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Zero-rate bonds must be studied but ‘invoice system’ shows promise

by Teruhiko Mano

F inance ministers and central bankers from the Group of Seven top economies wrapped up two days of talks last month with the recognition that the global economy will continue to deteriorate this year, and urged governments to act in concert to stabilize their finance sectors and inject stimulus to boost demand.

The joint statement also urged all economies to avoid engaging in protectionism.

Japan has little room to take monetary steps because it has already lowered interest rates to nearly zero. Expectations for fiscal stimulus therefore lie with the government.

But the question is: How do you finance such grandiose public expenditures?

Japan’s outstanding public debt has topped ¥1.8 quadrillion and the rapid decline in corporate earnings is sharply reducing tax revenue. In municipalities, the situation is becoming particularly serious in places heavily reliant on export-oriented companies. The city of Toyota, Aichi Prefecture, where the headquarters of Toyota Motor Corp. is located, says that local corporate tax income for fiscal 2008 is projected to drop 96 percent from the previous year.

One idea that has surfaced as a financing source is zero-interest bonds exempt from inheritance tax. Although the bonds would not accrue interest, they wouldn’t be subject to taxation either if inherited by the owners’ offspring. This has raised hopes in both the ruling and opposition camps that a viable source of funding is available.

But the idea has some apparent drawbacks.

First of all, we would have to assume that, in most cases, those who buy the new bonds won’t be tapping money kept in closets and gardens but that already invested in stocks, ordinary government bonds and foreign bonds.

To buy the new bonds, investors will first have to sell off the bonds and shares they currently own, which could put further downward pressure on share prices already battered by the collapse in corporate earnings.

Since the United States and other countries plan to issue massive amounts of government bonds, long-term interest rates have already turned upward. In some countries, government bonds are being issued with higher yields than obtainable from corporate debt. This raises the prospect of the AA sovereign debt rating assigned to Japanese government bonds, which amount to more than three times the size of the GDP, being downgraded further.

And because the minimum amount of assets required to trigger the inheritance tax is in the hundreds of millions of yen, those who would benefit from the new bonds are in all likelihood already rich.

How can politicians — especially those in the opposition who normally lash out against the rich-poor gap in this country — air this proposal to voters ahead of a crucial election? We have to remember that this measure will cut tax revenues in the not-too-distant future as the population continues to rapidly age.

Another possible source of funding for fiscal stimulus is the consumption tax hike advocated by Prime Minister Taro Aso’s Cabinet. While predicated on the condition that economic conditions improve, Aso has come under fire — not only from the opposition camp but also within the ruling bloc — for failing to explain why a tax hike must be debated at a time when a general election is set to be held within months.

Critics argue that wasteful government spending must be eliminated first. But what is also regrettable is that, despite the abundance of debate on the consumption tax rate, nobody is focusing on the way we collect the levy.

The introduction of an “invoice system” like that used in the U.S. and European economies would serve as a deterrent against certain types of fraud, such as label tampering and food-safety violations.

For example, lack of documentation allowed a rice-flour processor that bought 570 tons of tainted Chinese rice to resell part of it for human consumption to a rice retailer via several intermediaries. Similarly, labels denoting eel as imported were altered to describe them as “domestic” after the products went through a series of resales.

If the entities involved in these transactions were forced to pay consumption tax at each phase of the deal, an invoice system would allow authorities to determine how the problem originated and serve as a deterrent against fraudulent transactions.

Falsifying food labels can be a matter of life and death, and changing the way the consumption tax is collected can help deter such fraud. When the consumption tax started in 1989, the government decided not to use an invoice system because it wanted to minimize costs for small and medium-size businesses.

What is odd, however, is that the tax money taken from the consumers doesn’t go automatically into the state coffers, despite advances in information technology over the past two decades that have made high-performance computers available at much lower costs.

The author sincerely hopes that, as the public debates whether to hike the sales tax, it will also remember to discuss the idea of launching an invoice system as well.

Teruhiko Mano is a professor at Seigakuin University Graduate School.