How to push reform forward

by Shinji Fukukawa

Prime Minister Yoshihiko Noda has stated he would stake his political life on realizing integrated reform of the tax and social security systems. Japan’s financial structure is worse than those of other advanced countries and even that of Greece, which was responsible for the euro crisis. Therefore it is in dire need of reform.

Although the share of foreigner-held Japanese government bonds has long stayed relatively stable at about 5 percent, it is now on an upward trend. It is feared that should the Noda Cabinet fail to accomplish its proposed reform due to objections from inside and outside the ruling party, speculative investors may trigger a “sell-off” rush, causing the national bonds market to tumble.

The ruling Democratic Party of Japan has decided that the consumption tax rate, now 5 percent, should be raised to 8 percent in April 2014, and to 10 percent in October 2015. It plans to submit related bills in the current Diet session. But the DPJ move will probably cause a fierce parliamentary confrontation between the ruling and opposition parties. Should Diet business bog down and lead to dissolution of the Lower House, the nation’s political situation might drift into an unpredictably serious outcome.

The late Prime Minister Masayoshi Ohira, whom Noda admires greatly, attempted to introduce a general concise tax, saying that a politician must sometimes fight to carry out a crucial policy “even if it is unpopular with people.” His attempt faltered amid objections from both inside and outside the governing party. The late Prime Minister Noboru Takeshita, who introduced the consumption tax, was compelled to step down after it was enacted. Former Prime Minister Morihiro Hosokawa plotted to create a people’s welfare tax but gave up in the face of strong opposition from the ruling and opposition parties. The late Prime Minister Ryutaro Hashimoto, who raised the 3 percent consumption tax to 5 percent, suffered a major setback in the ensuing Upper House election and was forced to resign as a result. Past experiences have taught us that it is absolutely necessary to address the tax hike issue through careful preparations.

Such preparations must include the following: First, it is necessary to build a political environment in which politicians can obtain the public’s trust. Although its approval rating is better than that of the previous Hatoyama and Kan Cabinets, the Noda Cabinet is sowing seeds of distrust among the public due to its inability to devise and enact appropriate policies.

There are also complaints that there are too many Diet members. In an attempt to rectify the disparity in the value of a vote, the DPJ has decided to reduce the number of Lower House seats allotted to single-seat constituencies by five (one each in five prefectures) and slash by 80 the number of seats for proportional representation. But it is uncertain if the public will find this plan acceptable. There also prevail strong opinions calling for a reduction in government subsidies for political parties and a cut in Diet members’ pay. Unless politicians display modesty and a willingness to sacrifice on their part, it will be difficult to win public support for the tax hike proposal.

Second, there is a need to trim wasteful administrative costs. The government on Jan. 19 decided to reorganize 102 independent administrative agencies into 65 agencies and 17 special budget accounts into 11 accounts. But it must show how much spending such steps will save. Cutting pay for national public servants and selling housing facilities for government workers may be good policy measures. But the government must return to basic principles and work out a reform vision that meets the requirements of the times results in the creation of a “smart government.”

The Board of Audit recently pointed out that surplus funds amounting to ¥1.8 trillion remained unused in special account budgets for fiscal 2009. The prevailing public view is that the DPJ administration is adhering to a policy of scattering money around in accordance with its election manifesto in order to gain popularity. Therefore, if the government is unable to drastically reduce its administrative spending, it will find it difficult to win public support for its tax hike proposal.

Third, the government should clearly explain how it plans to use revenue from the proposed tax increase. In view of mounting public distrust of its financial policy, the government will face difficulty in convincing the public to accept its tax increase plan unless it makes clear that it will devote revenue from the tax hike to social security measures.

The speed at which Japan’s population is graying and shrinking is among the fastest in the world, making it impossible to maintain current pensions and medical service systems. While it is correct in principle for the government to promote reform of the tax and social security systems in an integrated manner, the content of reform remains the problem. Although it is unavoidable to reduce the level of pension benefits and to increase individuals’ financial burdens for social welfare services, it is essential that the government forge an overall direction on how to secure inter-generational fairness and rationality regarding tax increases and pension system reforms.

Fourth, appropriate corrective measures must be taken concerning the regressive nature of the planned tax raise. The consumption tax places a larger financial burden in relative terms on low-income people than on those in higher income brackets. European countries have devised ways to address this problem, including tax exemption of daily necessities and fund payments to low-income people.

Fifth, careful consideration should be given to economic trends. The European currency crisis is likely to cause a global credit contraction and a protracted depression. This will throw the Japanese economy into a severe situation. Generally speaking, the introduction of a consumption tax serves to decrease effective demand and push the economy downward. So it is essential that the timing of the consumption tax increase be carefully considered.

During times of business downturns, a tax increase must be coupled with business boosting measures. For example, with the aim of rectifying the gap between direct and indirect taxes, the government should consider combining the consumption tax increase with cuts in direct taxes as well as the introduction of a tax to help enhance technological development, a reduction of corporate taxes and the creation of special economic zones.

This year the Japanese political world stands at a critical point in the effort to pave the way for national revival. The Liberal Democratic Party and other opposition parties should present their own constructive proposals from the viewpoint of promoting national interests. The success or failure of the integrated tax and social security reforms will depend on whether politicians can present a reasonable choice of policy measures and secure the public’s trust, support and cooperation.

Shinji Fukukawa, formerly vice minister of the Ministry of International Trade and Industry (now the Ministry of Economy, Trade and Industry) and president of Dentsu Research Institute, is currently chairman of the Machine Industry Memorial Foundation.