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Cutting corporate taxes best course for Japan

by Yoshio Nakamura

The government’s 2006 basic policy on economic and fiscal management and structural reforms, approved by the Cabinet on July 7, established two national pillars of economic policy for the coming decade — the pursuit of growth in a shrinking population, and the rebuilding of state finances to reinforce the nation’s fiscal sustainability.

To return to fiscal health, it is imperative for both the national and local governments to maximize efficiency and pare expenses. Also, more efforts at revenue reform will be needed to achieve the state’s goal of a “primary balance,” where expenditures excluding interest payments and debt redemption can be covered by revenues — excluding bonds — by 2011.

But it would not be a good idea to resort to tax hikes to secure more revenue.

Nations with companies that compete against Japanese firms on a global basis usually provide favorable corporate tax rates to give them a competitive edge. What would happen if Japan raised corporate taxes? Tax hikes may produce temporary revenue boosts, but they can also cause longer-term damage by cooling off the nation’s economic engine, which is just warming up.

According to an outline of government revenues and expenditures for fiscal 2005, corporate tax revenue marked its third year-on-year increase in a row, while income tax and consumption revenues also posted sharp gains. Overall, tax revenue exceeded the initial budget by as much as 5 trillion yen — due chiefly to the economic recovery. This proves tax cuts stimulate the economy and subsequently lead to more tax revenues. In fact, tax incentives for research and development, as well as information technology investment — both of which were beefed up in the fiscal 2003 tax reforms — contributed a great deal to energizing the economy.

Tax deductions to promote R&D — the root of innovation — are important as Japan aims to become an even more advanced science and technology-oriented nation. One estimate shows that the R&D tax measure adopted in fiscal 2003 would push up Japan’s gross domestic product by 3.4 trillion yen within three years of implementation.

Aggressive IT investment is also key if Japanese firms are to prevail over fierce international competition, and tax incentives for such investment create strong economic effects.

To fundamentally revamp the international competitiveness of Japanese firms, corporate tax rates need to be lowered. This should not be considered a self-centered request from the corporate sector. Reducing the tax burden on companies will have a far-reaching positive effect on the economy.

Tax cuts lead to greater cash flow, which would allow companies to distribute more income to shareholders and employees, increasing consumer spending.

In its efforts to regain fiscal health and build a sustainable social security system, the government, aided by the ongoing slashing of expenditures, should pursue a natural gain in tax revenue via economic growth. This should start with corporate tax cuts to make firms globally competitive.