Japan's ruling coalition OKs tax reforms amid public skepticism

The ruling coalition gave the green light to a tax reform package for the next fiscal year on Thursday that includes setting a cap on controversial income and residence tax cuts, while again remaining silent on the schedule for planned tax hikes to boost defense spending.

“Under the current political circumstances, it is difficult to make a decision (on the timing of the tax hikes) this year,” Yoichi Miyazawa, who chairs the Liberal Democratic Party’s tax panel, said earlier this week.

Up until last month, executives of the LDP tax panel had intended to set a time frame, but gave this up in the end, as a fresh political fundraising scandal is hitting the LDP hard and is dragging down Prime Minister Fumio Kishida’s administration, which had to replace four ministers on Thursday.

Last year, the LDP-Komeito coalition had also blurred the timeline by saying that the tax hike would start at “an appropriate time after 2024.”

Japan is looking to ratchet up defense spending to a total of ¥43 trillion over the five-year period between fiscal 2023 and fiscal 2027, from the previous five-year total of ¥27.4 trillion. The government will be cutting other areas of spending and using surplus money and nontax revenue, but it is still expected to fall short by ¥1 trillion. To cover the shortfall, hikes on corporate, income and tobacco taxes are expected.

As the ruling parties have failed to specify the timing again this year, the tax hikes will likely have to wait until 2026.

Income and residence tax breaks came also under the spotlight this year. The government came up with a plan to cut income and residence taxes worth a total of ¥40,000 per person, based on Kishida’s wish to “give back” increased tax revenue in recent years to taxpayers who are struggling amid rampant inflation.

The ruling parties hammered out the details and agreed to apply an income cap, excluding those who earn ¥20 million or more annually. The tax cuts are expected to be implemented in June next year.

But the tax breaks are widely seen as a pork barrel move by Kishida, with his Cabinet suffering from plummeting support rates in recent polls. According to a Kyodo News poll conducted last month, 62.5% of those surveyed said they do not support the income tax cut.

A number of economists are also skeptical about the likely effectiveness of the policy. While the government has explained the tax breaks as a measure against soaring prices, “people are worried that the pace of their wage increases won’t be able to keep up with the level of inflation for a prolonged period,” said Takahide Kiuchi, executive economist at Nomura Research Institute, in his report last month.

Thus, temporary tax cuts would not really be helpful and any additional funds will likely just end up in savings, Kiuchi said.

In addition, many of those who may benefit from the cuts are concerned their impact will be outweighed by the planned tax hikes to boost spending on some of the Kishida administration’s critical policies, such as defense and child care, in the coming years.

Thursday’s tax reform package by the ruling coalition also covers a wide range of tax items, including creating new systems to facilitate investment and supporting companies keen to raise wages, as well as assuaging the impact of higher prices.

One part of the new tax plan is designed to offer decadelong tax breaks for companies that produce or sell products that are key for economic security and decarbonization, such as electric vehicles and semiconductors. For instance, it will offer a ¥400,000 tax benefit for each EV firms produce.

Also, to accelerate momentum for wage hikes, small and midsized companies that increase wages will be able to receive a tax break set at maximum 45% of the value of the wage increases compared to the current level of 40%. For large companies that introduce wage hikes of 7% or more, the maximum tax break rate will be hoisted to 35% from the current 30%.

With inflation pushing up costs for business people who socialize with clients and partners, the package also proposes to double the tax-free deductible amount for entertainment expenses to ¥10,000 per person.