules on government spending.
On the revenue front, the report emphasized that the government must not rely solely on revenue increases but on spending cuts, and that the basic policy should be — as Prime Minister Junichiro Koizumi has said on more than one occasion — that there will be no tax hikes without spending cuts.
At the same time, the report acknowledges that given the rapid aging of Japan’s population, even all-out reforms will not stop an increase in social security costs, which then will have to be covered by converting the consumption tax into a welfare tax.
As I have just mentioned, the report did not simply call for tax increases. We highly evaluate the report because it is a comprehensive set of proposals based on the implementation of every possible means of cutting government expenditures. It is noteworthy that the report clearly called for using the consumption tax as a source of revenue to cover shortages that may still remain after maximum efforts to cut spending.
True, it is generally said that securing a stable source of revenue for specific programs could lead to greater pressures for increased spending. However, it is appropriate to specify the consumption tax as a main pillar of measures to increase revenue.
The report explained that by using the consumption tax, people will equally share the burden of increased welfare costs. We also support the use of the consumption tax because negative impacts on the nation’s macroeconomic performance would be kept to a minimum.
Earlier, Keidanren analyzed the data of other industrialized nations to examine the effects that tax policies can have on economic growth. The result showed that a consumption tax hike may cause a temporary decline in growth rates, but will not harm a nation’s growth over the long term. On the other hand, the analysis shows, hikes in income tax and corporate tax will have more than a little negative impact on the country’s long-term growth.
Higher growth means greater tax revenue, and consequently any increase in tax rates can be minimized. Such considerations will be important when policymakers design a nation’s tax system.
We hope that Prime Minister Koizumi, with his new Cabinet launched on Oct. 31, will realize the LDP’s fiscal reform proposals as a key item on his reform agenda.
The ruling party and the government should similarly keep in mind considerations for strengthening the economy as they discuss tax reforms for fiscal 2006 in coming weeks. Discontinuation of various current tax deduction measures will likely be on the agenda, but we believe that tax measures to promote research and development as well as information technology investments — steps that would reinvigorate the economy — should be extended beyond their original deadlines or even expanded.
Steady efforts to increase tax revenue are indeed necessary, but they could result in reducing tax revenue if economic growth is derailed by such measures.