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As the government intensifies discussions toward compiling a fundamental tax reform blueprint next month, a new priority is emerging — using tax breaks as a tool to revitalize the economy.

The question is whether the final blueprint will really help revive the faltering economy. Tax measures currently being studied include both cuts and hikes, leaving the public to wonder how it all will eventually affect them.

Last week, the Council on Economic and Fiscal Policy, a key government panel headed by Prime Minister Junichiro Koizumi, outlined a tax reform package that would run from fiscal 2003 through fiscal 2006. It calls for reducing individual income tax and corporate tax rates.

To offset an expected tax revenue shortage resulting from the cuts, the outline also seeks to expand the individual income tax base by scaling down various tax deductions currently in place, such as spousal or other family exemptions.

“The proposed steps will do little to bolster the economy if overall tax burdens remain unchanged for most of the public,” said Masaru Takagi, an economics professor at Meiji University.

The ongoing debate illuminates a bureaucratic tug of war over the issue.

The council, with support from the Cabinet Office, seeks to revive the economy via quick tax cuts, while the Tax Commission, a government tax panel supported by the Finance Ministry, focuses on balancing tax breaks with hikes to avoid further depleting government coffers.

So far, Koizumi himself has asserted no leadership in directing the specifics of tax reform, and the discord within the government seems to be reflected in each tax item now under review.

Regarding the individual income tax, the economic council aims to lower rates for those with large incomes and build a system in which “hard workers are rewarded.” But the Tax Commission has maintained that rate cuts should be accompanied by tax base expansion.

Income tax rates are based on a progressive structure of four brackets ranging from 10 percent to 37 percent. The economic panel seeks to lower the top rate while moderating the jumps between the brackets.

Those subject to the 10 percent rate, or 80 percent of income tax payers, are unlikely to benefit from rate cuts, as both the Tax Commission and the Finance Ministry are reluctant to cut into that mainstay.

It is questionable, therefore, whether the proposed tax cuts for the rich can bolster overall consumer spending, as the negative impact of tax base expansion on the economy could be greater than the effect of the theoretical stimulus, said Susumu Takahashi, a chief economist at the Japan Research Institute.

Rather than benefit, those currently exempt from income taxes, or 25 percent of wage earners, will likely have to shoulder tax burdens as a result of tax base expansion.

Methods of broadening the tax base center on phasing out tax deductions and exemptions, such as a deduction for spouses earning less than a specified amount.

For a salaried worker who has a nonworking spouse and two children, for example, the income tax threshold currently stands at 3.84 million yen. Scaling down the spousal and other income tax deductions effectively means tax hikes for those just below the threshold.

Tax Commission head Hiromitsu Ishi has repeatedly said it is “unfair” that 25 percent of wage earners are currently exempt from the income tax and that they should shoulder their part of the tax burden under a principle of “breadth, lightness and simplicity.”

Also under scrutiny is a plan to unify inheritance and gift taxes with the aim of encouraging early transfers of wealth from the elderly to younger generations and boosting consumer spending, especially housing investment.

Due to various tax deductions and exemptions related to inheritance, only 5 percent of estates are subject to the inheritance tax. As a result, inherited assets worth tens of millions of the yen are usually tax-free.

In contrast, transfers of assets are taxed as gifts if older generations give their assets to their offspring while they are alive. The limit for tax-free transfers is just 1.1 million yen, prompting older generations to hold on to their assets until death.

Meanwhile, the ruling Liberal Democratic Party is proposing to change the gift tax scheme to benefit home buyers and promote housing demand. Under its proposal, the nontaxable limit for a financial gift would be raised from the current 5.5 million yen to 30 million yen when it is provided to help acquire homes.

But here again, Takahashi questioned whether the proposed steps can spur spending. “Even if the disparities between inheritance and gift taxes are drastically narrowed, there is no guarantee that younger generations will spend their money on homes.”

Indeed, many observers say changing inheritance and gift taxes would only cause asset transfers within the wealthy class, rather than redistributing wealth between classes.

While the ongoing tax reform discussion might lead to bitter revisions for many individual taxpayers, Takahashi said that businesses are likely to be the ones that benefit most.

The tax reform outline released by the economic council features tax incentives for businesses to spur investment in information technology and research and development in a bid to enhance their competitiveness.

Also proposed by the council is a reduction in the effective corporate tax rate — now at 40.87 percent — or the taxes that businesses actually pay to both the central and local governments.

The Finance Ministry, however, claims the current level is on par with other major industrialized nations, including the 40.75 percent in the United States. Tax Commission head Ishi has also ruled out such steps.

Given the discord within the government, Takagi of Meiji University questioned whether the government understands the urgent need to shore up the economy. “Now is the time to employ all available tax measures to squarely tackle Japan’s persisting deflation,” he said.

Fiscal policy minister Heizo Takenaka, who plays a central role in the economic council, has said the council will “take economic conditions into account,” hinting that some tax cuts might be front-loaded to be implemented in the current fiscal year to stimulate the economy.

Still, the fundamental question remains: How will the government finance the planned cuts?

Takenaka argues that tax cuts, in principle, should not be financed by additional bond issues and that the government should instead slash expenditures.

“Despite Takenaka’s pledge, drastic cuts in government expenditures would be unlikely,” Takagi said. “To fund tax relief, the government should issue government bonds beyond the 30 trillion yen cap for fiscal 2002.”

Bonds issued to finance part of the initial 2002 budget are already up against that ceiling.

Koizumi’s lack of leadership in designing the country’s macroeconomic vision could plow the entire debate into a quagmire, and supposed reforms could end up as superficial revisions, Takahashi argues.

“The private sector cannot make a move unless the government maps out the country’s future course,” Takahashi said. “What has kept the economy in a dismal state for so long is public anxiety about the future.”


Gist of tax proposals

The following is a summary of tax revisions being studied by the Council on Economic and Fiscal Policy for a fundamental tax reform blueprint due out next month.

The council proposes:

* Lowering individual income and corporate taxes.

* Introducing tax incentives for businesses to spur investment in information technology, and research and development.

* Consolidating and scaling down various tax deductions currently in place.

* Unifying the inheritance and gift taxes.

* Fostering greater fiscal independence for local governments by reviewing a system that reallocates national tax revenues.

* Carrying out the tax reforms from fiscal 2003 through fiscal 2006.

* Achieving a taxation principle of “breadth, lightness and simplicity.”

* Placing priority on economic revitalization.

* Accompanying tax reforms with a fundamental review of government spending.

* Relying less on additional government bonds as funds for tax relief, in principle.

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