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DPJ caught on the horns of a fiscal dilemma

by Kazuaki Nagata

While the Democratic Party of Japan-led government secured the passage of the ¥92.3 trillion fiscal 2010 budget this month, the party still faces a fiscal dilemma given its election pledge to realize ¥16.8 trillion worth of policy measures at a time when social security costs are ballooning.

Analysts are concerned how the DPJ will address the potential crisis, especially with attention focused on the economic debacle overwhelming Greece recently.

It will be difficult for the debt-ridden government to keep drafting massive budgets without drastically cutting extra spending, achieving economic growth or raising the consumption tax — all daunting, if not impossible, or politically suicidal, challenges for the DPJ, analysts say.

“Seeing the DPJ’s budget drafting process, fiscal discipline is weak,” said Toshihiro Ihori, an economics professor at the University of Tokyo.

“I thought the party would do more to cut spending.”

During last summer’s election campaign, the DPJ attacked the then ruling Liberal Democratic Party for what it called years of wasteful spending and the piling up of debt, and pledged to streamline the bureaucracy and save ¥9.1 trillion by curbing public-works budgets, civil servant payrolls and subsidies to quasigovernmental bodies.

But the fiscal 2010 budget compiled by the DPJ has amounted to ¥92.3 trillion, the highest-ever level, financed by the issuance of a record ¥44 trillion in new Japanese government bonds. At the same time, few cuts in spending have been achieved.

Yoshito Sengoku, minister in charge of the National Policy Unit, said the party plans to achieve the cuts in spending during the four years of the Lower House members’ term, not in fiscal 2010 alone.

Sengoku said the government had difficulty in drafting the budget because tax revenue fell dramatically amid the global economic slump to only ¥37 trillion, against the initial projection of ¥46 trillion.

Another major factor for the budget’s expansion is the DPJ’s campaign pledges, including a ¥26,000 monthly allowance for every child until graduation from junior high school, and an income indemnity for farmers.

For fiscal 2010, the DPJ set a child allowance of ¥13,000.

Due to the severe fiscal conditions, the party gave up or scaled down some of its campaign pledges, one of which was to eliminate the ¥2.5 trillion annual gasoline tax.

Prime Minister Yukio Hatoyama appears to be caught between piling up JGBs and delivering on the party’s campaign pledges.

Because the DPJ loudly trumpeted its promises while campaigning for last year’s general election, it is now difficult to renege on such generosity, including the allowances for child-rearing households and toll-free expressways.

Hatoyama has meanwhile indicated it may be impractical to deliver on every promise, particularly the full child allowance, if this further exacerbates the goal of reining in the issuance of government bonds.

Hisakazu Kato, a professor of economics at Meiji University and an expert on finance, said the DPJ must weigh the viability of its costly pledges against the limited financial resources available and the snowballing government debt.

The accumulated public debt is projected to exceed ¥862 trillion at the end of fiscal 2010, or about 180 percent of the country’s gross domestic product.

The ratio is by far the worst among developed countries and many analysts have even started warning the government could default in the future.

“It is hard to believe they drafted such a big budget when there is very limited tax revenues,” Kato said, adding the dependence on JGBs is too heavy.

The ¥92.3 trillion budget comprises ¥53 trillion in general spending, ¥17 trillion in revenue transfers to local governments and ¥20 trillion in payments for rapidly growing government bonds.

The ¥53 trillion for general spending is also a record high, and more than half — ¥27 trillion — is to cover ballooning social security costs as society ages.

According to the Health, Labor and Welfare Ministry, the social security budget is now projected to keep growing by ¥1 trillion every year, which experts say is one of the biggest threats for the nation’s fiscal sustainability.

In addition, social security expenses will grow even bigger if the DPJ distributes the full amount of child allowance in line with the party’s pledge to shift spending “from concrete to humans,” which it says means emphasizing social security-related budgets, rather than public-works construction.

This declared shift makes it unlikely the DPJ will drastically reduce social security spending, as the party has also stressed the importance of widening the social safety net, although analysts argue there is still much room for technical cuts in spending.

“There are many budget areas that can be cut. There are lots of hidden problems in the (budget) system,” said Kato, suggesting the basic pension for wealthy elderly people could be cut and monthly child allowances capped.

University of Tokyo professor Ihori noted the DPJ-led government has relaxed the criteria for welfare applicants.

‘I am not saying make the criteria stricter, but the government has to come up with a way to connect the system with self-reliant efforts,” Ihori said.

“The (social security) assistance indeed helps (people) in the short term, but what’s risky about welfare is that some people depend too much on it and get stuck,” he said. “If that happens, beneficiaries can lose motivation to work.”

Ihori added that spending cuts that increase the burden on ordinary citizens may be unavoidable, but a politician who sides with austerity measures may face a voter backlash.

“But it is the responsibility of politicians to make such cuts for the future. If they sweet-talk everyone and say they won’t be burdened, only the bureaucrats, there will be no financial resources,” Ihori said

Ihori said the civil servant payroll is considered another candidate for cuts. The payroll budget for central governmental officials is ¥5.1 trillion, and that for local governments officials comes to ¥21.7 trillion.

Ihori argued that personnel costs for public workers at local governments are still higher compared with the private sector.

If there is neither a consumption tax hike nor a drastic cut in spending, economic growth will be the only viable solution to improve fiscal conditions.

But many economists are pessimistic, given Japan’s sluggish growth rate in the past 10 years and the expected population shrinkage in the coming decades.

Kato warned that when social security costs increase, this has a negative impact on economic growth, and thus the budget for social security should be drafted more efficiently.

He also pointed out that the conventional stimulus package financed by massive government spending may not work in the current economy, as people are worried about ballooning public debt.

It might instead work better if the government raises the sales tax and maps out a firm fiscal reconstruction plan to wipe out consumer anxiety of the future, he said.

While the government will announce the midterm fiscal policy framework by the end of June, Cabinet members have shown more optimistic views on fiscal reconstruction. Finance Minister Naoto Kan advocated spending to stimulate the economy for a few more years.

But experts doubt the financial resources are available for such activity.

“Without a drastic cut in spending and a consumption tax hike, I wonder if the government can draft a budget for the next three years,” said Ihori.