Tread carefully on corporate tax cut

Prime Minister Shinzo Abe is considering cuts to corporate taxes as a key feature of his growth strategy. While few would object to the idea of making Japanese businesses more competitive and the nation more attractive as a destination of foreign investments, the effectiveness of corporate tax cuts as a means to achieve these goals needs to be carefully weighed against the impact on the nation’s already strained fiscal health. It also must be ensured that cuts to taxes on businesses do not come at the expense of the household sector, which is bearing the brunt of the April 1 consumption tax hike and rising prices.

In the speech he gave at the World Economic Forum held in Davos, Switzerland, in January, Abe pledged that Japan would launch further corporate tax reform this year, saying that the nation’s tax system for companies needs to be made “internationally competitive.”

The government’s tax commission is discussing specific ways for the cuts and possible substitute sources of revenue, and the Abe administration is hoping to include plans for the cuts in fiscal 2015 in a policy package to be released in June.

As concerns grow that the economic recovery under Abe’s watch is losing steam and could be derailed by the anticipated slump in consumer spending following the consumption tax hike this month, the prime minister apparently hopes to make sharp cuts to corporate tax a major feature of his strategy to help accelerate growth of the Japanese economy — which has so far been widely seen as disappointing for its lack of concrete and effective steps.

Proponents argue that Japan’s effective rate of corporate taxes — combining national and local taxation — of around 35 percent is too high and should be lowered to the levels close to the rate of around 25 percent in other Asian economies like China and South Korea.

The question is how to finance such cuts and whether the tax cuts would make Japanese businesses more competitive in ways that would benefit the whole economy.

It is estimated that a one-percentage-point cut in the corporate tax would create a revenue hole of about ¥470 billion. If a 10 percentage point cut is to be introduced without affecting the fiscal balance, substitute sources of revenue to the tune of ¥5 trillion will be needed.

Japan’s fiscal health is in a critical condition, with public debts topping ¥1,000 trillion — more than double the nation’s gross domestic product. The government needs to find other sources of revenue if it plans to cut the corporate tax. But it must find them in areas that would not directly affect households, which are already shouldering an additional burden due to the consumption tax hike — which will grow even heavier if it rises to 10 percent as scheduled in October 2015.

One potential source may be found by reviewing various special tax cuts on companies designed to spur research and investments, which amount to roughly ¥900 billion in fiscal 2014. These tax cuts should be constantly reviewed for their effectiveness as policy tools because some of them are said to have become vested interests for certain industries — and for some lawmakers backed by these business sectors.

Also subject to review should be the system that allows companies to deduct from their annual profits the losses incurred in previous business terms, effectively lowering their taxable income. These and other tax benefits on companies all combined are estimated to have reached ¥4.5 trillion in fiscal 2011, compared with the government’s corporate tax revenue of ¥8.7 trillion.

In its economic policies, the Abe administration has put priority on improving the conditions of businesses on the grounds that better corporate earnings would benefit workers and result in more robust consumer spending. The administration ended a year ahead of schedule a surcharge on the corporate tax introduced in 2012 to help finance reconstruction of areas hit by the Great East Japan Earthquake and expanded tax benefits for companies that raise wages for their employees.

Some of Japan’s leading firms that benefited from the yen’s steep fall against the dollar under Abe’s watch have indeed rewarded their workers with the highest wage raises in years. And the economy will benefit if, as some say, cuts to the corporate tax indeed stimulate more business activities and boost corporate earnings, resulting in higher tax revenues.

But it must also be noted that under the current mechanism, which does not tax loss-making firms, only about 30 percent of Japanese companies are in fact paying the corporate tax. And many of these tax-paying, profit-making large firms have for years accumulated internal reserves, which are estimated to total more than ¥200 trillion.

It needs to be carefully examined whether and how a cut in the corporate tax would benefit the whole economy.

  • Norm Stansfield

    Tax cuts don’t need to be offset by “additional revenue”. They can be offset by cutting spending too. Or, if they end up leading to economic growth, they don’t need to be offset at all, because economic growth means additional revenue.

    After the tax cuts in the US, during the Bush admin, for instance, revenue ended up exceeding that of the year before the tax cut within a couple of years.

    Of course, Bush ended up blowing that revenue (and more, in fact) on various spending programs (and a war, too, but, contrary to popular belief, most of it was spent on social programs). It would be helpful if Abe managed to avoid that.

    • Demosthenes

      Couldn’t agree with you more. The Gipper also cut taxes and the economy went like a locomotive within a year or two – though he had trouble rolling back the size of the government and, of course, military spending…

  • http://getironic.blogspot.com/ getironic

    Tax only became an issue because spending became an issue. Without these “hand in everything” programs, the tax rate would be a minor issue.

    Please observe that the portrayed solution to this problem is always some kind of maneuvering: floating a bond, manipulating the currency, further taxing the productive. Meanwhile the same-old, par-for-the-course governance continues to expand, with more public services, initiatives, regulations, and programs, requiring yet more maneuvering.

    A modern buzzword for all kinds of social justice types is “sustainability”, but the statist form of governance is the real unsustainability. Agonizing over what a 1 point deduction in the
    corporate tax rate would supposedly result in is not where anyone’s
    focus should be. Where the focus should be is on why we are in the
    situation where some believe it necessary to agonize over it.

  • http://www.sheldonthinks.com/ Andrew Sheldon

    I would be willing to bet that there will be a future increase in property taxes, and that local govt will bare the greater fiscal responsibility.

  • http://www.sheldonthinks.com/ Andrew Sheldon

    I couldn’t disagree more. I think Abe is doing more than anyone else. You can say that he’s beating bushes’ but ideas & policy are a precursor to ‘execution’. He’s talking constitutional reform, immigration, which means population increase. Raising GST 3%, corporate tax cuts, and I’d expect an increase in property taxes as well. What about the opening up of trade with tariff cuts. I can concede that more could be done on education.