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Fiscal ills not DPJ’s doing but it’s holding the bag

by Jun Hongo and Natsuko Fukue

Staff Writers

The tax and social security reform outline adopted by the Cabinet on Friday indicate the government has run out of options and must finally address welfare costs and public finances that have been spiralling out of control for years.

Many members of the ruling Democratic Party of Japan continue to demand that further budget-cutting efforts be made before the consumption tax is raised.

The party’s lawmakers fear the proposed hike is so unpopular among the public it could potentially result in the DPJ being booted out of power at the next general election.

But with Prime Minister Yoshihiko Noda refusing to yield over the reforms and determined to avert a looming fiscal crisis, the debate is no longer about whether or when the sales tax should be hiked — the focus has already shifted to just how high the rate will be set.

“We’re going to continue our efforts to cut public expenditures,” Ritsuo Hosokawa, who chairs the DPJ’s social security and tax reform panel, told The Japan Times earlier this week.

“But social security expenses are continuing to soar as society rapidly ages, and as the government for now can only cover the costs by racking up more debt, the system is creating a burden that will be passed down to future generations,” he said.

The government is proposing to raise the sales levy to 8 percent in April 2014 and to 10 percent in October 2015.

But Naoyuki Shinohara, deputy managing director of the International Monetary Fund, this month said the rate must be hiked to around 15 percent to enable Japan to find a way back from its current fiscal disarray.

Even that projection could turn out to be conservative, however.

The health ministry recently calculated that if the DPJ reforms the public pension system in line with its draft plan, which envisages a basic pension payout to increase benefits for low-income households, the rate would have to raised to a walloping 17.1 percent to cover the costs by 2075.

Even the government’s own estimates show the outline for tax system reform adopted Friday would raise nowhere near enough funds to restore the primary fiscal balances of the central and local governments by 2020 — a pledge Noda’s administration has made to the public and to Japan’s international allies.

If the sales levy is actually raised, government officials have already acknowledged that income and inheritance tax hikes may well be next in line.

At present, social security costs are ballooning by about ¥1 trillion a year as the population ages. And according to the government’s latest forecasts, such expenses will continue to expand rapidly in the future.

Given Japan’s disastrously low birthrate, the total population is expected to shrink 30 percent by 2060, while citizens aged 65 or above will comprise 40 percent of the populace, according to a population trend estimate released last month.

Sky-rocketing social security costs have also radically altered the structure of fiscal budgets and the allocation of funds among various competing areas, turning the restoration of Japan’s public finances into a hugely complex and intricate issue. This may explain why a succession of governments led by the Liberal Democratic Party avoided the issue like the plague for decades.

It is the DPJ’s misfortune that the point of no return was reached on its watch, just after the LDP’s almost uninterrupted postwar rule came to an abrupt end, and that its administration now finds itself having to sort out the country’s fiscal mess.

The structure of fiscal budgets now is radically different from those passed during the heyday of Japan’s postwar economic miracle.

Of the total ¥90.3 trillion proposed for the fiscal 2012 general account budget, some ¥26.3 trillion, or 29.2 percent, would be allocated for social security expenditures. By comparison, defense-related spending accounted for only 5.2 percent of the total, while 5.1 percent was set aside for public works projects.

Adding spending on social security to the ¥21.9 trillion that would be set aside for interest payments on government debt, the combined costs would drain about 53.5 percent of the total general account budget for the next fiscal year.

The government also plans to issue ¥2.6 trillion in special bonds in fiscal 2012 to cover pension benefits, meaning the mountain of public debt will grow even larger.

“In the 1960s, Japan’s social security focus was on providing jobs for the unemployed and protecting the livelihoods of those in need of assistance,” the National Tax Agency says on its website.

But since then, the focus has gradually moved to social insurance, including medical insurance and the pension system, and social welfare measures, such as caring for the elderly and nursing costs.

In its campaign for the 2009 Lower House election, the DPJ pledged to “rearrange the structure of the budget” and to take a butcher’s knife to bloated government budgets to free up additional funds. The then opposition party made no mention of raising taxes to cover welfare costs during its victorious campaign.

But despite the promises that propelled the party to power in 2009, the now ruling DPJ ultimately came to the realization that social security costs and interest payments have simply become unsustainable, and that raising taxes was the only option left.

Following the tax hikes included in Friday’s reform outline, perhaps the public could be forgiven if it is left feeling gypped by the DPJ, which promised so much during its 2009 campaign.

Some economic experts, however, said that increasing the sales levy is the best way to remedy Japan’s tattered public finances, though they conceded that the nature of the consumption tax is regressive and imposes heavier burdens on low-income households.

“Raising the income tax or corporate tax would mostly increase the burden on those employed, but raising the sales tax will spread the pain around various groups, including the elderly,” Jun Suzuki, an economist at Daiwa Institute of Research, said last week in Tokyo.

Data show that Japanese are currently taxed far less than people in many other countries.

According to statistics by the National Tax Agency, a household with an annual income of ¥5 million pays about ¥250,000 a year in income and residential taxes. An American family with the same level of income might pay somewhere in the equivalent of ¥455,000, while a British household might pay a staggering ¥830,000.

Other countries have raised their sales taxes to levels that seem exorbitant compared with Japan’s 5 percent levy. France’s current consumption tax stands at 19.6 percent, Italy has imposed a rate of 21 percent and the Greek public has been walloped with a near-extortionate 23 percent sales levy.

In Japan, raising the consumption tax by 1 percentage point would generate approximately ¥2.5 trillion in additional income, according to calculations.

When the rate is hiked by 5 percentage points in 2015, the government intends to use 1 percentage point of it to improve social security services. Its proposals include creating more places for children at day care centers, enhancing services to care for the elderly, and boosting pension benefits for low-income households.

The remaining 4 percentage points would be used to pay social security costs, to raise the government’s share of the basic pension system to 50 percent, and to pay costs related to the swelling ranks of the elderly.

Japan’s total debt compared with its total economic output has already topped 200 percent, easily the worst ratio among the Group of Eight major industrialized countries. It is even worse than in virtually bankrupt Greece, whose debt ratio is around 150 percent.

Prime Minister Noda’s priority now will be to persuade the LDP — the largest opposition party — to cooperate and join his government in drafting tax- and reform-related bills. The LDP had itself proposed raising the sales tax to 10 percent in the past, but so far has refused point blank to enter into talks with Noda on the reforms, refusing to debate the issue until he calls an election.

Noda also would require the opposition’s cooperation to pass through any legislation through the divided Diet, in which opposition parties control the Upper House and can block government-backed bills.