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With the government unable to find further effective ways to cut expenditures, Prime Minister Junichiro Koizumi’s goal of reconstructing government finances is facing a crucial test.

Observers say Koizumi might eventually have to increase the consumption tax for the sake of restoring sound public finances.

On Aug. 26, Koizumi reportedly told Finance Minister Sadakazu Tanigaki, “You should take one step forward and bear the brunt of criticism.”

The prime minister apparently meant Tanigaki should take the initiative in breaking the impasse over the fiscal and tax reform plan that Koizumi put forward as a fiscal reconstruction measure.

The reform consists of cuts of up to 4 trillion yen in subsidies by fiscal 2006 from the central government to local-level authorities, keeping tax grants to local authorities at fiscal 1990-91 levels, and a transfer of taxation authority to local governments from the state.

Koizumi feels pressed to carry out the reforms because he has no options left to cut government expenditure in short order.

The government has curtailed public works-related expenditure for the past several years and has almost achieved its reduction target.

For example, the budget for public investment in fiscal 2005, which begins next April, is expected to drop to the same level as in fiscal 1999.

Core policy-related outlays, excluding those for public works projects, have been slashed by 2 percent every year.

This sharp cutback has raised complaints from lawmakers in the Liberal Democratic Party.

“LDP policy research divisions, not consultative organs, actually reflect the people’s voices in the policymaking process,” argued a member of the LDP land, infrastructure and transport division, expressing dissatisfaction with the way structural reforms are being carried out by the Council on Economic and Fiscal Policy, a blue-ribbon advisory body to the prime minister.

LDP legislators attribute the decline in their regional vote-gathering power, as demonstrated in July’s Upper House election, to the sharp cuts in public works-related expenditures over the last few years.

Finance Ministry officials are still haunted by memories of how in the late 1990s the administration of then Prime Minister Ryutaro Hashimoto derailed a budding economic recovery by adopting an austere fiscal policy, a senior ministry official said.

Ministry officials are now divided into those who support fiscal reconstruction and those who question the wisdom of further spending cuts.

However, in view of the dire situation of Japan’s public finances, with the combined debts of the state and local governments exceeding 700 trillion yen, fiscal reconstruction remains an urgent challenge for the government.

It is for this reason that Koizumi wants to push ahead with the three-pronged reform drive, not only in the central government but also in local-level public finances under the goal of decentralizing power.

But with prospects for reform clouded — partly due to wrangling among government ministries — calls have mounted for measures aimed at increasing revenue.

“The fiscal 2005 budget is expected to mark the turning point in government fiscal policy, shifting from cutting expenditure to increasing tax revenue,” a ranking ministry official said.

The extension of this argument inevitably leads to an increase in the consumption tax.

Chief Cabinet Secretary Hiroyuki Hosoda has already cited the need to raise the levy, which Koizumi has promised will not happen while he is in office.

With any tax-increase plan certain to become a controversial issue that might shake the government’s political footing, the state’s fiscal reconstruction efforts have taken a new turn burdened with “a time bomb” in the form of a consumption tax increase.

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